The Overnight Report: Fed Fuels Further Confusion

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By Greg Peel

The Dow closed down 195 points or 1.1% while the S&P lost 1.4% to 2002 and the Nasdaq fell 0.9%.

The past 24 hours have featured much debate over interest rates, here, and across the Pacific. Locally, the ASX200 dutifully fell 26 points from the open of yesterday’s session in line with the big plunge on Wall Street, but the buyers were ready to move and the energy sector led the charge following a slightly more positive night for oil prices. Then came the release of the December quarter inflation data.

Economists had forecast headline inflation to show a 0.3% rise quarter on quarter for a 1.8% annualised rate, down from 2.3% in the previous quarter. The result was 0.2% for 1.7%, with the plunge in oil prices cited as the major factor. Economists believe the March quarter headline could be as low as 1.3% as the impact of cheaper energy continues to flow through.

The big surprise was the underlying, or core, CPI, to which the RBA pays most attention. It rose 0.7% for a 2.2% annualised rate. The underlying measure omits volatile energy prices, but a discrepancy of as much as 0.5 percentage points between headline and underlying is very rare. The result saw the ASX200 take another dive from the flatline to which it had recovered before the release, but once again the buyers moved in, ensuring a slightly positive close.

The initial plunge can be put down to disappointment that the much stronger underlying CPI now has economists revising the timing of their RBA rate cut expectations. Next week is off the table, and it looks like March is now also unlikely. The money markets are pencilling in April. But while lower rates provide a boost for many areas of the economy, they do not float all boats, so the stock buyers found reason to remain positive.

Attention then turned to the US, and specifically the first FOMC meeting for the year. Wall Street began on a positive note following the previous night’s after-market result release from Apple, which revealed no less than the biggest quarterly profit ever achieved by any company, anywhere, in the history of mankind. The enthusiasm was nevertheless tempered by the uncertainty of what the Fed was going to say.

There were three significant factors within the Fed statement which have sparked much debate. Firstly, after having spent at least all of 2014 describing US economic growth as “modest”, the committee now sees growth as “solid”. The major influence here is “strong” jobs growth. Secondly, the committee acknowledged that US inflation was not moving toward the 2% target at the pace expected, and indeed had softened, but suggested the factors behind this (read: oil) are “transitory”.

So here we have what one would assume is a more hawkish statement than the last. Jobs growth is “strong” and economic growth “solid”, and low inflation is only “transitory”. The Fed’s two major mandates are to control unemployment and inflation. On the strength of this statement one would assume the timing of the first Fed rate rise remains that of at least June, if not earlier. But then there’s the third factor.

The third factor is a caveat thrown in of considering “international developments”. The rest of the world was briefly mentioned two or three statements ago, causing some outrage from those who stress the Fed is only mandated to manage the US economy, and no one else’s, but the reality is we now live in a far more “globalised” world in which multinational companies operate outside of specific geographic boundaries, be they US- or elsewhere-based. The “international developments” line is clearly a reference to the ECB’s major stimulus package.

So, does this reference imply: (a) the situation is clearly very dire in Europe, and other economies such as those of Japan and China are also struggling, so it would be foolish to rush in and raise US rates too quickly; or (b), now that the ECB has joined the stimulus party the global economy is thus on track for recovery, it would be foolish not to raise US rates at an appropriate time?

The debate still rages, but shortly after the release of the Fed statement, the US ten-year yield began to plunge. While this would imply the market believes (a) is the answer, but on the other hand the “solid” US economy is clearly the only place to park one’s money, irrespective of rate rise timing. The ten-year is down 10 basis points to 1.72%. The US thirty-year bond rate, on which US mortgage pricing is based, is also down 10 basis points, to 2.29% — its lowest level ever.

Now, if the bond market is saying the US is the place to be, then surely US stocks, particularly those paying decent dividend yields, should also be sought? Clearly not. A confused US stock market sat at the flatline on the indices right up until inside the last hour of trade, when suddenly the selling floodgates opened. This would most likely imply the answer is (b), and a Fed rate rise will come sooner rather than later.

The jury is still out. Yet most commentary is suggesting, quite simply, that June remains the most likely timing from a “patient” Fed.

In other markets, another record weekly build in US crude inventories quickly put paid to any notion oil prices may be finding a bottom. West Texas plunged another US$1.48 to US$44.42/bbl and Brent fell US63c to US$48.55/bbl. Commodity prices were not aided by a stronger greenback, representative of the “solid” US economy, which rose 0.5% on its index to 94.49.

Gold is confused, so it fell back US$10.30 to USD$1284.00/oz. The Aussie is down 0.3% at US$0.7916.

The LME closed ahead of the Fed statement, so we’ll need to wait until tonight to gauge metal price reactions. Last night the base metals were largely steady. Iron ore is down US10c to US$62.70/t.

It could be a tough one on the ASX today. Another plunge on Wall Street and another plunge in oil prices have added up to a 68 point or 1.2% drop for the SPI Overnight.

Fortescue Metals ((FMG)), Newcrest Mining ((NCM)) and Oil Search ((OSH)) are amongst a late rush of resource sector quarterly reporters today.

Rudi will make his first appearance for 2015 on Sky Business today, between 7-8pm, on Switzer TV.

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