The Overnight Report: Wall Street Exits Yield

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By Greg Peel

The Dow closed down 106 points, or 0.7%, while the S&P lost 0.7% to 1648 and the Nasdaq fell 0.6%.

On Tuesday night the Dow rose around 200 points before falling to close up around 100 points. Last night the Dow fell around 200 points before rising to close down around 100 points. The broad market S&P has followed a similar, mirror pattern.

What we are seeing in such a pattern is not the volatility of uncertainty, but rather the beginnings of an adjustment to the inevitable. On Tuesday night initial strength was provided by a strong US consumer confidence number and solid house price data, both suggesting the US economy is on the mend. Last night the initial fall was sparked by some global forecast adjustments from both the OECD and IMF.

The OECD has downgraded its forecasts for global GDP growth to 3.1% and 4.0% in 2013-14 from 3.4% and 4.2%. The US forecast is downgraded to 1.9% in 2013 from 2.0% and the eurozone forecast is downgraded to 0.6% contraction in 2013 from 0.1% contraction. The IMF has downgraded its Chinese growth forecasts to 7.75% for both 2013 and 2014 from 8.0% and 8.2%.

The OECD further warned that “Exit from unconventional monetary policy [QE], when needed, may be difficult to manage and less smooth than desirable, possibly leading to sharp rises in bond yields and serious negative consequences for growth in a number of advanced and emerging economies”.

Speaking at a function last night, former Fed chairman Paul Volcker – the man who introduced central bank inflation control in the wake of runaway inflation in the 1970s – warned that the Fed was being asked to do too much with monetary policy to overcome the problems of misguided fiscal policy and structural imbalance, and would not fully succeed. Global central banks are being too aggressive, Volcker suggested, and inflation is thus a risk. In other words, Volcker was advocating a QE wind-back.

In a separate speech, current Boston Fed president and FOMC member Eric Rosengren suggested last night that “significant accommodation remains appropriate at this time,” but that a reduction in the pace of QE would “make sense” after a few more months of economic improvement.

On the subject of fiscal policy, the European Commission has finally decided to bow to pressure and shift towards a slightly more growth-focused policy than a pure austerity policy. Strict austerity has crimped the ability of EU members to grow out of debt and is causing dire levels of unemployment across Europe. The EC has now extended the time granted for the likes of France, Spain and other members to reduce their budget deficits.

If we add up all of the above we are looking at expectations of a slower global recovery, but a global recovery nevertheless. And if the economy is recovering, the need for ongoing “emergency” levels of monetary stimulus diminishes. If QE is not controlled, inflation spikes become a threat. Investors are thus beginning to reach the conclusion across the globe that there’s no point in arguing about QE exits as they are going to happen one way or the other. Rather than debate the timing, it’s best to set for their inevitability.

For Wall Street this means selling high yield defensive sectors and switching into cyclicals that will benefit from growth. This switch has already been evident over the past couple of weeks, but the last two sessions have emphasised the moves. Tuesday night saw positive movements for cyclicals based on consumer confidence. Last night was more of a “sell defensives” session, as high-yield sectors such as utilities, telcos and healthcare were hammered. QE tapering means higher government bond yields, and higher bond yields make the yields on stocks that carry risk premiums less attractive. Home builders were also hit last night, given US mortgage rates are now back on the rise.

On the other side of the coin, US banks were stronger last night. The move up follows on from Tuesday night’s upgrade of US banks to stable from negative by Moody’s for the first time since the GFC. If the economy is growing, banks are growing.

The mirror trade continued into other markets, with the US dollar index falling 0.7% to 83.61 having risen by the same amount on Tuesday. Gold thus rebounded US$12.20 to US$1393.50/oz. The Aussie fell slightly on Tuesday and has recovered equally to US$0.9639.

Base metals were again mixed on smallish moves, torn between lower global growth forecasts and a weaker greenback, while the oils reversed Tuesday’s gains. Brent fell US$1.80 to US$102.24 and West Texas was down US$2.14 to US$92.87/bbl.

The only market that didn’t post a mirror image reversal was the US bond market. The ten-year yield jumped 12bps to 2.13% on Tuesday, but fell only one bip last night to 2.12%. It’s all about bonds.

Oh, and there was one other market that did not play to script. The Chinese iron price is a world unto itself and the slide accelerated last night, with the spot price falling US$4.90 to an eight month low of US$112.90/t.

The SPI Overnight fell 22 points, or 0.4%.

Today in Australia sees the release of the much awaited March quarter capex and capex intentions report. It is this result that may confirm in the minds of economists and the RBA that the mining boom has peaked. Yesterday’s March quarter construction report, which is closely tied to the resource sector given stagnant housing growth, surprised to the downside.

National Bank ((NAB)) goes ex-div today, so be wary of the 93c adjustment there. Sims Metal Management ((SGM)) will hold an investor day.

Tonight will see the first revision of the US March quarter GDP.

Rudi will appear on Sky Business today at noon.
 

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