The Overnight Report: The Beginning Of The End?

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By Greg Peel

The Dow closed down 297 points or 3.8% while the S&P lost 4.6% and the Nasdaq 4.2%.

At about 3.30pm New York time (7.30am Sydney) President Obama signed the US stimulus bill into law. In his prefacing speech, Obama declared the US$780bn-odd package signified “the beginning of the end” of the economic crisis in the US. There was much cheering in Denver – Obama’s choice of signature venue. There was not the same level of euphoria on Wall Street.

Nor was there a lot of cheering in Berlin, Paris, London, or other European centres. While the Americans put their feet up for President’s Day on Monday, Moody’s Investor Services issued a report indicating its grave concern over European banks’ level of credit exposure to the rapidly collapsing economies of the former Eastern bloc. To understand Moody’s concerns, see “Could The Eastern Bloc Bring Down Europe?” published by FNArena yesterday. Last night European bank stocks were sold down 10% or more, leading all European indices 2-3% lower.

Last night the Dow closed down 297 points, but most of that loss had already been posted before 10am. The Dow is back at its November lows, and many bank stocks have now passed through their November lows. The US media is trying to weigh up last night’s session in terms of the stimulus package and ongoing lack of detail on the new TARP. While these issues continue to dog Wall Street, one might assume that last night eyes were turned across the Atlantic. Having adjusted to match Europe, the NYSE went quiet. It was a low volume day.

It was far from quiet in currency markets, however. As the Asian session continued through the afternoon yesterday currency traders were aggressively dumping the euro. They were also pounding the pound and sinking the Swissy. The yen also came in for selling treatment in the wake of Japan’s ominous 13% economic contraction. On the other side of the equation is the US dollar. Last night the US dollar soared. It was a “flight to safety”.

One can only shake one’s head at the irony of it all. Here we have a US president waving a magic wand to conjure up yet another trillion-odd dollars out of a fiscal budget already deep in deficit. The money is coming out of thin air. Yet around the world, investors see the US economy as perhaps the only remaining sanctuary. As fast as the US government prints money and issues bonds, the world is buying them. The world is financing the rescue of an economy which through years of financial market excess conspired to bring the global economy down.

It is all to do with relativities, of course. One does not actually “buy” US dollars, one simply “exchanges” another currency for the reserve currency – the currency backed by what is still the largest economy in the world by a huge margin. The rest of the world is in dire straits, no more so than Europe. European banks account for about three-quarters of all loans to “emerging” markets. Markets which are now crashing. There is growing doubt the euro, as a collective currency, can even survive.

And when currencies – “paper” money – are having their value and their ongoing existence questioned the only true safe haven is gold. Forget the traditional inverse relationship between gold and the US dollar – that is broken down at present. Gold leapt US$28.70 to US$970.20/oz last night as investors across the globe implemented another panicked “flight to quality”. Gold is rising against all currencies. It is the case of a hard commodity versus an IOU.

But while gold is indeed a hard commodity, it is not a commodity in the true sense of the word. The real commodities were trashed last night. Oil was down US$2.56 or 7% to US$34.95/bbl. Base metals in London were all down 2-4%. (Base metal prices in New York look worse, but they lost a day’s trade).

One could argue that commodity prices were down simply because the US dollar was up, but the greater reality is that commodities are being sold in the face of expected ongoing declines in global demand. The Japanese economy is buried. The European economy may yet go belly-up. Stimulus package or no stimulus package, the US economy is also shot.

Resources stocks were trashed overnight in Europe and the US. US coal stocks were down 12-15%. BHP Billiton ((BHP)) was down 4.5% in London and 9.5% in New York. Rio Tinto ((RIO)) was down 1.5% and 6.5%, respectively.

The Aussie dollar has lost another cent to US$0.6379.

The SPI Overnight fell 70 points, or 2%. Yesterday’s 1.5% fall in the ASX 200 was taking Japan into account and picking up on the Europe news later in the day.

When risk aversion takes hold, the first reliable indication is the euro/yen exchange rate. As the euro/yen falls, so too do world stock markets. Stocks are the most risky of all traditional assets. If the euro is sold down heavily then stock markets must ultimately follow. But one might ask: Hasn’t the yen been sold down heavily as well?

Not so. Because the Japan has been offering zero interest rates for years the world had sold yen and bought high-interest currencies all this century in the great “yen carry trade”. The yen carry trade is the epitome of risk appetite. Now that risk aversion has returned, carry traders are bailing out of high interest currencies and buying back their yen. So while the Japanese economy may be a basket case, one reason is because of a strong yen (which is undermining Japan’s export-based economy) against the US dollar. As the world sells the euro and buys the yen, the risk aversion signals are very strong.

Obama has heralded the “beginning of the end”. He might want to be careful how he uses those words.

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