The Overnight Report: It’s T-Time, Soonish

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By Greg Peel

The Dow fell 66 points or 0.4% while the S&P lost 0.4% to 1781 and the Nasdaq dropped 0.3%.

Perhaps Wall Street was hoping the last 24 hours would somehow bring a suggestion from the Fed that QE would simply have to be maintained at its current level, at least, for the foreseeable future. But it appears we are now seeing a disconnect emerging between the US economic recovery and the Fed balance sheet. Interest rates, on the other hand, are a different matter.

The Pollyanna view up to now has been that the Fed would only start tapering its bond purchases if the US economic recovery looked to be accelerating, hence tapering would actually be good news as it would imply a stronger US economy. Stock markets rise in times of economic strength. But it seems the Fed might be starting to worry that QE3 is not doing much at the margin other than build the central bank’s balance sheet into an ever more unwieldy position while artificially pumping up asset prices. The unemployment rate has fallen but so has the participation rate. The money is not getting through to the wider economy, and the longer financial markets remain on morphine, the harder it will be to kick the habit.

The Fed will not start tapering if the US economic recovery appears to be stagnating, but as long as “modest” or “moderate” improvement is being recorded in the data, it's best to start the withdrawal. And let’s face it, ticking down bond purchases from US$85bn a month to something a little lower is no cold turkey, just the beginning of a measured process to get America off the drugs.

Interest rates, on the other hand, can remain super-accommodative for as long as the Fed deems they need to be. A zero funds rate does not add to the Fed’s funny money balance sheet. Wall Street has, since May, been jumping to the conclusion that the first taper implies a rapid rush to increased interest rates. The Fed is now at pains to point out that is not true. QE and the funds rate are two separate issues.

In his speech yesterday morning Sydney time, outgoing Fed chairman Ben Bernanke provided the tapering warning shot:

“As reflected in the latest Summary of Economic Projections and the October FOMC statement, the FOMC still expects that labour market conditions will continue to improve and that inflation will move toward the 2 percent objective over the medium term. If these views are supported by incoming information, the FOMC will likely begin to moderate the pace of purchases.”

In other words, if the jobs numbers continue to look better and deflation doesn’t set in, tapering will begin. Some have now suggested a decent November jobs number might see December as the kick-off but the counter argument is a likely weak, shutdown impacted fourth quarter GDP, which puts us into the new year, followed by more fiscal follies in January-February, which could provide for further delays.

March is still looking good.

But Bernanke also said:

“In particular, even after unemployment drops below 6.5%, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labour market is sufficiently strong before considering any increase in its target for the federal funds rate.”

In other words the chairman is suggesting “Remember that 6.5% number I once upon a time pulled out of my hat? Well just pretend I never said it. There is no specific threshold. We’ll start to wind back bond purchases but on the other hand we’ll give you free money for as long as it takes”.

Nevertheless, the T-word was implied by the first statement. Bridge Street was the first line of attack around the globe yesterday, and the sellers moved in. As to whether or not the sellers would have moved in anyway, given building end-of-year fatigue on the local bourse, is another matter. But often Bridge Street gets the chance to pre-empt Wall Street.

And Bridge Street got it right, basically, in the end. Wall Street did respond to Bernanke’s speech immediately because it wanted to read the minutes of the last FOMC meeting before doing anything rash. Thus nothing moved until 2pm New York, and then down went the indices, falling away from the magical 16,000-1800-4000 combination.

Two points of note came out of the minutes. Firstly, the voting members are becoming increasingly edgy about QE and want to start tapering sooner rather than later. Secondly, the members realise that the data-dependency of the Fed’s implicit tapering timetable is doing Wall Street’s head in, and only fuelling volatility. The stock market and even the housing market are jumping around with every good or bad jobs number or other data point. We want to taper, says the FOMC, so just put a date on it. Assuming the economy is not about to fall into a hole, stuff the jobs thing and just say tapering will commence in the month of…

Then we can all get some sleep.

Meanwhile, on the other side of the world, another group of central bankers is losing sleep over the vexing question: “How might the ECB orchestrate its own QE program?”

At the end of the day, a Wall Street fall represented by only 66 Dow points was not much of a reaction to T-talk when one considers responses in other markets. Gold tanked, falling US$25.90 to US$1249.00/oz. The benchmark ten-tear US bond yield shot up 8 basis points to 2.79%. The US dollar index bounced 0.5% to 81.04 and the Aussie – and this is the good news – crashed a cent to US$0.9337. Nothing Glenn says much seems to work but when the Fed speaks, listen.

The LME took the news on board with familiar exquisite indifference. The oils were a different story nevertheless. West Texas was little changed at US$93.37/bbl on expiry but just as the protagonists sit down in Geneva once more to nut out what the world expects will be a resolution on Iran’s nuclear aspirations, Iran’s Supreme Ayatollah was quoted in the Wall Street Journal that his country had every right to enrich uranium. Brent rose US92c to US$107.84/bbl.

Spot iron ore rose US10c to US$136.40/t.

We must not forget that there were some important US data releases last night as well. Retail sales surprised with a 0.4% gain in Shutdown October when economists expected a flat result while existing home sales fell 3.2% as expected.

We recall that Bernanke said yesterday the Fed still expects inflation to move towards the target 2%? In October, the headline CPI fell by 0.1% to mark the first drop in six months. Annualised inflation fell to 1.0% — the lowest level since 2009.

Let the tapering begin, not.

The SPI Overnight fell 6 points.

Have we learnt anything new over the last 24 hours? Not really. One factor to note is that the VIX – the supposed “fear gauge” in the US – didn’t move at all last night and remains at an ambivalent 13.

Glenn Stevens plans to have another chat to us today while the flashers are out and about, with November manufacturing PMI estimates due from China (HSBC), the eurozone and US.

BHP Billiton ((BHP)) holds its AGM today as does Sonic Healthcare ((SHL)) and a handful of smaller names.

Rudi will appear on Sky Business at noon and again between 7-8pm on Switzer.
 

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