The Overnight Report: Looking For Direction

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By Greg Peel

The Dow closed up 37 points or 0.3% while the S&P was flat at 1123 and the Nasdaq gained 0.2%.

I noted yesterday that on Friday Wall Street traders were reluctant to carry positions across the weekend, wary of any untoward developments out of Europe or anywhere else. Aside from a bit more argument across the political divide in Europe, the only major development ahead of Wall Street opening this week has been the impending fall of Gaddafi. 

So on Friday night the Dow closed down 172 points – a movement ignored by the Australian market yesterday – and from the bell last night the Dow was up 200 points. We'll call that square. There followed a choppy session in which the Dow returned to almost flat, then rallied 100 points, then faded to the close.

All things being equal this will probably be the way of things this week, ahead of Bernanke's speech at Jackson Hole on Friday. Of course anything could emerge from Europe in the meantime to impact on markets one way or the other, but that side the world is waiting to hear if the Fed might once again come to the rescue, just as it did the same time last year. And there aren't too many US economic releases between now and Friday, when the US June quarter GDP result will be revised.

There is a heightened feeling among many that QE3 has become a given. Last night's session was not one of panic and stock market volumes were of the usual quite summer's day variety, yet gold rallied another US$45.00 to US$1898.10/oz. Clearly gold is the general safe haven of choice at present, but it would appear the world is preparing for the inflationary effect of further quantitative easing given QE simply means printing more money.

There is nevertheless a very real risk the world will be disappointed on Friday. For starters, Bernanke did not actually confirm QE2 at Jackson Hole in 2010, he simply outlined the possibilities. It took another month for stocks to actually turn on actual confirmation. Secondly, Bernanke has already outlined some “unconventional” monetary policy options for 2011 in Fed statements to date, and none of them include actual QE (purchasing Treasuries). Indeed one option has already been adopted – that of a zero cash rate fixed for two years. 

When QE2 was announced last year, there appeared, as there does now, a very real risk the US economy would double-dip. But inflation was also negligible, and all talk was of the US sliding into a Japanese-style period of deflation. This time, by contrast, recent inflation figures have been on the rise in the US. Bernanke has previously intimated that disinflation would be the trigger for further monetary policy action.

Other QE3 options suggested either by the Fed or from others so far include lowering the US bank deposit rate with the Fed to encourage more lending into the economy, selling the short-end Treasuries in the Fed balance sheet to buy longer dates, and even using Fed funds to physically buy US houses. The questions which arise are (a) would any of these other measures be as effective as straight QE and (b), what exactly did QE2 achieve?

The first question is possibly redundant if you consider the cynical answer to (b) is a big, fat nothing. The S&P 500 is today lower than where it was at 2010's Jackson Hole meeting (although it went lower still into September), we're still talking double-dip, and Europe has not gone away. The latter is important, because it has driven the sort of fear that encourages businesses and consumers all over the globe to be cautious and frugal, which in turn, from a “state of mind” point of view, implies a recession. All QE2 really did was provide temporary hope, and it coincided with a rebound in economic data from earlier depths (US December quarter GDP growth was 3.1% on the final revision) before levelling off once more (March quarter GDP growth 0.4% on the final revision).

Is it a bad thing to provide some hope? Well no, but as we all know the best way to avoid a hangover is to keep drinking. Yet we can't escape that hangover forever.

Coming back to Libya, the expectation last night was that Brent crude must rapidly lose its premium over West Texas which to some part has been driven by Brent playing substitute in Europe for lost Libyan production, but as it was Brent only lost US26c to US$108.36/bbl. So instead, traders speculated on the closing of the spread by buying West Texas, which rallied US$2.01 to US$84.42/bbl. It's a risky trade, given the spread is more about declining volumes in the North Sea and oversupply at landlocked Cushing than it is about the Arab Spring.

But within the West Texas rally was also the same QE3 speculation, given more money printing devalues the US dollar and if the dollar falls by default commodity prices must rise. They weren't listening in London however, given base metals last night closed down 1-2%. The US dollar index was actually up 0.2% to 74.14.

US bonds were relatively steady, as was the Aussie at US$1.0409.

After a rock and roll session on Bridge Street yesterday, the SPI Overnight closed up 2 points.

If Wall Street does manage to remain directionless this week, and the Europeans don't manage to stuff things up any further, Australia can continue to concentrate on earnings season. It's been a mixed bag so far.

Earnings highlights today include Foster's ((FGL)), Mirvac ((MGR)), Origin ((ORG)) and Sonic Healthcare ((SHL)). 

And remember China? Today sees the release of HSBC's “flash” manufacturing PMI estimate for August. 

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