The Overnight Report: Things Can Only Get Better

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By Greg Peel

The Dow closed up 106 points, or 0.7%, while the S&P gained 0.6% to 1660 and the Nasdaq added 0.9%.

Wall Street returned from the Memorial Day long weekend to find the Conference Board’s monthly measure of US consumer confidence had jumped to 76.2 from 69.0 in April to mark the highest level in five years. Economists had expected a rise to 72.3. The breakdown is interesting, with the “now” element of the index registering only 66.7, but the “ahead” element registering 82.4.

The results suggest Americans have now relaxed and dismissed the fiscal cliff and the sequester that came into force in March, despite the US budget cut stand-off between the White House and the Congress still not being resolved. Next up will be the debt ceiling debate. The focus is rather on improving job prospects and an improving housing market. Case-Shiller’s 20-city house price index, released last night, showed a 1.4% monthly increase to a 10.9% annual growth rate. That’s the fastest growth rate since 2006. That year saw the peak of the housing bubble, but prices are rising in 2013 off a much lower base.

The Richmond Fed also threw in some better news last night, with its monthly manufacturing index rising to minus 2 from minus 6 in April.

The strong data is good news for the US economy, but also throws up the ever present conundrum. The better the data, the more likely the Fed is to start tapering off QE sooner rather than later. This reality was very much evident in the US bond market’s response to the positive news, given bond prices plunged and the ten-year yield jumped 12 basis points to 2.13% to mark the highest rate in over a year.

The US dollar was back on the move, rising 0.7% to 84.36 on its index. The issue for the stock market is that a lot of the solid earnings gains posted in previous years were attributable to the export advantage of a weaker greenback, fuelled by Fed money printing. The dollar is now rising on anticipation of less money printing, which one presumes would impact on stock prices.

Not so.

Wall Street flew out of the blocks last night, rallying as much as 218 Dow points before 11am. That level represented the peak nevertheless, and prices drifted off for the rest of the session. Yet a net 0.6% gain for the broad market S&P 500 suggests Wall Street is not frightened of a Fed wind-back, as many have assumed it would be. Perhaps investors are focusing not so much on the wind-back threat itself, but on the Fed’s continuous talk of not wishing to reduce QE suddenly and risk a knee-jerk reaction that could derail the improving economy. The building feeling is that the Fed will be cautious and incremental in its withdrawal, so as not to upset markets. The underlying feeling is that if the Fed decides it’s time to taper, this can only mean the US economy is on the mend, which is a good thing.

Here’s an interesting point. Due to forced budget cuts, the US budget deficit is reducing. If the deficit is reducing, the Treasury needs to borrow less money, not more, which means it has no need to issue more bonds. If it’s not issuing bonds, what does the Fed buy? Therein lies a natural taper.

Gold was an unsurprising victim of the US dollar jump last night, falling US$13.10 to US$1381.30/oz. The Aussie by rights should be lower, but after recent steep falls, it appears to be consolidating somewhat. The Aussie is only 0.2% lower at US$0.9618.

London base metals, which were also closed on Monday night, finished their session little changed. The exception was lead, which jumped over 3%. The lack of movement otherwise reflects the positive impact of strong US data offset by the negative price effect of a resultant strong US dollar.

The stronger dollar didn’t bother the oils though. Brent jumped US$1.84 to US$104.23/bbl and West Texas rose US96c to US$95.11/bbl. Every now and again the oils move sharply, but realistically they’ve been stuck in a trading range rut now for a couple of months.

The bad news for the Australian market is that the iron ore price has fallen once again, substantially, and broken down below the 120 mark that has previously been seen as a support level. Yesterday, spot iron ore fell US$3.10 to US$117.80/t. The potential circuit breaker for iron ore now is the fact that at levels below 120, marginal Chinese domestic production becomes uneconomic.

Likely reflecting the iron ore price fall, the SPI Overnight is down one point.

It’s a relatively busy day on the news front in Australia today, with numbers for March quarter construction work done and housing affordability due, along with Westpac’s leading economic index. Aristocrat Leisure ((ALL)) will report its half-year profit and Programmed Maintenance ((PRG)) its full-year, while Wesfarmers ((WES)) will hold an investor day.

Rudi will appear on Sky Business this evening at 5.30pm.
 

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