Daily Market Reports | Sep 17 2009
By Greg Peel
The Dow closed up 108 points or 1.1% while the S&P smashed through technical resistance at 1060 to 1068 for a 1.5% gain. The Nasdaq added 1.4%.
In a week where the world is soberly remembering the fall of Lehman Bros and the beginning of the true GFC, stock markets across the globe are surging. Australia took only a weak lead from Wall Street into yesterday’s session, coupled it with bounces in metals prices and big jumps in oil and gold prices, and let loose. There was no sign of global index selling, and similar surges in Asian markets helped spur Australia on. It was a scramble for anyone still short and looking for a pull-back.
The Aussie dollar has also been surging of late, as well it may. Australia’s commodity-based economy has shown rude health compared to the rest of the developed world, and has posted two quarters of positive growth when others are still looking to post their first post-recession gain. The stock market is a leading economic indicator, and it makes perfect sense that a “fiat” currency, which has nothing other than an economy to underpin its strength, should rise on positive indications from the stock market. More directly, the RBA will shortly have to raise its cash rate, which attracts foreign investment inflows.
But on the other side of the Pacific, the world is upside down – and it’s nothing to do with hemispheres.
The US stock market is also rallying, indicating an expected return to economic growth. Such strength should thus translate into a stronger US dollar, but in fact, the opposite is true. At any other “normal” time, a surging Wall Street should invoke expectations of a Fed interest rate rise and thus a stronger greenback, which in turn would act as a dampener on commodity prices that are otherwise rising on fundamental demand. But in 2009, every time Wall Street rallies the dollar falls, and every time the dollar falls commodity prices push ever higher.
Not only is the US dollar not acting as a brake on commodity price strength as it should be, it is serving to exacerbate commodity price movements as both fundamental demand and mathematical dollar-pricing are competing with each other to send commodity prices skyrocketing on previously unheard of trajectories.
The reason for the conundrum is simple. This time last year, the world rapidly shifted its wealth in fear from “risk” assets such as the stock and commodity markets into the “safe haven” of the reserve currency. It might be a reserve currency backed solely by debt (and the US military, but that’s another story) but it’s the only reserve currency we have. Now that fear is diminishing, the world is shifting its wealth back out of that safe haven and back into risk assets, thus “putting money to work” once again. Until the Federal Reserve is convinced the US economy can stand on its own two feet, it will not raise its cash rate.
The fall in the US dollar is beginning to accelerate. Last night the index dropped another 0.4% to 76.18, and the euro passed through US$1.47 to its highest level since October. Ironically, the impetus for last night’s fall was a strong reading on US industrial production.
Industrial production is a fundamental element of a developed economy’s strength, and in August, US IP rose a better than expected 0.8%. This marks the second consecutive month of growth, post-GFC, and to top things off the earlier July reading of positive 0.5% was revised up to a full 1.0% gain. One again “cash for clunkers” came into play, but removing autos still leaves a 0.4% gain in net IP.
The level of US IP remains 10.7% below where it was one year ago. Capacity utilisation crept up from 69.0% in July to 69.9%, to be 11.3% below its long term average. The latter number is an important element in the Fed’s decision to keep rates on hold for some time. When an economy improves it must first redeploy idle excess productive capacity before there is any upward pressure on output prices, ie wholesale inflation.
After posting a positive PPI reading on Tuesday, last night saw the release of the US consumer price index (CPI). In August, the CPI rose by 0.4% against expectations of a 0.3% gain, and compared to a flat result in July. The bulk of the rise was related to gasoline prices, leaving a core increase of only 0.1% (ex food and energy).
Thus August saw a core PPI gain of 0.2% and a core CPI gain of 0.1%. These numbers are small enough not to bother the Fed in terms of inflation fears, but the Fed would nevertheless be concerned that its expectations of ongoing disinflationary forces (such as excess capacity and unemployment) are not playing out. It’s only one month’s reading, but if the Fed were also (for once) to pay attention to the fundamental cost of energy and not simply dismiss it as a volatile seasonal reading, then it might be a bit more concerned about rising oil prices in the face of a falling US dollar.
While inflation remains relatively low, US investors are not yet ready to dump US bonds. Despite ongoing weakness in the US dollar, and the reversal of the “safe haven” trade into the “risk” trade, the US ten-year bond yield has remained fairly steady around the 3.5% level this month. However, there was a slight tick up in yields last night on the release of the US Treasury International Capital (TIC) flow data.
This is a measurement of foreign flows in and out of US dollar assets. Last night’s data showed that foreign investors sold a net US$97.5bn worth of US assets in July, up from US$56.8bn of sales in June, and the highest level of selling since January. There is a clear connection to this data and a weaker US dollar index. The fear is that foreign investors will stop buying the US bonds the Treasury is constantly issuing to fund the country’s massive twin deficits. If that is the case, the Fed will have no choice but to raise its funds rate in order to attract lenders.
The good news is that “official” foreign purchases (by central banks and sovereign wealth funds) of US bonds in particular rose a net US$31.1bn in July. The bad news is that July’s number represents a big drop from June’s number, in which official bond purchases totalled a net US$100.5bn.
On the fall in the US dollar last night and the fundamentally positive story of improving US industrial production, commodity prices surged in London. All metals were up 3-4%, with the exception of a less inspired 1.5% gain in nickel. Oil jumped 2.2%, or US$1.58 to US$72.51/bbl. Oil’s rise was aided by weekly inventory data, which showed another drop in US crude supplies.
Natural gas, which has been falling throughout 2009 despite a stronger oil price, has been on a tear of late. Last night’s 13% gain marks the third daily gain in the teens in a row.
Silver is another star, rising another 2% last night in a solid week. The industrial/precious metal is leaving its pure precious metal big brother behind, despite gold posting a US$9.50 increase to US$1016.80/oz (up 0.9%).
Having stagnated for a few days in the low 86s, the Aussie has taken off again over the past 24 hours to mark US$0.8747 for a more than one cent gain.
A freshly exuberant local stock market will be boosted today by a SPI Overnight increase of 53 points, or 1.1%.
Damn the torpedoes.
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