The Overnight Report: Slow US Rewrites Views

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By Greg Peel

The Dow closed down 74 points or 0.4% while the S&P lost 0.4% to 2106 and the Nasdaq fell 0.6%.

Reversal

It is a truth universally acknowledged that if a market simply refuses to go up, it must thus go down. Usually three failed attempts at a technical level are enough to trigger a pullback, but in Australia’s case a fourth failed attempt by the ASX200 to breach 6000 only increased the likelihood.

So that’s one reason we fell 100 points yesterday. Clearly another reason was Tuesday night’s break-out rally in the Aussie dollar to a three-month high over 80, killing off all the good work done to graft down towards 75 and provide some encouragement for the local economy.

Then there’s the iron ore price. It’s one thing for the oil price to have bottomed and recovered, but it’s another thing for the iron ore price. Joe Hockey thankfully provided the rebound trigger when he called iron ore at 35, and now we’re back near 60. The rebound may yet prove fleeting (and we did see a drop last night), but the market is now wondering whether it’s enough to prevent the RBA from providing another rate cut.

To a combination of technical selling, strong Aussie and reduced rate cut expectations we can throw in a report yesterday from Goldman Sachs suggesting that Australia is indeed at risk of losing its AAA rating.

Interestingly, aside for the Aussie rebound, all of this was known last Friday when the index rallied 80 points. And that rally was largely driven by the same rising iron ore price.

Selling was relatively even across sectors yesterday with the exception of the banks, which did the bulk of the damage by falling 2.3%. If the RBA does not cut, that’s negative for the banks. If Australia loses its AAA rating, that’s negative for the banks. Three of the four big banks will report half year earnings next week.

Mario’s Headache

The rebound in the Aussie comes as a surprise because every man and his dog had assumed the US economy would continue to improve in 2015 and the Fed would respond with a rate rise. The same assumption was behind expectations the euro would fall to parity with the US dollar, and possibly below, on a combination of a strong US economy, and thus dollar, and ECB QE.

Well last night the euro was nowhere near parity, and has rebounded back to US$1.11. The trigger for the latest move up was last night’s US March quarter GDP result. It’s only a first estimate, but at 0.2% growth is a big disappointment compared to 1.0% forecasts.

The German stock market in particular, and French stock market as well, have been rallying strongly in past months on expectations for ongoing falls in the euro, thus improving the economic fortunes of the two big exporter countries. The euro has rallied quietly back as weaker US economic data have trickled out of late, but last night’s GDP was the final straw for stocks. The German DAX plunged 3.2% and the French CAC 2.6%.

The US dollar index fell a full 1% to 95.14.

Fed Acknowledgement

Yes, the US economy has clearly slowed, the FOMC acknowledged in its policy statement last night. However a lot of it to do with “transitory factors”, the statement suggested, just as the same statement had suggested in 2014. For “transitory” read “snow”.

In 2014 the US economy turned around from a contraction into the March quarter to 5% growth by the September quarter. March weakness indeed proved transitory. But will 2015 see a straightforward repeat? Not everyone believes so. For one thing, in 2014 the first Fed rate rise was still at least a year away and the US dollar was yet to accelerate its rally. The greenback is a lot stronger now, weighing on US exports.

In its previous policy statement, the Fed omitted the word “patient” and moved simply to a data-dependent stance, but Janet Yellen did specifically rule out an April rate rise. No great surprise there, but in last night’s statement, the FOMC did not specifically rule out a June rate rise.

So June is still on the table. However, at this stage June is considered unlikely unless the June quarter sees an extraordinary economic turnaround. September has now firmed as favourite for the first Fed move.

This is not particularly new news, so despite being down 150 points ahead of the statement release last night on the weak GDP result, the Dow recovered in the afternoon to a relatively benign close compared to markets in other economies.

Not so benign was the US bond market. Although the Fed in theory left the door open for a June rate hike, its acknowledgment of economic weakness and the market’s assumption nothing will happen before September should not have had much impact on US bond yields. But the US ten-year yield jumped 6 basis points to 2.04%.

The reason is that because for the same reason European stocks were sold last night, so were European bonds. The eurozone bond market is heavily overbought in many an analyst’s view on the back of ECB QE and ripe for a correction. Last night the German ten-year jumped 12 basis points to 0.28%. US bonds were sold on the differential.

Iron Ore Turnaround

It was inevitable that after a strong run, we would see some consolidation in the iron ore price. Last night iron ore fell US$2.30 to US$56.90/t, killing off any hopes for a 60 figure for the time being.

Oil prices had appeared to be consolidating after their strong rebounds but the big drop in the greenback last night, and lower than expected weekly US inventories, provided a second wind. West Texas jumped US$1.74 or 3% to a new 2015 high US$58.65/bbl. Brent rose US97c or 1.5% to US$65.58/bbl.

The LME closed just before the release of the Fed statement but did see the weak US GDP result and the falling greenback. Traders were not prepared to take any risk ahead of the Fed so metal prices were all stronger but on small moves, expect for tin, which fell 1%.

Gold just cannot break out of the gravitational pull of the 1200 mark to any extent, or for any length of time. Last night it fell US$7.20 to US$1204.70/oz.

Today

Technicians will tell you that any breach of 5850 for the ASX200 will signal a more extensive pullback, and yesterday we closed at 5835. With expectations of a pending Fed rate rise, ongoing strength in the greenback and a weaker Aussie now being reconsidered, global markets may be set for further adjustment and subsequent volatility. The SPI Overnight closed down 44 points or 0.8%.

Tonight will see a flash estimate of eurozone April CPI along with jobs numbers, which the ECB will be closely watching. The US will see personal income & spending.

The Bank of Japan will hold a policy meeting today.

In Australia we’ll see private sector credit numbers, which are important to RBA policy.

On the local stock front we’ll see yet another handful of resource sector production reports, a quarterly update from Mirvac Group ((MGR)), an interim earnings result from Ten Network ((TEN)) and Santos ((STO)) will hold its AGM.

Rudi will appear on Sky Business at midday.
 

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