The Overnight Report: Please Can We Just Get QE2 Out Of The Way?

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By Greg Peel

The Dow closed down 43 points or 0.4% while the S&P lost 0.3% to 1183 and the Nasdaq rose 0.2%.

I'm beginning to feel like a Chilean miner, kept in the dark for months, waiting for the rescue team to arrive, and whiling away the hours putting up with speculative arguments back and forward. The fact of the matter is the Fed will make some announcement regarding fresh monetary stimulus next Wednesday. The reality is that until then, the speculation will continue to flip-flop.

A while back Wall Street had pretty much settled on US$500bn of QE2 being announced. Then that figure began to blow out, and the latest is that one side of the fence is now talking as much as US$2 trillion. On the other side of the fence, talk is that the Fed will announced only US$100bn as a first tranche in an unknown total that will be dependent on what impact successive tranches have on the data.

One has to favour the latter camp for no other reason that this form of QE2 has been hinted at by the Fed itself. Yet when a Wall Street Journal article reinforced this notion before the opening bell last night, Wall Street panicked and sold. The Dow was down 150 points at lunch time.

The connection is that where goes the US dollar, so goes the US stock market in the opposite direction. At lunch time the dollar index was up 0.7% at 78.27. While dollar strength was largely attributed to tiresome QE2 speculation, it was also aided by weakness in the euro.

PIIGS sovereign debt issues never go away, they just slip outside the radar screen for a while. Then every now and again the familiar blips reappear and credit spreads blow out once more.

Last night the Greek prime minister suggested that if his government suffered a budget cut backlash in the upcoming local elections, he may call an early national election. The Greek government might be currently doing all it can to rein in the country's debt problems, including attacking widespread tax evasion, but unfortunately this does not go down well with the everyman and is perfect fodder for opposition parties to whip up a frenzy among the great unwashed.

As Australians know all too well, politics in the twenty-first century has nothing to do with serving one's country and everything to do with ensuring one's party is in power regardless.

The same story is playing out currently in Portugal, where that government is also facing defeat of its budget cut package in parliament as the opposition party seeks to leverage off public revolt.

The upshot is that both Greek and Portuguese sovereign credit spreads blew out again last night, sending the euro down 0.7%. The Aussie dollar does not feature in the US dollar index basket, but the greenback would also have felt a push from speculative long Aussie positions bailing out yesterday when the weaker than expected CPI figure was announced.

The greenback nevertheless found some selling later in the session and ultimately closed up 0.5% at 78.11. The Aussie had fallen under 97 but finished the overnight session at US$0.9724.

The Dow subsequently bounced to be down only 43 points at the bell. Or did the stock market find buyers late in the session and that turned the dollar around as well? Chicken and egg. 

Amidst all these shenanigans were more US economic data releases and earnings reports.

US new home sales jumped a slightly better than expected 6.6% in August, adding to weight to suggestions that the US housing market is at least stabilising rather than collapsing. The number of homes sold is still down 21% on last September when stimulus-backed buying was all the rage.

Durable goods orders rose 3.3% but that included a few big aircraft orders and if this lumpy and sporadic element is removed, new orders fell 0.8%. Orders (ex transport) have now fallen in July, risen in August and fallen in September, again supporting the notion of a US economy simply banging along the bottom.

Among the earnings highlights for the day, oil and gas giant ConocoPhillips and benchmark white goods manufacturer Whirlpool both posted disappointing results. The large cap energy sector's weakness was a major contributor to the market's drop.

Over in the bond market, a new trend is playing out. 

We know that QE2, in whatever size, will include Fed purchases of Treasuries in the two to ten-year range. Yet QE2 is aimed at having an immediate or short-term impact on preventing deflation, while the risk is freshly printed money may lead to inflation down the track if QE is unable to be withdrawn expediently. When QE2 speculation first mounted, all Treasury maturities were heavily sought after to the point the word “bubble” was being bandied around. Now we find investors are sticking with the short-end but are beginning to ease out of the long end.

Last night's auction of US$35bn of five-year notes found only mild demand, such that the settlement yield of 1.33% was higher than the previous equivalent auction. Foreign central banks bought only 40% compared to a running average of 46%. But Tuesday night's auction of two-years saw the opposite result – strong demand, a new record low yield, and greater than average foreign participation.

The benchmark ten-year yield last night continued its rise, adding another 8 basis points to 2.73%. Long-bond holders are beginning to bottle. Tonight sees the auction of US$29bn of seven-years.

Strength in the US dollar was bad news for gold last night, which fell US$15.00 to US$1324.90/oz. Oil dropped US61c to US$81.24/bbl while base metals in London were down 2-4%.

After a weak session yesterday in the physical, the SPI Overnight decided to rise 13 points or 0.3%.

There are no significant economic data releases in the US tonight. There are 254 earnings reports however, and the highlights include Dow components 3M, Exxon and Microsoft, along with foreigners Deutsche Bank and Shell. Of particular interest to Australians will be the result from BHP Billiton ((BHP)) target Potash, along with sleepy local ResMed ((RMD)). 

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