The Monday Report

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By Greg Peel

By Friday morning in New York a Dow Jones poll indicated consensus expectations for the US July jobs report to show 100,000 jobs added. The actual result was therefore a positive one, coming in at 163,000. The unemployment rate nevertheless rose in July to 8.3% from 8.2%, however this figure is impacted by the re-entry of previously disillusioned jobless into the job market, and thus may also have a positive tone from a confidence perspective.

It was not a volatile session on Wall Street on Friday – the indices jumped from the bell and while drifting a little on the death, remained fairly steady all day. The Dow closed up 217 points or 1.7%, the S&P gained 1.9% to 1390, and the Nasdaq added 2.0%. All losses for the week were recouped.

One may wonder, however, given Wall Street's current mindset, why one decent monthly jobs number is worth such a rally. Not only does it go some way to alleviating the need for the Fed to take further “emergency” action, we need also take into account that the capitalists on Wall Street are not, on average, Democrat voters. They would rather see Obama and his tax policies ousted, and with Romney starting from behind it would need ongoing poor jobs data to increase the chances. As we approach the election, and the “fiscal cliff” looms large, such matters will become more influential.

So why such a positive response? The answer is that it was not the jobs number per se which sparked Friday's rally, because Wall Street shot up from the bell before the data were released. The rally was all about Europe, with a bit of a jobs kicker.

I have made note on previous occasions in this Report that one should not gauge Wall Street's response to a Fed statement from the last couple of hours of trade on the day of the release. The smart money steers clear of the initial volatility invariably driven by traders, takes time to assess, and makes its move in the following session. Thus often we'll see a knee-jerk weak response on the day followed by a reversal the next day, or vice versa. On this occasion Wall Street has been true to form, except this time we're talking about the ECB and not the Fed. And a similar response played out in European markets.

One might suggest Mario Draghi was a little ingenuous in throwing in the “whatever it takes” line one week from a potentially significant ECB meeting. It served only to encourage market volatility. When “whatever it takes” did not manifest on Thursday, the world was initially angry. This was the knee-jerk response.

Yet Draghi's commentary on Thursday did not by any means kill off the notion of significant ECB action. Just as the Fed is prone to string Wall Street along with “if needs be” statements, Draghi assured that the ECB was indeed ready. On that basis, Thursday's ECB meeting need not to have sparked a global sell-off (the DAX fell over 2%), rather markets should have remained in limbo mode. Draghi specifically noted that neither Spain nor Italy had asked for a bail-out and that until such time, the safety catch would remain locked. Italy immediately declared it would not need a bail-out, but Spain was a bit coy.

Which brings us to arguably the real reason for Friday night's rally (the DAX was up 4%). Indications were that Spain was indeed preparing to go cap in hand. It's hardly a stretch of reasoning – Spain has already asked for and received an E100bn line of credit to support its banks and, in the interim, two of Spain's provincial governments have asked the national government for a bail-out. It seemed only a matter of time.

The funny thing is that over the past three years, markets have tanked intermittently as first Greece, then Ireland, then Portugal, and then Greece again have approached the troika for help. And as each “domino” fell, the fearful cry was “What if Spain goes?! The sky will fall!”. And now here we are, with a big rally on global markets on anticipation Spain will ask for a bail-out. Just as Wall Street has often welcomed bad economic data as being a prompt for Fed QE, now the world is egging on Spain to capitulate. Then, and only then it seems, will we get the action from the ECB, for which we've been waiting the past three years.

At a press conference on Friday the Spanish prime minister said he had made no decision yet (on a bail-out) and is waiting for the ECB to better outline its bond-buying plans. We know, so far, that Draghi intends to attack shorter maturities once he gets the green light. So if Draghi and Rajoy can sit down and collectively endorse a plan, the only obstacle becomes the German Constitutional Court challenge to Germany's participation in the EFSF/ESM, the decision on which is due in September.

On Friday night a senior member of Angela Merkel's coalition suggested there would be no objection to bailing out (via bond purchases) the “less risky”, larger states of Spain and Italy, implying the opposite would likely be true were, say, Greece to go back for yet another round.

Put it all together, and we had a rally.

Friday was also service sector PMI day across the globe, which provided mixed results. For two-speed Australia it was another depressing result following on from the shocking manufacturing PMI, with the services PMI falling to 46.5 in July from 48.8 in June. China's results provided a familiar conundrum, with the official number falling to 55.6 from 56.7 but HSBC's number rising to 53.1 from 52.3. At least all numbers are over 50.

The eurozone surprised with a slight improvement to 47.9 from 47.1, albeit the zone's composite measure (combining manufacturing and services) fell deeper into contraction. The UK slipped to 51.0 from 51.3. The real surprise came from the US, which posted 52.6 against 52.1 when economists had expected a decline.

So Wall Street was presented with both a good jobs number and a good service sector number. Other data last week were more positive than negative for the most part as well and the US housing sector continues to show tentative signs of improvement. June quarter corporate earnings have proven flat year on year, and revenues have fallen, but Wall Street puts a lot of the blame on Europe. So – could we actually be looking at a quite positive scenario playing out?

Many on the Street are begging for QE3, but the smart money knows QE is little more than a sugar pill. It provides an instant high but too much sugar will lead to health problems down the track. What if the US economy was in a sufficient state to avoid QE3, and the ECB provides a big sugar pill for Europe? Would not the stars be aligning? It might just be the stuff of rallies.

We won't count our chickens yet – Lord knows we've been disappointed so many times in recent years.

Another anomaly of sorts is the reaction of the euro at this time. On Friday night the euro shot up a whopping 1.6% and sent the US dollar index crashing 1.1% to 82.37. If the Fed announces QE, the dollar goes down. Yet on anticipation of ECB action, the euro shoots up. For Europe, the relief of central bank support outweighs the devaluation impact of “money printing”.

When the US dollar goes down, commodity prices go up. Throw in a good US jobs number, and “risk on” becomes attractive once more. Base metals all jumped 1-3% in London on Friday night, but oil was where the action was. Brent crude jumped US$3.04 to US$108.94/bbl while West Texas leapt US$4.11, or almost 5%, to US$91.24/bbl. The gold price rose US$15.70 to US$1603.70/oz.

The most interesting moves were in the bond markets. Both the Spanish and Italian short date (two-year) bond yields plunged 50 basis points, dragging the benchmark ten-year yields down 30-odd points to 6.82% and 6.06% respectively. On the flipside, Germany's ten-year jumped 10bps to 1.42% and the US equivalent followed suit, rising 10bps to 1.57%.

It's time for the ECB to deliver. We may yet have to wait another month or so, nevertheless.

The Aussie jumped a cent to US$1.0563 and the SPI Overnight was up 58 points or 1.4%.

The Fed, ECB and BoE all held policy meetings last week and no immediate changes were made. There is also little expectation the RBA will see reason to provide another rate cut on Tuesday. With stock markets feeling more confident about Europe, the RBA can focus domestically and let the earlier 75bps of cuts continue to flow though the system and the data. Interestingly, the June quarter GDP result will be released the day after the September RBA meeting.

It's a bank holiday today in NSW, but the ASX will trade as normal. Today we'll see the ANZ job ads series and the TD Securities inflation gauge. Tomorrow is the rate decision, and on Wednesday it's the construction PMI, housing finance and investment lending. Australia's jobs numbers are released on Thursday, and an RBA quarterly bulletin will wrap up the week on Friday.

On Thursday we'll see China's monthly data dump of inflation, industrial production and retail sales numbers.

It's a quiet week in the US this week for economic releases, with Thursday's trade data the highlight. The US earnings season is still running, but is now rapidly tailing off.

The opposite is true for the Australian result season, which steps up the pace this week. Result highlights include Bradken ((BKN)), Cochlear ((COH)) and Leighton ((LEI)) tomorrow, Rio ((RIO)) and Stockland ((SGP)) on Wednesday, News Corp ((NWS)), Tabcorp ((TAH)) and Telstra ((TLS)) on Thursday, and Crown ((CWN)) and Goodman Group ((GMG)) on Friday.

But, as usual, all eyes will be on Europe, and specifically Spain. When will Rajoy approach the troika this week?

Rudi will appear on Sky Business on Thursday at noon and again at 7.30pm on the Switzer program. 

For further global economic release dates and local company events please refer to the FNArena Calendar.

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