The Overnight Report: Bumpy Path To Summit

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By Greg Peel

The Dow closed up 32 points or 0.3% while the S&P gained 0.6% to 1319 and the Nasdaq added 0.6%.

US ratings agency Egan Jones – one of the lesser known Marx Brothers – last night downgraded Germany's sovereign debt to A+ from AA-. The downgrade was not a reflection of a debt problem for Germany, as has been the case across the rest of the eurozone, but rather the fact Germany has, is, and will need to further carry the can for all and sundry.

Markets didn't blink. Not because Egan Jones is not as influential as your S&Ps and Moody's, but because after three years markets have finally come to realise that they have already priced in risk in respective assets and any agency downgrades are only bringing ratings into line well after the fact. The popular press still likes to jump up and down about downgrades but the markets now only shrug, as well they should. No one in Europe will stop investing in German bonds just because Egan Jones says A+ rather than AA-. We all know Germany is the paymaster, and we all know that if Germany has to bow to pressure to pursue a more pro-growth eurozone policy then it can only mean the German taxpayer dipping even further into the pocket.

Spain, meanwhile, tried to borrow more money last night through the usual channels. The Spanish Treasury managed to sell E1.6bn of three-month bills at 2.36%, up from 0.85% in May, and E1.5bn of six-months at 3.24%, up from 1.74%. The Spanish ten-year bond yield is quietly moving north again, last night reaching 6.81% despite the government having put out its hand on behalf of its banks. It remains uncertain as to whether the bail-out funds will go directly to Spanish banks, in which case it's not really a “sovereign” bail-out, or to the Spanish government to then pass it on to the banks, in which case it is. It's all academic, and the general feeling is more will be needed soon on the sovereign front. Particularly if those bond yields keep rising.

We nevertheless have the EU summit ahead of us, beginning Thursday night. Markets are generally poised as they await what significant, definitive and ground-breaking decisions might be made at the summit, but good God – that'd be a first. A draft road map has been offered to Germany ahead of the summit, seeking a gradual path to fiscal union and a banking union, with a common eurozone bond part of the mix. The bond, as always, was swiftly rejected by Berlin. A euro-bond would simply mean everyone else riding on Germany's back and Germany's borrowing cost reflecting zone-wide risk.

The rest of the draft was criticised by economists as reflecting too slow a path and criticised by Berlin as not featuring sufficient budget control measures. The reality is the whole thing will inevitably be a stalemate, just as all of the EU has been in a stalemate since early 2010. A tighter fiscal and monetary union means Germany supports every member economically, and Germany won't have a bar of it unless a central body can control sovereign budgets. No country is prepared to cede sovereignty.

The eurozone is, was, and always will be a failure and a blindingly naïve idea. The sooner it's blasted apart the better, but that won't happen until all else fails some several years down the track. The problem is that Germany needs the PIIGS as much as the PIIGS (and Cyprus) need Germany. Without them the Deutschmark would be through the roof and China would steal Germany's export market.

Wall Street had all of the above to ponder last night, and some home grown data as well. First up the Conference Board's monthly measure of consumer confidence was released showing a fall to a five-month low of 62.0 from May's 64.4. Wall Street traded down on this news with the Dow falling 50 points, although realistically the man on the street is as much a lagging indicator as a rating agency's opinion.

There followed some good news however, with the Case-Shiller house price index for April “surging” 1.3% after seven consecutive months of falls. The average US house price in the 20 biggest cities is now 1.1% up over twelve months. One in a row is hardly an inflection point, but Wall Street liked it, and the Dow was soon up 74. Then it lost ground at the death.

The other big news on the night was Rupert's declaration he was thinking about splitting News Corp ((NWS)) in two, separating the entertainment and publishing businesses. News shares jumped 8% as a result, with investors no doubt looking forward to investing in the successful entertainment franchise without the Old Media earnings anchor dragging along behind.

In other markets we saw largely a reversal of Monday night's moves, with the US dollar index falling slightly to 82.37, the Aussie up half cent to US$1.0066, and gold falling back US$11.90 to US$1572.40/oz. Brent jumped up US$2.06 to US$93.07/bbl, but West Texas managed only US20c to US$79.41/bbl. Base metals were all a little weaker.

The SPI Overnight rose 8 points or 0.2%.

The Aussie market seems to have been marching to its own drum this week, no doubt reflecting our individual financial year-end. Window dressers, portfolio repositioners and tax sellers are all battling it out, so anything can happen.

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