Daily Market Reports | Apr 12 2012
By Greg Peel
The Dow closed up 89 points or 0.7% while the S&P gained 0.7% to 1368 and the Nasdaq added 0.8%.
When a central bank sets a monetary policy target, such as a cash rate, it maintains that target by injecting or removing funds from the overnight market as necessary. This is known as “open market operations”. But when, say, the RBA “cuts” the cash rate, often the central bank does nothing at all. The market simply adjusts to the new stated target.
In the US, this year has featured excessive speculation over on again, off again QE3. Quantitative easing is the rate cut you provide when you can no longer cut a rate that's already at zero, and is achieved by expanding the central bank balance sheet. For QE1 and QE2 the Fed bought US bonds with money the Treasury had freshly printed. While these purchases were ultimately real, all along Wall Street has carefully monitored Fed language, looking for hints. Hence Bernanke knows that he only has to drop a subtle hint about QE3 and the market will do the rest. Words can be just as effective as actions in the shorter term.
So how might one halt the rise in Spanish and Italian bond yields, so easing the potentially disastrous build up of renewed euro-fear? It's simple. Just come out and remind everyone that the ECB can always buy those bonds if it has to. And that's what an ECB official did last night, pulling Spanish and Italian yields back from ever more dangerous levels.
The ECB was buying Greek bonds back when the European crisis began to get serious, and Irish and Portuguese bonds. The Fed simply buys US bonds, but there is no common eurozone bond. The ECB's bond purchases have thus to date been controversial, and upset the likes of Germany. In short, it is simply unfair to all of the eurozone to use ECB funds to buy only specific sovereign bonds. It's like a father using up the family estate to constantly help out one black sheep child while the responsible children simply watch their inheritance disappear.
The ECB stopped buying individual sovereign debt last year and new president Mario Draghi implemented the far more equitable Long Term Refinancing Operations (LTRO) which provides a form of QE through allowing all European banks to borrow cheap funds. No sovereign is thus singled out. The problem is the banks have not been lending that money into the European economy as is the hope (let's face it, why would you?) but investing in higher yields to rebuild cash positions. What offers a high yield? The bonds of wobbly eurozone members.
So the ECB has lent the banks the money to buy Spanish bonds but now that the bond vigilantes are selling Spanish bonds the ECB will have to step in and buy them lest its original investment via the banks is lost and the banks falls over. Yes, it's all smoke and mirrors, and that's why there are plenty of commentators across the globe suggesting there's a lot more significant rescuing to be done, a la Greece. But Spain would be a stretch, and Italy is simply “too big to fail”.
While Spain watches its borrowing cost rise to potential default levels, the Spanish suffer under harsh austerity. The sort of austerity that had Spanish industrial production down 5% in February from the previous year. It's a tough ask to service debt at higher borrowing costs while your income is rapidly diminishing.
The US Treasury held an auction of ten-year bonds last night and while demand was solid the auctioneers weren't knocked over in the rush as they were on Tuesday night when three-years were up for grabs. The statement from the ECB would have dampened demand. But Germany also auctioned ten-years last night, and they settled at a record low yield of 1.77%. Italy will be putting some bonds up for auction tonight. How will that go? It was a lack of demand for Spanish bonds a week ago that really sent Mediterranean yields into an upswing.
Wall Street would really like to think that behind all of this, QE3 is locked and loaded. At least last night as the opening bell rang, there was an easing of euro-fear given the ECB's comforting statement. And the surprisingly positive earnings result from Alcoa (Dow), posted after the closing bell on Tuesday, inspired thoughts that maybe March quarter earnings are not going to be as bad as feared.
With Spanish and Italian bond yields falling for once and European stock markets bouncing back, Wall Street opened higher, with the Dow up around 100 points, and pretty much tracked that level all session in a tight range on low volume. The wind only went out of the sails somewhat later in the afternoon when the Fed provided some good news. As we know, good news from the Fed is bad news for QE3.
The Fed's Beige Book is an anecdotal assessment of economic activity in each of the twelve Fed districts and April Book was one of the more upbeat seen in some time. Growth across the regions was “modest to moderate”, and despite the risk posed by higher energy prices, and the distortion of retail sales provided by mild weather, things were generally improving in various economic sectors. Manufacturing and services are growing, freight volumes are increasing, vehicle sales are strong, tourism, mining and agriculture are all positive, and there are even signs of growing loan demand.
Omigod, get me out! If the US economy improves then there'll be no QE3 to push up stock prices!
Or maybe a stronger economy can push up stock prices. And maybe, were Europe to implode once more, QE3 is actually always there ready anyway. It's all , as I say, smoke and mirrors, this monetary policy thing.
The easing of fear was enough to see the Aussie up half a cent last night to US$1.0303, but other markets were mostly less enthusiastic than the stock markets. The US dollar index slipped slightly to 79.75 and gold was little changed at US$1659.30/oz.
Some of the base metals tried to recover some ground but copper was again off last night, albeit slightly. Brent crude was little changed at US$119.98/bbl, while once again those weekly US inventories surprised to send West Texas up US$1.60 to US$102.62/bbl.
There was certainly little enthusiasm from the SPI Overnight, which rose only 5 points.
Wall Street is looking ahead to tonight's major earnings releases. Google will set the scene for tech sector results while JP Morgan (Dow) and Wells Fargo open the account for the banks. At that point traders will know how the Italian bond auction went, and they'll also know what Australia's jobs numbers looked like in March following today's release.
Then on Friday, they can worry about the Chinese GDP.
Rudi will be appearing on Sky Business today at noon.
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