The Overnight Report: Wanna Get High?

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By Greg Peel

The Dow closed up 26 points or 0.1% while the S&P gained 0.3% to 2129 as the Nasdaq added 0.6%.

No Go Joe

It is “unlikely to be in Australia’s long-term interests to engineer a consumption boom by encouraging people to borrow large amounts against future income,” RBA deputy governor Philip Lowe told an audience of chief financial officers yesterday morning. “This is especially so when debt levels are already high and prospects for future income growth are not as positive as they once were. So, there is a fairly fine line to tread here.”

This assessment rather puts a dampener on the Treasurer’s appeal to Australians to “go out there and have a go”. Lowe’s rather more grounded assessment of the Australian economy’s capacity to navigate its transition away from mining investment in the near term also seems rather in contrast to the Treasurer’s optimistic growth outlook, but then Mr Lowe is appointed and Mr Hockey is elected.

But if the RBA is concerned that transition may prove difficult, why then did it appear to herald the end of its easing cycle in its last policy statement? Well, apparently that is not the case.

“We still have scope to lower interest rates if we need to,” said Lowe, when asked that question. “That doesn’t mean we’re going to, but we have scope to do that.”

The RBA’s biggest problem remains the fine balance between providing economic stimulus through another rate cut and the collateral damage of runaway housing investment. The more the housing market issue is raised by the regulators, the more the market begins to assume APRA may be preparing to act more decisively than it has to date in attempting to restrict a housing investment bubble.

Heading South

In essence, Philip Lowe rather cast a pall over last week’s post-Budget party in the stock market. Thus yesterday saw heavy selling, led down by the banks (-1.9%) with budget winner consumer discretionary following close behind (-1.4%). All sectors finished in the red. BHP Billiton ((BHP)) closed down 7.3% which would otherwise put a big dent in the index, but this was largely a mathematical adjustment to account for the spin-off of South32 ((S32)) and thus roughly a zero sum move.

It was not an auspicious start for the love child, falling 3.8% on debut, but given BHP shareholders were handed South32 shares for nothing it was an opportunity to take some cash out of an investment in the former leviathan. I suppose now we’ll have to refer to BHP as “the company formerly known as the Big Australian”.

There is likely some concern among resource sector investors with regard the government’s bizarre talk of holding an enquiry into the iron ore industry. Sorry, which stripe of political ideology is in power at present? The irony is that the supermarket duopoly has been getting away with murder for years but that’s a domestic issue. Now Tony Abbott wants to bite the hand that feeds him.

Weakness in the materials sector yesterday was aided by an iron ore price that has continued to trickle back from its sudden rebound peak. It won’t get much better today, with the trickle turning into a flood overnight. Iron ore is down US2.00 to US$59.00/t.

High-Ho

Philip Lowe’s speech yesterday also included a mandatory talking down of the Aussie dollar. The currency did fall marginally but likely more so on the confirmation the RBA can still cut if it feels the need rather than the broken record of a too-high exchange rate. The fact the Aussie is down 0.6% over 24 hours to US$0.7988 is mostly a result of last night’s snap-back rally in the US dollar after a period of weakness. The dollar index is up 1.0% to 94.18.

The snap-back suggests the market has become oversold dollars of late, having previously become overbought on Fed rate rise speculation. The recent stream of weak US economic data has pushed rate rise expectations further out in time, and last night’s fall in the US housing market sentiment index to 54 from 56 last month, when economists had forecast 58, is just another in a long line of disappointing numbers.

There is little doubt the US bond market had become very overbought, and still is, and last night the volatility continued. The longer the Fed holds off the less reason there is to sell bonds, but the US ten-year jumped up 9 basis points to 2.23% last night as selling in German bonds continued unabated.

US stock markets were being spooked last week when bond yields were going the wrong way but traders seem to have come to terms with the contradiction, given last night the Dow hit a new all-time high for the first time since early March and the S&P500 marked its third ATH in three sessions. The weaker the data, the longer the Fed will hold off, the better that is for stocks. Or so the story goes.

Bucked Off

Commodity markets have been a little unsure of where they should next be heading in recent sessions, following rebounds in oil, iron ore and to some extent among the base metals. But when the US dollar jumps 1% it’s easy to come up with an excuse to sell.

Iron ore fell 3.3% last night as noted, while all base metals bar tin were sold down 0.5-1.0%, other than aluminium, which fell 2%.

The oils were also weaker but only marginally so, with West Texas dropping US31c to US$59.60/bbl and Brent dropping US54c to US$66.27/bbl for its new July delivery front month.

Gold, of course, rarely behaves the way you’d expect, so it rose US$2.20 to US$1225.70/oz.

Today

New high for the Dow? The SPI Overnight closed up 22 points or 0.4%.

Philip Lowe probably said it all yesterday but this morning’s release of the minutes of the May RBA meeting may still provide more colour.

Tonight the eurozone will be able to see if ECB QE is beginning to work as inflation and trade numbers are released along with the ZEW investor sentiment index.

Rudi will today travel through cold Canberra to present his latest insights, and more, to local members of the ATAA.
 

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