The Overnight Report: I’m Still Here, Says Europe

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By Greg Peel

The Dow fell 107 points or 1.0% while the S&P lost 1.2% to 1091 and the Nasdaq dropped 1.1%.

Over the last couple of months, global focus has swung squarely back upon the world's largest economy as US economic data have first weakened alarmingly and then more recently picked up a notch to relieve some of the angst. Europe, however, had shifted well out of the spotlight.

It was late July when almost all European banks “passed” the stress tests applied by the ECB which assessed whether the banks were in a sufficiently strong position to weather increased global and regional risk. There was at the time, however, scepticism from a market that saw the tests as being specifically constructed so that nearly all banks passed.

But the strength of that scepticism waned over the ensuing period as the eurozone, courtesy of a weaker euro and stronger German exports, appeared to be putting in better economic data results than the US thus allowing it to slip back out of the fear spotlight. There's been some worry over Irish banks and debt, but the market had long written off Ireland as a basket case.

Well, now the scepticism is back. A report in the Wall Street Journal last night – possibly held back until the end of the summer holidays – suggested the stress tests understated the levels of risky European sovereign debt being held on European bank balance sheets. The WSJ nevertheless admitted exact levels were hard to nail down given the limited disclosure of test results, and naturally the banks in question denied such claims.

Adding to concerns were data released showing German manufacturing orders had fallen 2.2% in July when a 0.4% rise was expected.

The result was that the spread between Irish sovereign debt and benchmark German debt blew out to its highest level since the introduction of the euro, and Portuguese debt also stretched its spread. Markets were also unsettled by demonstrations in the UK and France against austerity measures which reignites concerns that European deficit reduction by austerity will not be tolerated by electorates, leading to sovereign instability.

With no US data releases last night there was little for Wall Street to do other than sell. However, the selling cannot be taken as representative of the intention, in light of the recent rally, of traders and investors returning from vacation. The handful of players who did wander back into the office, dusting the sand off their feet, were not ready to play ball just yet. Volume on the NYSE was back to the depths of a dull August at 800m turnover.

Commentators suggest that while the Labor Day holiday marks the end of summer, it's really another week before Wall Street offices refill. And those coming back on board are not just going to dive in until they get their heads back on a Wall Street wavelength.

So after five days of rally no one was putting too much stake in the Dow's 100 point fall, albeit the counter-trade was also apparent as the US ten-year bond yield lost 10 of the basis points it had been grafting back last week (2.60%).

Renewed European fears also threw a spanner in the works Treasury auction-wise. Wall Street would have been hoping that demand for this week's auctions would ease on a better stock market performance, but last night's three-year note auction met with strong demand and settled at a record low yield of 0.79%.

Underlying demand, we must remember will always be the knowledge that the Fed is (a) rolling maturing mortgage securities into 2-10 year Treasuries and (b) is ready to outright buy more Treasuries if things go too pear-shaped. Renewed concerns over Europe makes things look a bit fruity.

The US dollar index unsurprisingly jumped 1% to 82.89 on euro weakness helping the Aussie to fall 0.8 of a cent to US$0.9099. But the Aussie had already pulled back in yesterday's session when the RBA kept rates on hold and a Labor government ensured some sort of mining tax.

Gold added US$5.50 to US$1255.20/oz.

There was a brief panic on the LME last night when someone started a rumour that the Chinese were selling, but this was quickly dismissed and the metals bounced back from session lows to end the day mixed on smallish moves. Oil fell US51c to US$74.09/bbl.

The SPI Overnight dropped 21 points or 0.6%.

On the subject of the Australian election result, it was hardly a surprise to see the ASX 200 go nowhere as soon as Tony Windsor spilled the beans yesterday, despite warnings from some that a Labor victory would spark a big sell-off in the mining sector. The past two weeks have always suggested, in my mind at least, that a Labor government would be more readily formed than a Coalition government, even as fortunes appeared to swing back and forward.

I'm sure the market generally saw it this way as well, perhaps simply looking at a surprise Coalition victory as a outside-bet bonus. But at the end of the day, the local market rallied last week on Wall Street strength and positive Chinese data and really any election result was neither here nor there. In that context, if you want to nail down what impact a now certain, but perhaps further watered down, mining tax might have, consider this:

At the close of yesterday, shares in Fortescue Metals ((FMG)), self-acclaimed distraught victim of any form of MRRT, closed higher than they did the day before the original RSPT was announced in May.

Go figure.

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