Daily Market Reports | Apr 06 2010
By Greg Peel
Thursday night saw a strong rally in the US resulting in the Dow up 70 points and the S&P reaching 1178. Strength was driven by the ISM manufacturing index which increased to 59.6 in March from 56.5 in February, well ahead of economist expectations of 57.5.
Thursday had been manufacturing index day across the globe. Australia proved the disappointment, with the AiG index falling to 50.2 in March from 53.8 in February. Japan was also sluggish, with a drop to 52.4 from 52.5. But from there results were positive, with China rising to 57.0 (55.8), the UK 57.2 (56.5) and the Eurozone 56.6 (56.3). The UK result represents the fastest pace of growth since 1994, while the US figure is the highest level since 2004.
Australia's poor performance presents the RBA with somewhat of a dilemma this afternoon. With iron ore contract prices set to rise by a possible 100%, and coal having traded up 55%, Australia is looking at a couple of percentage points of GDP being added from bulk commodity exports alone. Given GDP growth is already suspected to have returned to “trend” levels, this would imply our economy will grow faster than that for which even a “normal” monetary policy stance would be applicable. But we are still a good 100 or more basis points below that level.
Australia's manufacturing industry is not a significant proportion of output. But the weak result only serves to highlight that which finance minister Lindsay Tanner was astute and well justified to point out – if Australia's economic wellbeing relies almost entirely on selling commodities to the rest of the world, and China in particular, then our GDP is dangerously under-diversified. Just as was the case in the pre-GFC boom, Australia is running a “two-speed” economy. If the RBA is forced to raise interest rates due to rapid GDP growth and subsequent inflation pressure, those industries and households not benefiting directly from the mining and oil & gas industries will be kicked while still down.
We shall know more this afternoon. But whether or not the RBA moves or stays put this month, economists largely agree that at least a 5.00% cash rate is the target for year-end. So that's four more 25 basis point increases which would have to occur over nine months. Perhaps a rise every other month might be the go, and we had a rise in March.
Returning to the US, the ISM manufacturing index was a stellar result. Clearly economists had expected improvement, but there was underlying concern given February's index – albeit snow-affected – represented a drop. Two consecutive drops would have likely signalled the US economy was rolling over towards the dreaded “double dip”. The index had not seen more than a couple of single-month blips since the rally began last March. And the ISM is considered a reliable leading indicator for the stock market. It had returned to growth in December.
Attention then turned to Friday night's jobs number, which was to be released on the stock market's Easter break. Expectation was for 200,000 new jobs to be added, but whispers had already put the number higher still, particularly given the unknown impact of temporary census employment.
The result of 162,000 therefore fell short, despite representing the greatest number of jobs added in three years. The bond market was the only market open to respond in the US, and the benchmark ten-year yield rose seven basis points to 3.94% as rate rise expectations intensified.
It thus became a question as to how the US stock markets would react last night, and they reacted positively, with the Dow making an early session push toward the 11,000 mark. However, it was not all about jobs given there were two fresh data releases to consider.
In the wake of Friday's ISM manufacturing index came the ISM services index. Service industries represent 80% of US output to manufacturing's 20% so while manufacturing is a traditional bellwether harking back to a bygone day, services clearly carry the clout. The index rose from 53.0 in February to 55.4 in March against economist expectations of 54.0.
This result provided Wall Street with evidence that the US economic recovery is broadly based.
Then came pending home sales, which had fallen 7.8% in January and caused concern. But a rebound of 8.2% in February was another fillip for last night's trade, and led economists to suggest a strong sales period ahead in the US spring. Aside from spring being the season to sell houses, the last of the government's home buyer stimulus expires end-June and sellers are clearly keen not to miss out.
The Dow made it as far as 10, 988 by 11am but lost momentum thereafter, drifting to a close of 10,973 – up 46 or 0.4%. That makes 116 points of positive Dow movement since the ASX closed for Easter. The S&P closed at 1187.
The US dollar index is half a percent higher since Thursday night at 81.14. In recent sessions we have seen a breakdown of the risk trade correlation, the one which has stocks falling if the US dollar rallies. That trade implied a flight to safety but recent dollar strength is all about interest rate rise expectations on the back of economic strength.
For the same reason, oil is also ignoring the dollar. Oil was up another 2% last night after rising on Thursday night and has closed at US$86.62/bbl. Traders are now talking US$90 and maybe US$100.
In one of the first warning shots with regard to the economic drag affected by higher energy costs, Deutsche Bank last night downgraded Alcoa not because of weak aluminium prices – which are strong – but because of rising production costs.
Base metals were closed last night. Gold has nevertheless also managed to creep higher and is currently sitting at US$1131.50/oz.
The Aussie has remained relatively steady at US$0.9216 while the SPI Overnight traded up 11 points on Thursday night but was closed last night.
Attention was not simply focused on whether the Dow could hit 11,000 last night, but whether the US ten-year bond yield would breach 4.00%. With another push from positive economic data, that yield is currently 3.99%. many in the market believe that 4% is a tipping point that could see stocks turn to the negative. It is an important week in the market with another US$82bn in longer dated Treasury debt on offer.
The first of four auctions was held last night and demand was solid. But last night saw US$8bn of ten-year Treasury Inflation Protected Securities (TIPS) up for grabs and it is monetary inflation which foreign buyers of US debt most fear. Foreigners bought 37.5% of this relative small offering, up from a recent average of 34%. It is nevertheless this week's other auctions that are causing anxiety.
The Treasury will auction US$40bn of (not inflation protected) three-year notes tonight, US$21bn of ten-year notes on Wednesday and US$18bn of thirty-year bonds on Thursday. Weak demand for these issues will surely see the ten-year yield push above the 4% mark, fuelling fears that America's creditors are backing away from the seemingly endless supply. This would spark expectations of interest rate rises on two fronts – one based on price inflation from economic strength and the other from a simple need to retain lenders. The two seem at odds with each other, but one must recall that the recovery from March 2008 has been based on a near zero cost of funds provided by the Fed.
Tonight in the US sees the release of the minutes of the last Fed monetary policy meeting which, despite being three weeks old, and despite Bernanke having yet again reinforced his “exceptionally low rates for an extended period” stance, will be carefully evaluated for any clues as to just how long that “period” might be. Wednesday brings consumer credit, Thursday same-store sales from the major chains, and Friday wholesale sales and inventories.
It's an important week in Australia beginning with the RBA's rate decision today, as discussed. Today we also learn the latest ANZ job ads figures, and tomorrow sees the release of our AiG services industry index. On Thursday its the monthly unemployment data and on Friday the AiG construction index.
Elsewhere across the globe, Japan, the UK and the Eurozone will each make their own rate decisions, and there's unlikely to be any change. The UK and Eurozone will also release their services indices while on Friday, China issues its business climate report for the first quarter.
Whatever happens this week, it won't happen on strong stock market volume. Turnover remains poor in the US and now they're blaming the Spring Break, and school holidays are also upon us in Australia.
For further global economic release dates and local company events please refer to the FNArena Calendar.
