The Overnight Report: The Rising Problem

This story features DEXUS. For more info SHARE ANALYSIS: DXS

By Greg Peel

The Dow closed down 174 points or 1.0% while the S&P fell 1.2% to 2041 as the Nasdaq fell 1.5%.

Fail

The ASX200 did not make it back to 5000 yesterday, peaking out at midday at 4984 as momentum stalled. Having already jumped over 3% the day before on a turnaround in the oil price, the energy sector managed only a 1.4% gain despite oil prices being up 3% overnight.

The market appears not yet convinced there is any reason for a push above 5000 at this point. When that’s the case, the only other way is down. Last night Wall Street provided the incentive for a possible lower low to be established today on this most recent down-leg.

While news that Arrium had placed itself into voluntary administration was hardly a shock to the market yesterday, it does highlight the extent of the reversal of fortunes of Australia’s economy from the heady days of the China-driven “super-cycle”. Is the steel industry in Australia set to go the way of the car industry? BlueScope’s hanging in there, but unlike Arrium, BlueScope doesn’t mine iron ore. And it sells Colorbond rooves, not construction girders.

If Arrium goes under so does the town of Whyalla, and that means increased unemployment. Arrium can’t move the market anymore but it can impact on sentiment.

Only the telcos and consumer discretionary finished in the red yesterday. The banks managed a 0.3% gain but that might change today.

Watch the Yen

The Japanese yen is the world’s “safe haven” currency. This might seem strange given the Japanese economy has been in the doldrums for 25 years but it was Japan’s persistent deflation that long ago created the “yen carry trade” that has served to drive the value of risk assets globally ever since.

Given Japan’s ultra-low interest rates, which existed long before the GFC, investors can borrow in yen at next to nothing and invest in the likes of the US, Europe or Australia to receive an “arbitrage” return on the yield differential. This requires selling yen and buying the currency of the target assets. That “arbitrage” only works so long as yen exchange rates remain relatively stable. If global risk begins to increasingly worry carry trade investors, foreign assets are sold and yen loans repaid. The result is a rising yen. The yen thus appears to be a “safe haven” currency because whenever risk increases, the yen rises.

Last night the yen hit its highest level against the US dollar in almost 18 months. The yen’s rise has been exacerbated by weakness in the US dollar since the Fed started backing down on its rate rise plans. Wall Street had not been paying a lot of attention up to now but when last night the Japanese government said they would not intervene in the currency, the world took notice. The last time the yen hit this level the Bank of Japan shocked the world by announcing a massive expansion to its QE program. More recently the BoJ has cut its cash rate into the negative. Last night the BoJ confirmed it will “undertake additional monetary easing measures if necessary”.

Which opens up the prospect of the Japanese cash rate going even further into the negative. The issue here is the “race to the bottom” among central banks, each equally desperate to devalue their currencies so as to maintain export competitiveness. If Japan goes again, then Europe would likely have to follow, and China. The Fed would likely need to hold out on raising for longer.

Hence the US ten-year bond yield fell 6 basis points to 1.69% last night. The German equivalent fell to 0.09%. The German yield curve is negative almost up to ten years. How does a bank make money on loans if rates are negative that far out on the curve?

Well they don’t. Last night European banks came under renewed selling pressure. The German index closed down 1.0%. On Wall Street, the primary driver of last night’s fall was a hammering of the financial sector.

And that, of course, prompted renewed calls of “overdone” and “oversold” when it comes to the US banks. Outspoken JP Morgan CEO Jamie Dimon, for one, described his bank as so well capitalised it is a “fortress” that would remain standing even if every other bank in the country went under.

With oil prices coming off slightly last night after Wednesday night’s big rally, there was no oil correlation support provided to offset weakness in the hefty financials sector. Yet traders are not overly concerned. Most have been expecting a pullback following the sharp rebound rally off the mid-February lows. Some are even salivating at the prospect of cheaper entry prices ahead of the earnings season, which begins next week. Earnings expectations have been marked down so low as to suggest, as has so often been the case in past quarters, that upside surprise is almost inevitable.

Commodities

West Texas crude is down US20c at US$37.53/bbl and Brent is down US22c at US$39.59/bbl.

Constant talk of slowing global growth is not providing any incentive to buy base metals, outside of supply curtailments. Last night copper fell 3%. Zinc fell 2.5%, nickel 2% and aluminium 1%. Only tin bucked the trend.

Iron ore is unchanged at US$53.80/t.

Despite the soaring yen, counter-balancing moves in other currencies sees the US dollar index steady at 94.49. But the “safe haven” shift means gold is up US$18.00 at US$1240.30/oz.

Which developed economy has not recently joined in the “race to the bottom” among central banks, nor even adjusted to account for it? The Aussie is down 1.25% at US$0.9505.

Today

The SPI Overnight closed down 74 points or 1.0%.

Coincidently, Japan will release its February trade data today.

Locally, REITs Dexus Property ((DXS)) and Investa Office ((IOF)) will hold extraordinary shareholder meetings today to discuss the proposed takeover by Dexus of management of Investa’s portfolio.

Rudi will skype-link with Sky Business this morning, around 11.30am, to discuss broker calls.
 

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