Daily Market Reports | Oct 07 2009
By Greg Peel
The Dow closed up 131 points or 1.4% while the S&P gained 1.4% to 1054 and the Nasdaq added 1.7%.
An article appeared yesterday in UK newspaper The Independent suggesting secret meetings have been underway among some of the world’s finance ministers and central bankers to plot a move away from the US dollar as the mandatory currency for trading in oil. The Independent suggested the Arab Gulf states, along with China and Russia, and more importantly Japan and France, are planning a move to trade oil in a basket of currencies instead. That basket would include the yen, the euro, the Chinese renminbi, a new basket currency unit planned among the Gulf states of Saudi Arabia, Abu Dhabi, Kuwait and Qatar, and, most notably, gold.
As a result, gold began to creep up in the Asian session yesterday to US$1020/oz, but it was when London opened last night that gold really took off. New York then joined in the surge, and gold waved goodbye to its previous high of US$1033. By mid-session New York it had hit US$1045 before finally easing slightly as the US dollar regained some ground. But a late kick has gold currently at US$1042.10/oz (up almost US$25.00).
This was one big influence on Wall Street last night. The other was news that a small but not insignificant economy on the underside of the world had raised its interest rate.
You’d have thought they must have re-released Crocodile Dundee in the US last night, so prevalent was the talk about Australia. The RBA was the first rest-of-the-world central bank to aggressively cut rates post the Lehman collapse, and now is the first to raise again in the wake of the GFC (not counting Israel, or any basket cases such as Iceland). The US dollar opened weaker in New York on a combination of the oil currency news and on the Aussie rate hike. When the US dollar falls, the US stock market rises.
The Aussie is not a currency within the US basket of major trading partner currencies, which fell as low as 76.10 last night before recovering to 76.27 – down another 0.5% from Monday. However the relativities of all major currencies create the desired effect. The Aussie surged over a cent again over 24 hours to US$0.8894.
It is not that Australia’s economy is so globally significant as to turn the entire world around on one interest rate rise. It is simply that the first easing of monetary policy stimulus from a sufficiently major economy is indicative of a global economy in recovery mode. The importance of Australia’s commodity-based economy and its direct connection to China in particular is far from lost on US investors. It was cause enough for Wall Street to put in another solid day of buying, and the materials sector led the charge, along with the gold sector of course.
The US dollar hit its low and gold and the stock market hit their peaks simultaneously around late morning in New York. At that point the Dow was up 175 points. But it was then that Saudi Arabia came out to strongly deny the rumour suggested by The Independent with regards to the US dollar and oil. The Saudi central bank governor, currently in Istanbul for the IMF summit, told reporters the story was “absolutely incorrect”. (More on the story in FNArena later today.)
The Dow fell quickly to be up only 69 points as the dollar rallied back and gold dipped under US$1040. But a late surge in gold and subsequently stocks had the Dow regaining triple digits at the close.
The overnight movement in the price of oil was muted compared to gold, focusing more on the implications of an Australian rate rise than on currency talk. Oil closed up US47c to US$70.88/bbl having peaked at US$71.77.
And over in London, finally the Ashes were forgotten. “The Australians changed the game,” one trader told Basemetals.com, “that rate hike sent a signal that the bigger picture is changing. This price strength is not just a [US] dollar move”.
Base metal prices were indeed higher last night, albeit held back somewhat by across the board increases in inventories. Aluminium and lead rose 0.5%, tin 1%, copper and zinc 1.5% and nickel 2.5%. Copper received added support from news of potential strike action in Chile, where annual miners’ wage negotiations are underway. Striking for higher pay each year is now an annual event (except for last year).
While gold was up 2.5% last night, silver jumped 4.3% to US$17.31/oz.
The irony of all this global focus on the Land Downunder, which sent New York up 1.4%, Hong Kong up 1.9%, London up 2.3% and Germany up 2.7%, is that the Australian stock market did the opposite. After a very weak Friday and a holiday Monday, the ASX 200 opened up 50 points from the bell yesterday on the back of the Wall Street surge but quickly gave most of that back ahead of the RBA decision at 2.30pm. Despite economist consensus (other than the most astute of commentators) suggesting the RBA would remain on hold, the Australian stock market clearly decided a bit of profit-taking was sensible just in case. When the rate rise was announced, the ASX 200 stumbled to a close of only up 18 points.
So why is the rest of the world so enthusiastic about Australia and Australia isn’t?
It comes down to how one interprets an interest rate rise. Traditionally rate rises are bad for stock markets, because they (a) increase the cost of funds and reduce the face value of discounted future corporate earnings and (b) they affect an increase in bond yields at the expense of dividend yields, making bonds look more attractive. Furthermore, rate rises are traditionally seen as bad for banks – a significant weighting within the ASX 200 – as they reduce the demand for credit and squeeze margins.
However, such traditional responses are more relevant in an economic boom. If the economy is already strong, then a rate rise is seen as a move by the RBA to step on the brakes. But in this case, being the first rate rise from an historically low level post-GFC, the RBA is indicating it no longer sees economic disaster as a threat. It is a vote of confidence in an Australian economic recovery more than an attempt to rein in a runaway economy. Indeed, the RBA did not use the expression “tightening monetary policy” yesterday, but rather it used the expression “lessening the stimulus”.
On that basis, the rest of the world saw Australia’s move as a vote of confidence as well – a vote of confidence in the global economy. In this day and age, everyone is part of one big global economy. And moreover, the more “micro” consideration of bank margins being undermined by a rate rise has long been in dispute. Australian banks have proven over recent years that they can just as easily maintain solid margins when interest rates are going either up or down. Again, a rate rise could be interpreted as good for banks if it indeed confirms a recovering economy.
But has the RBA done the right thing? History suggests that central banks always go one step too far on the upside and one step too far on the downside. In retrospect, the RBA’s last rate rise (from 7.00% to 7.25% in March 2008) was foolish, but then the RBA did lead the rest of the world in madly easing post-Lehman. After the 7.25% peak, the RBA cut by 0.25%, 1.00%, 0.75%, 1.00% and 1.00% to get to 3.25%, before finally cutting to 3.00% in April. Was that last cut the “one too far”? If so, we are only now back where we should be, perhaps.
There is still a strong argument to suggest that a rate rise in Australia is premature. The effect of fiscal stimulus is winding down. Business credit demand continues to weaken. Unemployment is still rising and the significant drop in hours worked acts as quasi-unemployment. Across the globe, interest rates are at historically low levels and credit spreads have shrunk back to less panicked levels, but the credit multiplier remains at post-war lows (meaning the number of times the same dollar is lent as credit, also known as the velocity of money). A low credit multiplier is very disinflationary, but the RBA has moved based on fears inflation will return.
And then there’s the Aussie dollar. It is clear that the Australian economy has recovered far more quickly than the US economy (and it was never as weak) which is one reason why the AUD/USD exchange rate has soared. The world has been anticipating an RBA rate rise sooner rather than later, while the Fed has staunchly indicated it will not move from near zero for a while yet. But the US is also running up an enormous twin deficit as it continues to issue record amounts of government debt, while down in Australia, the government is already considering holding back on earlier debt issue plans. And then you can throw in rumours of the demise of the US dollar as reserve currency, such as the oil currency situation above. All of the above is behind a weak US currency and a resurgent Australian currency.
A stronger Aussie dollar acts as a natural tightening mechanism on the Australian economy. Imported goods become cheaper, thus reducing inflation pressures, while repatriated profits from commodity (and other) exports fall in value. Investors need to be fully aware that stock analysts have already started to rein in earnings expectations for exporters based on a stronger Aussie. These are offset by commodity price rises, but the point is there’s a cancelling out effect. Exporters do not simply make more and more money (in Aussie) when commodity prices rise (and that goes for gold too).
So how will the local stock market react today? The SPI Overnight was up 59 points or 1.3%.
Note that tonight in the US Alcoa reports its third quarter profit, the first major outlier to “officially” kick off the US earnings season.
