The Monday Report

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By Greg Peel

There is little point in analysing the big fall in the local market on Friday, as it was all about “Draghi Disappointment”. Suffice to say it was a market-wide sell-off, consistent with falls around the globe, triggered by the announced extension to ECB stimulus, and on Friday night Mario Draghi eased concerns and effectively assured markets the ECB is still ready with shock and awe if necessary.

Alongside yet another positive US jobs report, which cements a rate hike from the Fed next week, Friday night saw the Dow turn a 250 point drop on Thursday night into a 370 point rally. European markets did not participate in the rebound during their sessions as Draghi spoke in New York after they had closed.

Lock it in

Ahead of the release of the US non-farm payrolls report for November, Wall Street was reeling in its expectations. Assuming the big surge in the October report to be a seasonal blip of sorts, some commentators were talking a mere 100,000 new jobs. But not only did the November result come in at 211,000, the October number was revised up for a total of over 300,000 job additions.

The unemployment rate remained unchanged at 5.0% on a slight tick-up in the participation rate. The only stumbling block was wage growth, which eased to an annualised 2.3% from October’s 2.5%. But that alone is not going to stop the Fed.

Whether or not one believes the Fed had already made its decision, the November jobs report locks in a December rate hike once and for all, as far as Wall Street is concerned. As is oft noted in this Report, the biggest enemy of markets is uncertainty, and uncertainty has reigned throughout 2015 in regard to Fed policy, up until Friday night. Certainty was arguably worth about half of the subsequent rally on Wall Street, which saw the Dow close up 369 points or 2.1%, the S&P gain 2.1% to 2091, and the Nasdaq rally 2.1%. The “technical damage” done to the indices from Thursday night’s big drop was more than repaired.

The other half came thanks to Mario Draghi.

“Well, of course”

It is important to note that while ECB president Mario Draghi has been consistent in his hints that QE would be extended from December, and consistent in his “whatever it takes” mantra over the past few years, never did he actually provide any numbers that should be expected at the ECB’s December policy meeting last week. It was left to the markets to assume the quantum.

The market assumed a 20 point cut to the ECB’s bank deposit rate and some increase above the prevailing E60bn per month of bond purchases. Thus when a 10 point cut and no increase were delivered, the market spat the dummy. Mostly because the market had set loaded itself up long or short as appropriate – long US dollar, short euro for example – to the point that if Draghi had delivered on assumed numbers, there may even have been a “buy the fact” rally in the euro, for example. Disappointment meant the biggest move in the euro since 2009.

Mr Draghi, it seems, got a bit of a shock at just how big the moves were on Thursday night, and just how destabilising they were for markets when the whole point of central bank stimulus is to provide some stability. But he had an immediate opportunity to set things straight in a speech he was due to deliver in New York on Friday night.

In that speech he emphasised that while the ECB only extended QE to a level the market was disappointed with at the December policy meeting, there is “no limit” to what the ECB is prepared to do and the central bank will act “without delay” to bump up the stimulus in 2016 if deemed necessary. European markets were already closed when Draghi spoke, but Wall Street, which had arguably been oversold on the ECB knee-jerk reaction, was open, and ready to reverse Thursday night’s moves.

The comical moment came in the Q&A panel session after Draghi’s speech, in which former Bank of England guv’na Merv King evoked chuckles from the crowd when he asked Draghi whether his speech was in direct response to the market carnage the night before. “No, not really,” Draghi replied, “it…um…well, of course”. Hilarity ensued.

It’s a relief to see a bit of Italian self-deprecation in contrast to the typically po-faced Janet Yellen.

As to whether the strong US jobs report was the main driver of Wall Street’s rally on Friday night, or Draghi, or both, it doesn’t much matter. Clearly Draghi held sway over the US bond market, given the ten-year yield fell 5 basis points to 2.15%. This is the wrong direction for a certain rate hike, but the right direction to reverse the carry trade rally in yields on Thursday night which was prompted by big jumps in European yields, following ECB disappointment.

Similarly, gold posted an ECB response. While additional stimulus in Europe is a positive for the gold price in isolation, Fed tightening and a stronger greenback are more pervasive for USD-denominated gold. With expectations strengthening that the Fed will raise next week, gold has been sold down heavily, talk of triple-digits has prevailed, and everyone had set themselves short. The disappointing ECB package only served to reaffirm short positions.

So despite the US jobs report, gold surged US22.00 to US$1086.50/oz on Friday night. Draghi’s comments were enough to trigger a short-covering scramble. The rally came despite the US dollar index also rallying, as the euro rebounded, by 0.7% to 98.37.

Commodities

The LME was well and truly closed when Draghi spoke in New York, so base metal traders only had the US jobs report to respond to. A strong jobs number implies a Fed rate rise and thus a strong dollar, thus weaker commodity prices. That is if you ignore the fact a strong US jobs report implies a healthy US economy, which is good for commodities. Once again, the base metal market had set itself very short, and thus on the jobs numbers, a short-covering scramble was triggered.

Copper rose just under 1%, lead, nickel and zinc all rose just under 2% and aluminium jumped over 2%. Tin sat still.

The oil markets weren’t ignoring US jobs and Draghi’s comments on Friday night, but the overriding influence was the OPEC meeting also underway. While no one really expected the Saudis to concede to production cuts, disquiet among OPEC members who all have, Saudi Arabia included, heavily bleeding national budgets, meant that maybe there would be some talk of production cuts in 2016.

The Saudis proved defiant however, and continue to assume a combination of rising global demand and falling US shale oil supply will lead to oil price stability returning at some point in 2016. Oil prices had jumped on Thursday night due to the terrorism implications of the San Bernardino massacre, and following the OPEC meeting fell back from whence they came. West Texas is down US$1.07 to US$40.05/bbl and Brent is down US80c to US$43.07/bbl.

Iron ore cares not for central bank policy outside of China. It is official – iron ore is now sub-40. The spot price fell US90c on Friday night to US$39.40/t.

The Aussie dollar is caught in a bit of a push me-pull you situation at the moment under the influence of both global and domestic central bank policy, as well as commodity prices. It was down 0.2% on Saturday morning at US$0.7340.

The SPI Overnight closed up 31 points or 0.6% on Saturday morning.

The Week Ahead

We can now all start tediously debating just when the second Fed rate rise might be. Oh joy.

US data releases drop off a bit this week and ahead of Wednesday week’s Fed policy meeting. The important data releases this week are all on Friday, being November retail sales, which include “Black Friday” and the general Thanksgiving weekend shopping spree, and the PPI and fortnightly consumer sentiment. Next week sees the CPI ahead of the FOMC meeting.

China is back in the frame this week. November trade numbers are due tomorrow and inflation numbers on Wednesday. The usual data dump of industrial production, retail sales and fixed asset investment numbers will occur on Saturday.

Locally we’ll see the construction PMI today along with ANZ’s job ad series. Tomorrow it’s NAB’s monthly business confidence survey, and on Wednesday Westpac’s consumer confidence survey along with housing finance data. On Thursday it’s our own November jobs numbers.

The local AGM season is all but over but there remain some stragglers including Westpac ((WBC)), who will host on Friday. National Bank ((NAB)) is due to update on the UK situation tomorrow and CSL ((CSL)) holds its annual R&D Day on Thursday.

This week, Rudi will give his final presentation (the first after publishing his book) to members of Australian Shareholders Association (ASA) in Canberra on Tuesday. He'll make his final TV appearance for the year on Sky Business on Thursday at noon. There will be no more Weekly Insights until late January.
 

For further global economic release dates and local company events please refer to the FNArena Calendar.

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