FYI | Jun 08 2007
By Greg Peel
What is it about 5%?
As this column had noted, Wall Street had recently been trading as if on financial ecstasy as a general exuberance resulted in record-breaking days despite whatever implications economic data may have brought. Well it looks like the party’s over and the teeth grinding has begun.
Wall Street had been taking news of renewed economic strength as a positive, particularly as M&A deals continued apace. But at the same time it was in an Egyptian river with regards to persistent Fed warnings on inflation. Somehow there was still a glimmer of hope that there might be a rate cut, particularly as everyone other than the Fed was calling for ongoing economic weakness. This false hope would only finally disintegrate if US bonds, which have been ticking up and up in yield, were to pass the magical 5% level. Why this is magical is unclear, but that’s how it works with round numbers.
US bonds yields finished at 5.1% last night – up 2.6%. That was enough to tip a now wobbly Dow over the edge, and a 198 point or 1.5% drop ensued. The S&P 500 and Nasdaq faired worse, each falling by 1.8%.
There is a general fear now that global interest rates are going higher, driven by inflationary forces on the cost line. Persistently high commodity prices and wage price creep had to take their toll eventually. The ECB raised rates on Wednesday, China has raised rates, the Fed looks like it might raise rates, the RBA looks like it might raise rates, and New Zealand did – to 8%. The UK bucked the trend and left rates unchanged last night, although traders are unconvinced and the FTSE still slipped slightly. Germany seems quite in panic mode, with a 1.4% fall in the DAX following a 2.4% fall on Wednesday.
The real fear is that Japan will raise rates, and despite continuing economic sluggishness this is what economists are expecting. Although recipients of the yen carry trade such as New Zealand are rising, a rate rise in Japan will make yen carry traders very uneasy. Higher interest rates across the globe also imply lower returns on risky assets, and risk spreads have been at worryingly low levels. Suddenly the world doesn’t look so much like an oyster anymore.
Despite implications of higher inflation, a higher US bond rate is not good news for gold, which provides no return. The euro corrected sharply against the US dollar last night, dropping as far as US$1.3422 from US$1.3504. This set gold into retreat, falling US$11.40 or 1% to US$658.70/oz. Silver also suffered, falling 2%.
A rise in the US dollar is similarly not a good sign for base metals, although it was only superstar nickel that took the major hit, falling 5.6%. Only crude oil bucked the trend, rising nearly US$1 to US$66.93/bbl for July delivery – again not a good sign inflation wise.
The US is poised to learn just how bad the April trade balance might be tonight. Locally, we find out about April housing finance as economists begin to call a rate rise as early as next month. Yesterday’s performance by the local bourse was surprisingly strong, but as to whether that can be repeated today is another matter. The SPI Overnight was down 91 points. Morgan Stanley’s triple-signal call must be ringing in a few ears by now.
