The Monday Report

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By Greg Peel

It was a more-of-the-same session on Wall Street on Friday, with indices fiddling about, but ultimately drifting higher on little volume. The Dow closed up 25 points or 0.2% to 13,275, the S&P gained 0.2% to 1418, and the Nasdaq added .5%.

On May first the Dow hit a four-year post-GFC high of 13,279 and the S&P marked 1419. As you can see, we're almost back there again. One gets the feeling this is where Wall Street wants to be ahead of what might transpire in Europe next month – at the inflexion point. If we don't see definitive action from the ECB, we will no doubt fall back quickly. If we do see action well…a lot of that appears already priced in…however a break-up through the May highs will likely prompt a new leg to the rally.

We are unlikely to see anything substantial from the Fed, although if Wall Street was still hanging on QE3, we'd be lower by now. Recent US economic data have been, and continue to be, more positive than negative. On Friday, the Michigan Uni fortnightly consumer sentiment index returned to its May high when economists had expected a tick down. Retailers have been among the late earnings reporters, and on Friday clothing brand Gap typified a round of retailer results with a beat on earnings and an upgraded outlook.

If we were to use the VIX as a gauge, we'd have to say Wall Street is looking very confident indeed. On Friday the VIX fell to below 14 – well into the “complacency” zone. Were investors worried about what might happen next, they would be buying put option protection and pushing the VIX higher. However, given there is so little money invested in the stock market at present – in the US, Australia and elsewhere – there is not a lot of need for protection. Hence the VIX is not really telling us anything useful. Cash and bonds have become the new put options.

That doesn't preclude the fact that Australian investors holding stock portfolios and worried it all might go pear-shaped once more should seriously look at XJO option protection at this level. It's cheap as chips.

Aside from a positive confidence reading in the US, Friday featured another comment from Angela Merkel which warmed the hearts of traders. Merkel voiced support for ECB president Mario Draghi's suggested emergency strategy and again urged European leaders to move swiftly towards further fiscal integration, as time is running out.

As to whether this marks anything new from Merkel is debatable. One thing we do now, however, is that reality will begin to replace summer holiday dreaming this week when Greek prime minister Antonis Samaras travels to Berlin to discuss budget progress. A couple of months ago economist consensus had Greece inevitably leaving the euro, but recent polling suggests a change of heart. Germany will do what it can to keep Greece, and everyone else, in.

Thereafter, all hinges on the ruling by the German court on the constitutional challenge to participation in the ESM. This is due on September 12, and will be critical in determining just what the ECB and the eurozone is able to do on the rescue front. Problem is, the world is holding its breath for the ECB monetary policy meeting, and that's on September 6. It may be that Draghi can announce nothing concrete at that time if the court ruling is not yet known.

Furthermore, Draghi has insisted that emergency measures, being the purchase of sovereign bonds, will only be implemented if said sovereigns request a bail-out. Italy is maintaining its insistence that it won't need bailing out, which just leaves Spain. When the Spanish ten-year yield was rocketing past 7% last month, it appeared all that was standing in the way of a Spanish request for a bail-out was ratification of the ECB's intended bond-buying program and its impact on the ranking of existing bondholders. But now that market anticipation of a bail-out has been priced into European bond yields – the Spanish yield closed at 6.44% on Friday – indications from Spain have been of a reluctance to capitulate and a preference to hang on under cheaper borrowing costs. If this is the case it will prove the stuff of folly, given that if Draghi announces “no change” next month because Spain has not knocked on the door, the Spanish yield would hit 8% in a heartbeat on its rapid way north.

Yields priced by the so-called “bond vigilantes” are hardly a platform for critical sovereign and central bank policy decisions.

So again we must consider the calendar ahead. Bernanke typically announces new policy at the Jackson Hole symposium, and that begins on August 31. Assuming he does not know Draghi's intentions at that point, he really can't do a lot and the US in isolation does not need full-blown QE3. The ECB then meets on September 6, at which the world expects the “magic bullet” announcement. But Draghi may have to wait until he knows the outcome of the court ruling, due September 12. Whatever that result may be, the Fed will provide a new policy statement on September 13. Quite frankly, anything could happen. The world, it would appear nevertheless, is feeling confident.

The US dollar index was up 0.2% on Friday to 82.56, gold was steady at US$1615.70/oz, and base metals were all a bit stronger. The movements of interest over the 24 hours of Friday were in the Aussie and oil.

In Australia on Friday, media reports suggested Australian Treasury officials were concerned over the stubbornly high currency and its effect on the economy, and that the issue could impact monetary policy decisions. The market took it as a hint of potential RBA currency intervention, in the manner of the Bank of Japan and Swiss National Bank which do so with gay abandon. The Aussie plunged a cent to US$1.0415. Treasury economists were nevertheless quick to dismiss such a suggestion and warn that central bank intervention was dangerous.

ANZ Bank economists released a report on Friday, suggesting that recent RBA rhetoric implied a desire to assess the impact of the rate cuts to date before taking further action. As a result, ANZ no longer expects another rate cut in 2012, albeit the economists have only pushed out their expectations to 2013.

The oil market was surprised by a Reuters report acknowledging a “source within the White House” that the president was contemplating releases of crude from the Strategic Reserve to stop high oil prices from undermining sanctions against Iran. Officials will monitor US gasoline prices, the source suggested, to make sure they drift typically lower in September as the US summer driving season winds down.

The report was immediately questioned, and if assumed true, written off as a political ploy to reduce gasoline prices before the election. It was Brent crude that took the fall, dropping US$1.56 to US$113.71/bbl, while West Texas actually rose US61c to US$96.21/bbl.

The SPI Overnight was up 5 points.

I have already outlined the general macro situation for this week, so on to the specifics.

Thursday will be the critical day macro-wise this week, as all of the flash PMIs for China (from HSBC), the eurozone and the US will be released. The US will see the release of the minutes of the last Fed meeting on Wednesday, along with existing home sales, while Thursday brings new home sales and the FHFA house price index. Friday wraps with durable goods. The UK will also revise its June quarter GDP estimate on Friday.

In Australia, we'll see the Westpac leading economic index for June released on Wednesday and the Conference Board equivalent on Friday. June quarter housing affordability will be revealed on Thursday and on Friday RBA governor Glenn Stevens will make a regular testament to the Senate Finance Committee, having released the minutes of the last RBA meeting on Tuesday.

On the micro level, this week is the busiest for the local earnings season. BHP Billiton ((BHP)) will report, as will Woodside ((WPL)), Qantas ((QAN)) and Woolworths ((WOW)), but there are far too many to highlight and readers are otherwise directed to the FNArena Calendar.

The following week will see reporting drop down a gear before it all wraps up on Friday, August 31.

Rudi will appear on Sky Business on Thursday at noon and again between 7.00-8:00pm on the Switzer Report. 

For further global economic release dates and local company events please refer to the FNArena Calendar.

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