The Overnight Report: Beijing Hikes, Wall Street Shrugs

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By Greg Peel

The Dow gained 71 points or 0.6% while the S&P added 0.4% to 1324 and the Nasdaq rose 0.5%.

The People's Bank of China yesterday announced another rate increase, following on from the Christmas Day hike. The PBoC lifted its one year lending rate to 6.06% from 5.81% and this time simultaneously lifted its deposit rate to 3.00% from 2.75%. Inflation is clearly in Beijing's sights. China's latest round of inflation data is due out at the end of this week.

Had this hike occurred in 2010, Wall Street would have taken a dive. Last year was a year of panic not just every time a small European nation blew itself up, but every time Beijing threatened, in nervous traders' eyes, to kill the golden goose with monetary tightening. But a new, warm breeze has swept through Wall Street in 2011. Economic data are solid (except for jobs), corporate earnings are healthy, and money grows on trees. QE2 trees.

So it was that the reaction to Beijing's move was a small dip at the open that lasted about five minutes. Then it was onward ever upward once more, with Mickey D's leading the charge.

Mickey D's (McDonalds, stock code MCD) announced better than expected global like-for-like sales in January and helped send Wall Street to its seventh straight gain. Sales improved everywhere across the planet, including in China, and in Chubby Land Downunder, except for one region – the US. But that's okay. China's been exporting its cheap crap to the US for a decade so now it's “right back at ya”. With a dollar kept in check by the Fed, US exports are finding keen demand.

But can the US have too much of a good thing? Mitchell Johnson spent the whole Ashes series warning us that it's best to know when you've had enough. Now that easy monetary policy seems to have served its purpose, and the US economy looks strong, questions are being raised as to whether America should just keep on chugging on those QE2 beers.

There was dissent in the ranks of the Fed back in 2010 when QE2 was being considered, but by the time it was implemented the world was already talking about a probable QE3. Last night Richmond Fed president Jeffrey Lacker piped up and suggested that while QE2 should not be halted suddenly, the size and pace of the program should be reconsidered in light of the current situation. It's unlikely Uncle Ben will do any more than listen politely however, given that in his recent “meet the press” he dismissed the notion that QE2 had anything to do with current global inflation. Egyptians may disagree, along with the PBoC.

Last night the Fed was in buying US$2.19bn of thirty-year bonds, although most of its purchases are concentrated in the two-ten maturity range. But Fed or no Fed, 2011 has seen a pricking of the supposed US bond bubble as investors have shifted money back into risk assets. And so it was that last night's Treasury auction of US$32bn of three-year notes received a lacklustre response. Foreign central banks bought only 28% compared to the running average of 35%, and the benchmark ten-year yield rose another eight basis points to 3.72%. The Treasury will auction US$24bn of ten-years tonight.

A Chinese rate hike by default implies a lower US dollar given the renminbi is pegged in a range and not at a price. But the euro also took a hit last night on a weak German industrial production number for January, but that was put down to the heavy snow. The Aussie also took a hit on the rate hike given Australia's greater sensitivity to the Chinese economy, but as the US dollar index dipped to 77.95, the Aussie ultimately held its ground at US$1.0148.

Gold, on the other hand, jumped again on the weaker greenback and on the inflation scare implied by Beijing's policy move. Gold was up US$14.20 to US$1364.00/oz, and silver retook the US$30/oz mark. Oil similarly rose US33c to US$87.80/bbl.

Like Wall Street, the LME initially got a scare from the Chinese rate hike but then swiftly recovered, with most metals closing slightly higher on the session. Copper remains above US$10,000/t.

The SPI Overnight rose 14 points or 0.3%.

With QE2 now causing debate at the Fed, one is reminded that a significant contribution to the GFC came from then Fed chairman Alan Greenspan's policy of dropping the funds rate to 1% in 2004 in the wake of the tech wreck and 9/11. Critics suggest the rate was dropped too low and for too long, and since 2009 now Fed chairman Ben Bernanke has been pushing the “exceptionally low rates for an extend period” mantra of which QE2 is the primary element. Another bubble on the horizon? One presumes that as long as the US unemployment rate remains elevated then QE2 is here to stay. The rest of the world's food and oil inflation woes are not America's concern.

Today locally the interim results season steps up a gear with the highlight being Commonwealth Bank ((CBA)). Westpac economists will also inform us just how consumer confidence fared during the January floods. 

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