The Overnight Report: Relief

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By Greg Peel

The Dow rose 165 points or 1.4%, while the S&P added 1.5% and the beaten-down Nasdaq shot back 2%.

The Dow shot out of the gates to the upside on the release of the May CPI, wobbled into lunch, and then regained momentum toward the close. It was a Friday session in summer, the weather on the east coast has reached heat-wave proportions, and the beach beckoned. While the square-up trade for the last session was to buy, there was no one much around to sell anyway. This particular bounce lacks much significance.

Yet again the monthly CPI has belied anticipation of a food and energy-related spike, and a passing on of such cost into the wider US economy. While Vietnam, for example, is currently reeling with inflation levels reaching 25%, the May headline CPI in the US showed a rise of 0.6% against expectation of 0.5%, to take the annualised inflation figure to 4.2%. The figure for the last three months alone (annualised) is 4.9%.

The core reading, which excludes food & energy, rose exactly as expected by 0.2%. This puts annualised core inflation at 2.3%, and only 1.8% (annualised) over the three months. The current Fed measure of inflation includes a component for homeowners’ equivalent rent – suggesting a rise or fall in the monthly cost of owning a house even though a mortgage is paid (or not), not actual rent. As one might expect, the influence of this component is very much to the negative. If removed (and it was only introduced in the Clinton era), US headline inflation is now well over 7%. This sort of reading likely seems more realistic to the average Americans lining up at the pump, or sitting down to a meal of corn tortillas.

A feature of the past week has been massive flooding in America’s bread basket states, which has sent the price of corn in particular on an upward spiral. The rains have stopped for now, but those floodwaters will spend the coming week making their way down the mighty river system to the Gulf. It’s not over yet. The heat-wave is expected to ease in the east, and shift to the west, but the great fear lies south, where warmer waters are a precursor to cyclonic formations.

As Iowa farmers tend to their washed out crops, it might be interesting to note that they will now have to re-fertilise.

With a CPI number coming in close enough to expectation, there should not have been much of a reaction in the US dollar. However, this weekend sees the latest meeting of the G8 finance ministers, in Osaka, and all the rhetoric to date has hinted at intervention in the dollar. The last meeting a couple of months ago had the same build up, and the G8 did come out and “warn” of possible intervention, thus setting US$1.60 in the euro as a likely line in the sand. The dollar has been volatile ever since, but mostly stronger as a result. Reality is the euro is now at US$1.54. Aside from intervention talk, threats from the Fed to raise interest rates to fight inflation have also bolstered the greenback.

Yet the CPI is, again, relatively benign. This supposedly takes pressure off the Fed to raise rates soon, and reinforces the general belief US rates are “on hold” now for a while yet. That rates are not about to be hiked is positive for stocks, and this was reflected in Friday’s rally.

The US dollar did post a rally nevertheless, as traders set themselves before the G8. It probably doesn’t pay to be short over the weekend. The strength in the dollar allowed oil to fall by US$1.88 to US$134.86/bbl.

It was mid-May when oil first leapt strongly one night to US$135, and suddenly the reality of oil hit home across the globe. Arguments ensued over whether US$135 oil represented supply/demand or speculation, and wise heads suggested a pullback was due. A pullback began, and we reached US$122, but suddenly Israel became overtly bellicose and we found ourselves at US$139. A month later, we’re sitting back at US$135 again. Is this “fair value”?

The dip in the price of oil was another positive for Wall Street, and aiding oil’s fall was a move by Saudi Arabia to increase its production at least up until the next OPEC meeting on June 22. OPEC announced that demand for oil from OECD countries had increased in 2007, but the cartel was expecting a fall in demand in 2008. Hence the Saudi increase is likely only temporary, as OPEC has continually argued that it is speculation, and not demand, that is pushing up the price of oil.

Another positive for Wall Street on Friday was a 14% jump in distressed investment bank Lehman Bros, following news that the call had gone out for fresh investors and that private equity specialist Blackstone, for one, had stepped up to the plate. Is a full takeover also a possibility? This meant a generally positive day for financial stocks. While such short-covering spikes are now common for Lehman, Friday’s move must be cold comfort for the board of local investment bank Babcock & Brown ((BNB)), whose collapse this week can be attributed to some extent to renewed fears the Lehman debacle has sparked across the globe.

Despite a stronger dollar and weaker oil, gold actually rallied by US$3.10 on Friday to US$870.70/oz, following a period of high volatility. The Aussie also clawed back US0.4c to US$0.9390 after the big drop earlier in the week on the jobs number.

It was again a mixed session on the LME. A tight copper market encouraged a 1.5% jump in the base metals bellwether, while after a strong week nickel fell over 2% as BHP Billiton ((BHP)) announced it could make up nickel production through other smelters despite the announced maintenance closure of one of them.

The SPI Overnight rose 54 points.

After the jobs-related 400 point drop in the Dow last Friday, last week actually saw a rally of 0.8%. For the ASX 200, the Monday-Monday move will still show a loss. The index flirted with a drop through 5300 on Friday as Babcock & Brown sparked panic through the market, but that technical level held and a late Friday rally ensued. With the big Dow drop last week having resulted in the ASX 200 gapping down through support at the significant 5500 level, the new mark is now 5300. Below that it’s 5000. This is all still part of a bottoming process that is not yet over.

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