The Overnight Report: Dollar Demons

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By Greg Peel

The Dow fell 332 points or 1.9% while the S&P dropped 1.7% to 2044 and the Nasdaq lost 1.7%.

Turnaround

There was a distinct change of tone on Bridge Street yesterday. Whereas the past month or so has seen buyers always fronting up on any dip, looking specifically for any perceived bargains in yield stocks, yesterday saw the sellers kill off a come-back rally. The ASX200 was up 35 points at midday, only to close flat.

Worrying markets at that time was a surprise jump in China’s CPI, suggesting the PBoC may not have the scope assumed to provide for further stimulus. Headline inflation jumped to an annualised 1.4% in February from January’s 0.8%. However economists were quick to point out that the jump was mostly to do with food prices, which typically see price rises ahead of the New Year holiday, before swinging back the other way thereafter.

Moreover, China’s PPI hit minus 4.8% in February, down from minus 4.3%. Wholesale disinflation is entrenched.

Lack of Confidence

But the real killer of yesterday’s recovery rally on Bridge Street was NAB’s February business confidence survey. Confidence was expected to rebound from its low level thanks to the RBA’s rate cut, but this has not been the case. Confidence fell to zero on NAB’s index from plus 3 in January to mark its lowest level since the federal election.

A lack of confidence in the resource sector is understandable and has a lot to do with the weak number. However the retail sector also expressed its concern, and that sector should have been a clear beneficiary of the rate cut. In general terms, instability in Canberra is weighing on business confidence, and inhibiting the transition towards non-mining capex growth.

I have said it before in this Report – ultimately stock markets care not who’s in power, but investment does need to be underpinned by policy certainty.

The sector breakdown of yesterday’s flat index close told the story. The materials and energy sectors were down on lower commodity prices but consumer discretionary was the worst performer, with consumer staples also in the red.

Earnings Fears

US markets are now in a conundrum. Wall Street had come to accept that while one could argue all day over the specific timing, a Fed rate rise was inevitable eventually. But that’s okay, because it means the US economy is recovering. The Dow and S&P hit new all-time highs and the Nasdaq regained 5000. The US dollar was creeping up in anticipation, but a strong dollar means a strong America.

Unless that dollar is too strong. The ECB’s introduction of shock and awe QE has sent the euro spiralling, and subsequently the US dollar index soaring. Last night that index rose another 1% to 98.62. In late 2014 analysts were predicting 8.0% net earnings growth for the S&P500 in 2015. That figure has now been slashed to 0.8%, and may yet turn negative, as the offshore earnings of US-based global enterprises are whittled away by the ever rising greenback.

Thus when the latest US jobs numbers were much stronger than expected, Wall Street got the jitters. A rate rise may be inevitable but not right now please. Rumour has it the Fed is set to remove the word “patient” from the next FOMC statement, in theory starting the countdown clock for the policy shift. But the dollar is no longer rising on simple rate rise anticipation. It is rising because currencies around the globe are falling.

Bond Strength

A rise in the Fed funds rate should by rights mean a rise in US bond yields, and indeed we did see the ten-year yield spike on last week’s jobs numbers. But whereas last Friday night’s sell-off in stocks was accompanied by a sell-off in bonds, last night’s stock market rout was matched by bond buying. The US ten-year yield fell 7 basis points to 2.13%.

To understand why, one need look no further than the German ten-year, which has fallen to 0.28% (the German five-year is at minus 0.16%), or the French at 0.52%, or the Netherlands at 0.28%. The yields on Italian, Spanish and Portuguese bonds are much lower than the US. Whose economy would you rather back?

It has been suggested that there may not even be enough eurozone bond issuance to meet the intended size of Mario Draghi’s bond buying program, particularly given he won’t buy anything at below the ECB deposit rate of minus 0.2%.

Commodities Carted

Supply-side issues may have provided some sudden strength in copper prices on Monday night but last night all commodity prices were forced to bow to the strength of the greenback. All base metals prices fell 1-2%.

Spot iron ore always marches to its own drummer. It rose US50c to US$58.50/t, which might offer some relief.

West Texas crude dropped US$1.35 to US$48.65/bbl and Brent dropped US$1.96 to US$56.56.

Gold lost US$4.70 to US$1161.70/oz, having suffered its big plunge last Friday night.

Today

The good news is the Aussie’s down a percent to US$0.7625 on US dollar strength. The bad news is the SPI Overnight is down 47 points, or 0.8%, on Wall Street weakness. However, the lower global bond yields fall, the more attractive are Australian yield stocks.

The ASX200 will open with a notable handicap today in the form of BHP Billiton ((BHP)) going ex, along with a few others. Although we probably won’t notice at all.

Westpac’s consumer confidence survey is due out today and if we saw the consumer sectors plunge on disappointing business confidence, it may not be pretty if the more direct consumer survey echoes the same sentiment. We’ll also see housing finance numbers today, to bring the focus back on another RBA rate cut, or not.

China will provide February industrial production, retail sales and fixed asset investment data today.

Rudi will make his weekly appearance on Market Moves, Sky Business, 5.30-6pm and later present to members of the Chatswood chapter of the Australian Investors' Association (AIA), in Chatswood (starts at 7.30pm at Chatswood Club, Help Street).

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