Daily Market Reports | Feb 18 2010
By Greg Peel
The Dow closed up 40 points or 0.4% while the S&P gained 0.4% to 1099 and the Nasdaq added 0.6%.
I suggested yesterday that the outcome of the euro-zone finance ministers' meeting in Brussels – in which no new details were offered on Greek debt protection – might not have been well-received by the market but for the fact the market was already well short euro. And so it was that positive US economic data actually brought in some US dollar selling and sparked a sharp short-covering rally in the euro.
This was easy to pass off as a positive reaction to the euro-zone ministers' tough stance on Greek budget reduction, but that would be to miss the point. Nothing has changed, and indeed nothing had changed last night either when, despite no new news, the euro turned around and ran straight back down to where it came from. Over two sessions, the euro is now little changed.
The effect of Tuesday's night's big run-up in the euro was to send the US dollar on its biggest down-day in weeks. This in turn sparked aggressive short-covering in commodities and sent gold racing back up over the US$1100/oz mark. But last night's reversal in the euro affected an equivalent rally in the US dollar index such that it, too, is now back around where it was two days ago, at 80.39.
Thus in theory, commodity prices and stock indices should all have turned around again last night and ran back down as well. This would have been rather ominous for Australia, which yesterday posted its biggest gain for the year as if the whole European crisis had been solved overnight. But instead, commodity prices and stock markets held firm. European markets even rallied to catch up with the late US and Asian sessions of yesterday.
So last night we had gold slipping back only US$3.40 to US$1116.00/oz and oil actually adding US27c to US$77.30/bbl. Base metal markets closed in London on small, mixed moves, and the Aussie only slipped back slightly to US$0.9000. This is not what one would expect when the US dollar index rallies 0.9%.
Is it that the world is now happy to consider Europe as somehow quarantined, that the EU is on the case, and that we might as well carry on where we left off because nothing much new is going to happen in the meantime? This would be an interesting scenario, given the world thought exactly the same thing about the US in late 2007 at the time of the subprime crisis. But at least from last night's perspective, the data are pointing to a recovering US economy.
Last night it was revealed US housing starts rose a better than expected 2.8% in January. Building permits (the step before housing starts) fell 4.9% but economists brushed this off given the previous two months showed substantial increases.
US industrial production rose 0.9% in January, in line with expectation. The number was driven by a 1.0% gain in factory output following a 0.1% drop in December. Capacity utilisation (the percentage of factories etc active and not sitting idle) ticked up from 71.9% in December to 72.6%. This is the highest level since December 2008.
These two numbers alone were enough for commodity markets in particular and the stock market in general to rethink the standard response of selling off on a US dollar rally. Adding to the enthusiasm was a Fed increase in forecast US economic growth for 2010 – from 3.0% to 3.2%.
This increase was contained in the minutes of the previous Fed meeting, released last night. The contents of the minutes were also a driver of US dollar strength which would have assisted in pushing the euro back down.
As it stood before the meeting, the plan was that the Fed would wind up the last of its quantitative easing strategies, being those of buying debt assets and mortgage assets in particular, by end-March. The Fed was also looking at raising the discount rate – the rate at which banks can go to the Fed for emergency loans – shortly as a precursor to an eventual cash rate rise.
The minutes revealed that this was quite a heated meeting. Several of the board members pushed for a more rapid reduction in the Fed balance sheet, meaning they wanted the Fed to sell the assets it bought in the emergency back into a market which is now more ready to absorb them. Including mortgage assets. But Ben Bernanke would not be rushed, and his original timetable remains intact.
What the Fed will shortly do soon, nevertheless, is raise the discount rate. But this step would be to re-establish the previous spread of the discount rate over the cash rate, such that a cash rate rise need not follow so quickly (and if it does the discount rate would go up again as well). But the simple fact that there is now widespread dissent in the ranks of Fed members tells Wall Street that an eventual cash rate rise is looming ever closer.
And so the ten-year Treasury bond shot up last night by 8 basis points to 3.73%. America is getting ready for an interest rate hike, although many economists still do not expect one in 2010.
The interesting thing here is that while an interest rate hike might reflect a recovering US economy, one would have previously expected similar moves in Europe. But there seems little reason why the ECB would now consider raising its cash rate in the near term given the current debt crisis and some limp GDP growth numbers. This means the US dollar can continue to rally, rather than decline steadily on the back of its deficit as many in the world had assumed would be the case from here on.
And that rather puts a prick in the reflation trade bubble. A recovering US economy should be good for commodity prices, but not if they are fighting against a stronger greenback. China, of course, is the big influence in commodity prices, and we are setting for big jumps in iron ore and coal contract prices this year, but China is currently going the other way and attempting to slow down its economic growth.
Interesting times. What we've experienced since mid-January is a stock market correction sparked by Europe that most in the market were happy to take on the simple basis we'd run too hard in a straight line anyway. But even if we now consider the European crisis as quarantined, where do we go from here? Onward ever upward?
The SPI Overnight gained 12 points or 0.3%.
[Note: All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts in the Cockpit and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.]
