FYI | Dec 01 2007
By Greg Peel
The Dow closed up 60 points, or 0.4% on Friday while the S&P faired better with a 0.8% gain. The Nasdaq, however, fell 0.3%.
Investors in the Asian time zone banking on a big surge in US stocks in the wake of Fed chairman Bernanke’s speech on Thursday night will probably feel disappointed this morning. Markets in the Asian time zone all added over 1% in Friday trade, while the news wires ran hot with assertions that Bernanke had guaranteed a rate cut. The Dow burst out of the blocks on Friday morning looking set to follow the trend.
The 155 point rise the Dow achieved on the opening bell proved the high of the day, and the index thereafter sank slowly to be in the red at 3.15pm. At 3.45pm it was almost in the red again, before a final 15 minute jump affected the +60 point close.
The close marked a fourth consecutive up-day for the Dow – the first time this has happened since July. But in failing to set the world on fire the US stock market simply showed that for whatever you want to read into Bernanke’s speech, there was no “scoop”. Bernanke told the world that financial and economic conditions had weakened since October 31 – the day the Fed cut the cash rate by 25 points and signalled it would now go on hold. The market already knew that.
What Bernanke’s speech did do was officially dissolve the “on hold” stance and move to one of being “alert and flexible”. To many that screamed rate cut, but given Fed 2IC Kohn had said the same thing two days earlier, sparking a 331 point rally in the Dow, a repeat of the same mantra should never have necessarily provided a deja vue performance. The only difference was that this time it came from the boss.
Bernanke had also reiterated inflation concerns, and while these may have become a bit hackneyed it was important that the chairman made special mention of food and energy, signalling for once that headline inflation cannot be ignored as it has been in the past. He also made mention of the weak US dollar, as if warning against indiscriminate monetary easing. He then suggested the economic data releases between now and December 11 would be important in the final decision.
Is this 25 basis points on a platter? Commentary said yes, the market said well, that’s what we expected, and Fed futures have had a 25bps cut “baked in” all month anyway. But if there was anything that would have reinforced a rate cut expectation, it was the first set of numbers post Bernanke’s dissertation.
Friday night saw the release of the October consumer spending number. At a 0.2% rise, it was the lowest gain in four months and half the consensus estimate. Tick box number one for a rate cut.
Next came the PCE deflator for October. This statistical measure of personal consumption expenditure (PCE) is considered by many to be a better gauge of inflation levels than the CPI, and is a favoured indicator for the Fed. The headline PCE rose 0.3% in October while the core (ex food & energy) rose 0.2%. The year-on-year core thus registered 1.9%, and the Fed has always felt comfortable between 1-2%. Inflation scare overblown? Tick box number two for a rate cut.
There are a handful of data to be released before next Friday but the biggie will come on that day – the November jobs report. Consumer confidence for December will also be revealed. That will be the make or break, but at this stage one would have to think the jobs number needs to be very positive to avoid a 25 point cut. A 50 point cut perhaps? Well the jobs number would have to be really bad, one assumes.
When arguing the old 25-50, it has to be remembered there is also the discount rate that can be manipulated. It still stands at a 50 point premium to cash and is a fundamental facility available to credit-crunched institutions. It would be of little surprise if, for example, the Fed cut the cash rate by 25 and the discount rate by 50.
We can speculate about this until the heifers are once more in residence but given economist consensus is trending towards expectation of a 3.5% cash rate by mid-2008 (it’s 4.5% now) the short term agonising and accompanying volatility can really seem a bit pointless. The data are there – does it really matter how carefully Bernanke chooses his words?
The bottom line is Wall Street is currently in a more buoyant mood and that mood may yet persist. It certainly received a boost last night when it was revealed US Treasury Secretary Hank Paulson has been working on a plan to allow Americans facing a crippling reset on their mortgage rate to be allowed a break. This has been labelled as “saving subprime”, and is an adjunct to Paulson’s other act of persuasion – the creation of the US$75bn “super SIV” designed to put a floor under collapsing CDO prices.
Ben – you bail out Wall Street. I’ll bail out Main Street. Free market capitalism may be “the best path to prosperity” but only if no Americans are injured in the filming.
The effect of the Paulson revelation was a sharp rally in all the decimated mortgage-related financials. Stocks such as lenders Countywide, Washington Mutual and Freddie Mac and mortgage insurers such as Ambac all soared high-teens percentages on Friday night. Banks and brokerages were sucked along in the slipstream. Meanwhile up in Midtown, the poor result from Dell was putting tech stocks under pressure. Given that the most popular trade of late has been short financials/long tech, Friday night saw some sharp unwinding. That’s why the S&P and Nasdaq shifted in opposite directions. The Dow split the difference.
Back in the real world, oil continued its tumble last night, breaking down through technical levels to close under US$90/bbl for the first time in a month. Crude for January delivery dropped US$2.30 to US$88.71/bbl. Inventory lotteries, talk of OPEC production increases (which are a lot of rubbish anyway) and recession fears have broken oil’s back, and now it’s all about getting rid of dodgy longs.
The fall in the oil price was also assisted by a stronger US dollar. A stronger US dollar? Hang on – didn’t we all decide on Friday the Fed would cut the cash rate?
Which just goes to show that anything Ben says is still behind the times. The dollar has been so heavily sold that confirmation of a rate cut has become more of a “sell the rumour – buy the fact”. The dollar rallied strongly against all currencies, including the yen. This meant two opposing forces at play against the Aussie, so it remained virtually unchanged at US$0.8835. Between a stronger US dollar and weaker oil, gold didn’t stand much of a chance, even if a rate cut means monetary inflation. Gold fell US$8.90 to US$783.10/oz.
In spite of all of the above, however, constantly confused metals traders pushed prices generally higher late in London, as hints of a rate cut should mean economic stimulus.
The SPI Overnight was similarly two-minded, and ultimately fell 7 points, following the 1.4% Friday rally in the ASX 200 which had a lot of Bernanke bias built in.
