The Overnight Report: Six Months Or That Type Of Thing

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By Greg Peel

The Dow closed down 114 points or 0.7% while the S&P lost 0.6% to 1860 and the Nasdaq dropped 0.6%. Prior to the release of the Fed statement at 2pm, all indices were flat.

“Six months or that type of thing.”

This is the definition provided by Fed Chair Janet Yellen during last night’s press conference as clarification of the expression “a considerable period”, which the Fed statement suggests is the gap between when tapering ends and the first rate hike occurs. This definition was worth about a hundred Dow points to the downside, in a heartbeat, at a time the Dow had already rapidly fallen around a hundred points.

The first hundred points was mostly a response to the confirmation the Fed’s tapering program would be complete “by next fall”, which was then clarified to mean “this fall”, which in the northern hemisphere suggests November at the latest. Then add the “considerable period” of a minimum six months and we’re looking at mid-2015.

Clearly this timeframe is a lot quicker than Wall Street has been building in. However the smart money never trades the market in the afternoon of the statement. There are invariably knee-jerk reactions, algorithms run amok, and a true picture rarely emerges. It’s usually the following session, after everyone has had more time to assess the information, which provides the more measured adjustment.

Janet Yellen has just endured her first lesson in how to conduct a press conference. It would appear she could use some more experience. The bottom line, nevertheless, is that in reality not a lot has changed. Go back a year or more and the Fed was targeting the first rate hike around mid-2015. One difference between then and now is the old unemployment rate target of 6.5% as a trigger has been tossed out and replaced with a wider set of economic measures, although that has been assumed for some time. Importantly, everything still depends on the data. Fed policy can just as easily be altered as it can be specified.

Going into the press conference, Wall Street most likely expected Yellen to be a little more dovish, perhaps discuss the weather and hint at the tapering pace being eased if the US economic recovery appeared hampered. By sticking to the game plan, and “defining”, at least to some extent, the meaning of “considerable period”, Yellen has come across as hawkish.

The fallout can be summed up in four distinct market moves. The Dow closed down 114 points, although it was down 210 at one point, the US ten-year bond yield jumped 9 basis points to 2.77% (with a high in the session of 2.80%), the US dollar index jumped 0.8% to 80.03 and gold fell US$26.00 to US$1329.30/oz.

From an Australian perspective, the Aussie is down 0.9% to US$0.9041 and the SPI Overnight closed down 34 points.

These are immediate reactions. If we reflect, we might firstly suggest (1) Fed policy hasn’t really changed, (2) it still depends on the economic data from here and (3) the sooner the world is rid of QE, the sooner the world is functioning under its own capacity. And it must be noted that tapering does not end QE, it just stops it growing. The actual wind-down of QE will likely progress as a natural attrition of maturing bonds and mortgage securities and thus could take a decade.

Were markets to be functioning without further funny money assistance then asset valuations are less likely to “bubble”, reducing “bust” risk down the track. If stock PEs regress towards averages then stocks are more attractive to investors wondering what to do from here.

Now, on to China.

The price of copper initially drifted lower on the LME last night before triggering further technical selling and stop-losses. Recent weakness has had a lot to do with fear surrounding Beijing’s clampdown on the “shadow banking” practice of copper financing. But then news came through Chinese copper producer Jinchuan had declared force majeure on its contracts due to severe technical problems, suggesting output would fall some 100,000t. The copper price bounced and a short-covering scramble ensued. Copper ended the session up 1.5%.

More concerning was news yesterday unlisted Chinese property developer Zhejiang Xingrun Real Estate had collapsed owing some RMB3.5bn (USD570m), including 2.4bn of loans from 15 different Chinese banks and 0.7bn in illegal, or “shadow banking”, borrowings.

National Australia Bank reports Xingrun’s interest rates on illegal borrowings were between 18-36% and that property developers use land as collateral, hoping that rising real estate prices will service their debt. Land prices have fallen in the city of Fenghua, where Xingrun operates.

NAB suggests at this stage it would be premature to assume evidence of systemic risk in this first failure, given Xingrun’s collapse may simply reflect poor business practices. But NAB does point out that at in 2013, China’s real estate sector represented 16% of GDP, 33% of fixed asset investment, 20% of outstanding loans, 26% of new loans and provided 39% of government revenue.

On that cheery note, let us return to last night’s markets.

Copper was the only move of note among the base metals last night, which otherwise closed flat ahead of the Fed statement release. Spot iron ore was unchanged at US$110.50/t.

US weekly crude inventories fell short of expectation so West Texas rallied US64c to US$100.34/bbl when Brent fell US78c to US$105.87/bbl.

As noted, the SPI Overnight fell 34 points or 0.6%.

Wall Street can now go back to plain old data watching, although it will be interesting to see what tonight’s more thought-through reaction to Yellen’s bombshells will be, if we can call them bombshells.

Locally, Myer ((MYR)) reports its interim earnings today and today is also stock index derivative (XJO and SPI) expiry day on the ASX which can generate its own volatility.

Rudi will appear on Sky Business at noon and again between 7-8pm on Switzer TV.
 

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