The Overnight Report: Cold Turkey

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By Greg Peel

The Dow fell 189 points or 1.2% while the S&P lost 1.0% to 1774 and the Nasdaq dropped 1.1%.

On Tuesday night Wall Street rallied on, among other things, anticipation of a Turkish rate hike. It’s not often Turkey steps into the global financial market spotlight. By the opening bell on Bridge Street yesterday, Turkey’s central bank had lifted its cash rate to 12% from 7.75% in order to support the lira and stem the rush out of Turkish bonds. It worked, and Bridge Street put on a solid session in anticipation Wall Street would follow last night.

Fundamental to that anticipation was a widespread expectation the Fed would announce further tapering last night and no one would bat an eyelid. Indeed, were the Fed not to announce more tapering Wall Street might well sell on the implication of insufficient economic growth, many assumed.

In the meantime, the South African central bank lifted its cash rate to 5.5% from 5.0% in a similar crisis control move. Once again the trick came off, with the rand and South African bond yields stabilising.

For about five minutes. By the time the opening bell sounded on Wall Street last night, the lira and rand were falling once more against the greenback and Turkish and South African bond yields were rising. The levee of emerging market central bank intervention is proving insufficient against the flood of funds out of high-risk assets and back into the safety of the largest economy in the world. This emerging market crisis is spooking Wall Street, and as such the Dow was down a good 120 points before the Fed statement even hit the wires.

When the statement arrived, it didn’t surprise. Fed bond purchases will be cut by a further US$10bn to US$65bn per month. But Wall Street fell again on the news, sending the Dow down 200 points.

It is now assumed the Fed will continue to taper at every meeting, thus bringing an end to QE by late 2014. The assumption is reinforced by the pledge within this statement that the Fed funds rate will remain at zero “well past” the point unemployment falls to 6.5%, as long as inflation remains low. Clearly the Fed believes the US economy is now recovering sufficiently to go it alone, and that ongoing QE at this stage would only lead to higher inflation.

There was no mention in the statement of the plight of emerging markets. A sceptic would suggest this is because the Fed couldn’t care less, although collectively the emerging economies equate to the Club Med of years past. Rising bond yields make emerging market budget deficits more expensive to fund. The take-away is that the Fed does not see the current emerging market crisis as anything more than temporary.

Wall Street is not so sure. Indeed, Wall Street is not so sure a rapid end to QE is such a good thing after all. Late last year, the assumption was the Fed would taper slowly. Taper and assess, taper and assess again. This assumption was enough to evoke one hell of a Santa rally following that initial announcement in December. But now it seems the band-aid is going to be ripped of quickly. It’s all a bit scary. It’s enough to create nervousness and send investors back into cash for the time being.

We may yet get that long overdue correction. It will depend on just how keen the buyers prove to be. In the last hour and a half of trading Wall Street tried to fight back, but could not hold on.

In the background of the macro is the micro, being the US results season. Weak results released after the bell on Tuesday night saw AT&T (Dow) down 1% and Yahoo down 8.5%. During the session Boeing (Dow) beat on earnings but weak guidance sent its shares down 6%. Facebook has just announced after Wednesday bell, and is up 6% in the after-market.

US December quarter earnings continue to be so-so collectively rather than solid enough to justify the dizzy PE heights of late 2013.

Throughout all the goings on of the past week, the US dollar index has remained steady, as it was again last night at 80.59. This is because we are seeing a developed versus emerging market currency play rather than plays of magnitude between the developed market currencies which make up the index. The US ten-year bond yield, on the other hand, fell 7 basis points to 2.68%.

In a sense this is the wrong way. When tapering was first hinted at last year, US bond yields rose on the assumption the first rate rise would soon follow. Since then the Fed has watered down its unemployment rate target guidance, and last night the Fed confirmed 6.5% was no target at all. And all the US money flowing out of emerging market bonds is going straight into US bonds.

Gold rose US$10.50 to US$1261.70/oz, while the Aussie fell 0.5% to US$0.8733.

Base metal markets closed in London ahead of the Fed statement, and all were down again by small increments. Spot iron ore clocked up one more session before the break, and it fell US$1.30 to US$122.60/t. The oils were mixed, with Brent up US42c to US$107.79/bbl and West Texas down US23c to US$97.18/bbl.

The big story in the US energy space remains that of natural gas. Last night the Henry Hub price jumped another 13% or US65c to US$5.69. While the Fed relaxes in a climate of low core inflation, Americans are beginning to worry about their next winter gas bills.

Sound familiar?

The SPI Overnight fell 62 points or 1.2%.

The first estimate of US December quarter GDP is due out tonight.

Locally, Fortescue ((FMG)) is among a handful of miners releasing production reports today while Energy Resources of Australia ((ERA)) will post its full year result. Navitas ((NVT)) will post its interim according to some, but not all, broker calendars.
 

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