The Overnight Report: Holding Steady

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By Greg Peel

The Dow closed down 16 points or 0.2% while the S&P did the opposite and rose 0.2% to 895. The Nasdaq was little changed.

The Dow was down over 50 points earlier in the session as the wake-up call on green shoots continued on from yesterday. It was announced May existing home sales rose 2.4% but that was not as much as economists had assumed. A nervous market responded accordingly.

The truth is the rise represented the first back-to-back monthly increase in three years. This little statistic and the response to it are a clear example of why this market had simply become too wound up. One must remember that “green shoots” have almost only been about a slowing in economic contraction, not a sudden about-face into raging expansion. Investors had nevertheless begun to assume we were simply going straight back up to the 2007 highs. This would require the US housing market to bounce accordingly.

But the US housing market is not bouncing – it is simply showing signs of stabilisation. That should be good news, but too many players have decided they now expect great news. Hence we have been correcting. The correction has come in small bursts to date, given there appears to be enough buying below the level to prevent any major and sustained collapse. At least so far.

There were similar signs of stabilisation in Europe overnight, with the EU purchasing manager’s index posting a small rise from 44.0 to 44.4. The figure below 50 still implies contraction, but again the pace is slowing. This true “green shoot”, rather than burst of flowers and fruit, followed on from Monday’s announcement of a 7-month high in German business confidence, which rather got lost in the wash of a disappointing World Bank revision.

The US dollar fell overnight, on a stronger euro, a halt in yesterday’s sudden risk aversion, and anticipation the Fed might announce a step-up in quantitative easing after its FOMC meeting tonight. The index dropped nearly a full point to 79.86. This allowed commodities to recover from yesterday’s falls, albeit with little gusto.

Oil jumped 2.5% or $1.74 to US$69.24/bbl. Zinc rose 3% while the rest of the spectrum managed 1-2% gains. Gold added US$4.40 to US$925.80/oz while the Aussie jumped back 0.8 of a cent to US$0.7939.

This allowed the materials sector – much beaten down yesterday – to post a reasonable recovery. Rio Tinto ((RIO)) shares, for example, were up 4% in New York trade. The banks also made a come-back after their big falls, but keeping a dampener on the mood was news that Boeing’s new 787 Dreamliner had yet again been delayed, sending airline stocks lower.

The morning session thus ended with the Dow about square but nervousness unsurprisingly surrounded the afternoon auction of US$40bn of 2-year Treasury notes. This week sees the largest total offering of US government debt in history as part of the US$2.5-3 trillion the government needs to raise by September.

Fears were unfounded as the auction was oversubscribed by more than three times at a settlement of 1.15% yield. However, these are short bonds, not long bonds, which are more adversely affected by inflation. Two weeks ago the same issue was twice oversubscribed, setting off panic selling of 10-year bonds and a big drop in the Dow. The reason for the panic was more than 40% of the issue went to foreign central banks and sovereign wealth funds, implying the rest of the world might only be prepared to take a short term bet on lending the US money, and not a long term one.

This time, nearly 70% went offshore. Yet this time, the 10-year yield dropped 6bps to 3.62% instead of leaping about 25bps (to 4.00%) as it did two weeks ago, and the Dow was steady. Since last time we have had PPI/CPI numbers which have indicated the US is still in disinflation, and since last time longer bond auctions have been safely dispatched. Throw in the World Bank’s dour report and all up, inflation fears have been assuaged for now.

Tonight its 5-years and on Thursday it’s 7-years. The 5-year is still considered a short bond and the 7-year somewhere in between. It’s 10s out to 30s that are considered “long”. It will nevertheless be interesting to see whether these medium maturities are as well received as the 2-years.

The SPI Overnight fell 15 points or 0.4%, quite a weak response against an S&P 500 gain of 0.2%.

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