The Overnight Report: Uncle Ben Is A Pin-Up Again

This story features BHP GROUP LIMITED. For more info SHARE ANALYSIS: BHP

By Greg Peel

The Dow closed up 331 points or 2.9%, and the S&P added 2.9% and the Nasdaq 2.8%. This was not at all a volatile session – the only way was up. The VIX, just out of interest, has now fallen to 21.

Initial momentum was provided by a continuation of the oil price fall. With damage from Tropical Strom Edouard deemed to be minimal, oil was able to break down through a significant support at US$120, falling US$2.24 to US$119.17/bbl. This is the first sub-120 close since early May.

Further fuel was added to a bullish fire when the July ISM performance of services (non-manufacturing) index was released, noting an increase to 49.5 over June’s 48.2 – ahead of consensus expectations. While anything under 50 still implies contraction, a more heartened Wall Street is happy to take what it can get at present. More faith was provided by a good result from Dow component and consumer staple king Procter & Gamble, and a UBS upgrade of insurance giant AIG to Buy also sweetened the mood.

All of this led to a surprising rally of over 200 points – surprising because at 2.15pm the Fed was due to announce its rate decision. Were the Fed to hike, momentum would have been shot. But with oil continuing to fall, hopes of more “on hold” ahead were intensified. Then out came the statement, accompanying no change in rate.

If the RBA statement of yesterday was subtle in its variation from last month, the Fed statement was almost cryptic by comparison. Wall Street had been fearing a rate hike – unlike Australia, which has been looking for a cut – so clues were needed so that this fear could be abrogated. A hint of more “on hold” would be sufficiently positive.

In the June statement, the Fed suggested “Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending”. In last night’s statement, the Fed confirmed its earlier view was correct by noting “Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports”.

So far so good, but economic growth was taking a back seat to inflation in June. This led the Fed to remark in June:

“The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.”

But last night the committee said:

“Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.”

(My emphasis in each case). Here we note that while “high uncertainty” is still attributed to the inflation environment, there is a recognition that possibly we have seen a peak. Last night’s statement notes inflation “has been” high, rather than “is” high, and “continued increases” in prices have become “earlier increases” in prices.

This could be construed as a little hint that the Fed sees no need to raise rates just yet. An even more subtle a hint came in the final paragraph. In June, the Fed said:

“Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risk to inflation and inflation expectations have increased.”

But last night the committee said:

“Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee.”

So in June the Fed was beginning to not worry so much about economic growth and to worry more about inflation. In August it has begun to worry about economic growth again, indicated by the fact that the line “risks…appear to have diminished somewhat” has disappeared. But rather than suggesting once more inflation risk has increased, it simply noted this time that inflation is still a “significant concern”.

Which sounds to me like a father telling a teenager “Okay you’re no longer grounded, but I’ll be keeping my eye on you and if you do that again there’ll be trouble mister!”.

Wall Street clearly felt the same, although there was a bit of a wobble in the indices as traders tried to quickly digest the subtlety. In the end though, another hundred-odd points was added to the already two hundred-odd point rally.

Unsurprisingly, the financial sector loved it. The financial index jumped 5%. Citi was up 6%, Lehman up 13%, Fannie up 15%. The only real laggard was the materials sector, for the commodity bubble-burst is still weighing on Wall Street. Energy stocks held up reasonably well, but materials were once again in the red.  Following a big fall yesterday, London metals stalled for the most part last night, with nickel down another 2% and zinc off 1%. Aluminium and copper held steady, but long commodity players might have been hoping for a bit of a bounce.

Gold, nevertheless, tanked once more, down US$19.90 to US$874.30/oz. The US dollar posted another good rally against the euro on general stock market strength, despite not getting a rate hike and not seeing one ahead soon. The dollar slipped lightly against the yen, but that would have been a reflection of yen buying as the flipside of carry trade unwinding.

Carry trades are not, this time, being unwound on heightened fear and uncertainty. They are being unwound because high interest rate currencies suddenly look like they may not remain so for too much longer. The Aussie collapsed in yesterday’s local trade as the RBA gave its big hint the next move in local interest rates will be down, and that undermines the “borrow in yen, invest in Aussie” trade. The Little Battler fell close to US1.4c to be US$0.9159.

The SPI Overnight was up 88 points – a nice contrast to yesterday, although those investors looking for some relief in the big miners today will not be heartened to know BHP ((BHP)) fell another 1% in London and 2% in New York.

The 300+ rally in the Dow was the biggest since the April Fool’s Day rally, which ultimately made everyone look the fool. Investors should again beware of enthusiastic rallies that move too fast, for while a bottoming process is starting to look more evident, bottoming processes take a lot of time and can break a lot of hearts. We might also need to be wary of an ECB rate hike on Thursday night.

Oh, and I inadvertently gave the wrong impression about New Corp yesterday, which actually reported this morning. Yesterday was just a precursor. It was a great result, and despite rallying 5% in the day session, News was up another 10% plus in the after-market.

Click to view our Glossary of Financial Terms