The Overnight Report: Greenback Fights Back

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By Greg Peel

The Dow closed down 65 points or 0.8% while the S&P lost a heftier 1.4% to 931 and the Nasdaq slipped by 0.6%.

Since late in the first quarter, US equities have been driven by a euphoria fuelled by those now famous “green shoots”. While green shoots began in the form of “less bad” economic data, which signalled the pace of economic contraction was slowing, more recently Wall Street has enjoyed data that can more readily be construed as positive, ie “good”. But the result of the euphoria is Wall Street is at risk of becoming overly optimistic, expecting that all subsequent data will be positive.

Hence a couple of not so good numbers will not necessarily derail the rally, but they will bring a few investors back to earth. Nothing can ever just go up in a straight line, and more and more commentators are wondering just when this market will take a breather and allow more solid evidence to catch up. Last night saw the release of the ADP employment number ahead of Friday’s official number, along with the ISM monthly services index and the monthly factory orders number.

Last month Wall Street was expecting a jobs number showing around 600,000 Americans were newly unemployed, but they were shocked when the ADP release rather accurately predicted a number closer to 500,000. This month, with more optimism, they have been expecting 500,000 again but last night’s ADP number came out at 593,000. This is still better than the 691,000 average over the first quarter, but also not good.

Again, Wall Street was expecting the ISM services index to rebound from 43.7 in April to 46 in May, but was disappointed by only a 44.0 result. An improvement – yes – but not quite up to recent green shoot standard and still under 50, meaning ongoing contraction. The services industries represent about three-quarters of all US industry, even though Wall Street still gets more worked up over the ISM manufacturing number.

March new factory orders fell 0.9%, but Wall Street had pencilled in a rise of 0.9% for April. Not only did the result fall short at 0.7%, the March figure was revised to a fall of 1.4%.

The “less bad” and “green shoot” figures of a month or two ago were exceeding more dour Wall Street estimates. The “less bad” theme is still working, albeit slowly, but Wall Street has clearly become a bit drunk on recent strength. Last night’s numbers are not a shocking wake-up call, just a reminder that these things take time.

And so US stock markets began the day lower and continued to slide steadily during the session. The US dollar fell from 78.55 to 78.38 on the “weak” data. But then a funny thing happened.

The dollar has been on the nose of late as the world has become more and more critical of US government debt and more fearful of potential inflation. America’s creditors in Asia, the Middle East and Russia have argued for a move away from the dollar as reserve currency, and have argued against buying more US Treasuries to support the reserve currency. All this has put the greenback in a rather perilous position.

However, last night a report came out of Reuters, citing the usual “unnamed sources”, suggesting China, Japan, South Korea and India are prepared to wear losses on their US Treasury portfolios, even if the US loses its AAA rating. The reason is that they really cannot find any alternative, liquid asset in which to invest their foreign reserves and, along with Russia, they thus endorsed the greenback as the reserve currency, at least for the time being.

Sounds like someone’s been on the phone.

The greenback has been heavily sold and was probably due a correction. From its 78.38 low last night it bounced sharply to finish up at 79.49. The yield on the US 10-year bond, which has traded as high as 3.72% lately, dropped to 3.55%.

The effect was unsurprisingly that everything which has been bought hard on the back of a weak US dollar of late was sold off last night, and that mostly meant commodities. Oil fell US$2.58 or 3.8% to US$65.97/bbl. Copper, nickel, lead and zinc all fell 3-4% while tin fell 1% and aluminium managed to remain unscathed. Real commodities were hit with a combination of the strong dollar, the weaker than expected economic data, and their arguably overbought status.

Gold tumbled US$17.70 to US$963.90/oz and the Little Aussie Skyrocket had a fizzer, plummeting two cents back to US$0.8002. The euro and pound also took a hit, and this was despite both Europe and the UK enjoying some reasonable “green shoot” data of their own last night.

In its latest rally phase, Wall Street has been driven mostly by higher commodity prices fuelling the materials sector, and last night the Dow fell to as low as 142 points down. That was at 3.40pm, and then those waiting-on-the-sideline buyers swooped on the opportunity and drove the average straight up to only 65 points down in the last 20 minutes. They didn’t, however, prevent a bad night for Aussie commodity stocks. BHP ((BHP)) and Rio ((Rio)) were both down 4% in London and New York.

Ben Bernanke also weighed into the equation last night, reiterating to the House Budget Committee that he saw the end of the “technical” recession probably later this year. He also indicated little concern over recent rises in US bond yields, implying the Fed may not step up its quantitative easing after all. But he did warn the Committee that the government must be serious about fiscal debt reduction in the near future.

The SPI Overnight fell 48 points or 1.2%. It seems the ASX 200 needs to do a bit more work before it can truly claim the 4000 level. Yesterday’s GDP surge also smacked of euphoria running amok, particularly when you realise the bulk of the positive GDP gain was due to a fall in imports.

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