The Monday Report

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By Greg Peel

Derivative Dive

On Friday afternoon a very large trade was booked in May 5000 put options on the SPI futures contract. Clearly the deal had been agreed upon the night before, which is why the SPI Overnight closed down a surprising 47 points on Friday morning and the SPI continued to plunge when daylight trading commenced at 9.30am.

The put options were likely bought as a market hedge and were sold by local market makers, who themselves then had to “delta hedge” by selling futures contracts. Heavy selling in the SPI then dragged down the physical ASX200 from the opening bell, and within a blink the market was down 80 points for reasons that were not immediately apparent.

Then the futures selling stopped.

It took till lunchtime to be back to square, and eventually the ASX200 finished up 12 points for the day. Given a flat Wall Street on Thursday night, the only explanation for initial market weakness – until such time as the options deal was revealed – was weakness in iron ore and base metal prices but as it was, the materials sector closed up a percent on the day. Oil prices were slightly stronger overnight but energy closed down a percent.

The only other sector to finish in the red were financials, but only just, while otherwise we saw squaring up ahead of the weekend and the Friday night release of the US April jobs numbers.

The talking point of the day came from the release of the RBA’s quarterly Statement on Monetary Policy. The board has reduced its 2016 core inflation forecast range to 1-2% from a prior 1.5-2.5%, suggesting inflation will not reach the RBA’s target 2-3% range this year. Once again it is clear the weak March quarter CPI data came as quite a shock to the central bank. Not only can we see why we had a rate cut last week, the market is now baking in a second cut, if it were not already suspecting such.

By Saturday morning the Aussie was down a further 1.3% at US$0.7367, which was all to do with the RBA and very little to do with a slight tick up in the US dollar.

Goodbye June?

The US added 160,000 new jobs in April, well short of the 200,000 expected. Previous results for March and February were revised downward. The unemployment rate remains steady at 5.0% due to a tick down in participation. On the other hand, wages grew by a reasonable 0.3%, in line with expectation.

On the release of the report, a handful of major houses issued their own reports informing that prior expectations of a Fed rate hike in June had now been pulled back to September. There is one more jobs report to go before June and another Fed meeting in July but by September, June quarter GDP growth numbers will be known. (Note: the Fed meets six-weekly, not monthly).

Once again Wall Street was caught between the benefits of lower for longer rates and the unsettling reality of a slowing pace of US growth. The Dow fell and recovered and fell again, before finally recovering to finish the session up 79 points or 0.5%. The S&P rose 0.3% to 2057 and the Nasdaq added 0.4%.

While September is now the preference for some, more dovish commentators suggest that in a year which is yet to see the Brexit vote and the US election, December is the most likely option, if only to save face. The trend in US economic data would need to turn around significantly in that time to even justify December.

This is not the sought of news incoming RBA governor Philip Lowe really needs. While local inflation has forced a rapid reaction in RBA policy, the problem of the too-strong Aussie was meant to be alleviated this year by rising US rates.

Commodities

Australians can no doubt empathise with our Canadian friends who saw a 25,000 acre wildfire in Alberta grow to 250,000 acres in the space of 24 hours. While the fires have moved close to oil sands production, no infrastructure has as yet been damaged. Production has ceased nonetheless given the evacuation of local residents means there is no one there to run operations.

The fires have put a floor under oil prices for now, but has not sent them skyward, suggesting that once Canadian production is back to normal there might not be much holding oil prices up. West Texas was only slightly higher at US$$44.56/bbl on Saturday morning and ditto Brent at US$45.33/bbl.

Lower for longer rates in the US means a weaker for longer US dollar, hence base metals prices were mostly positive in London on Friday night. Nickel and zinc were the best performers with gains in excess of one percent but aluminium fell half a percent.

Iron ore fell another US$1.80 or 3% to US$57.70, to mark a fall for the week of US$7.50 or 11.5%.

While the reduced likelihood of June Fed rate hike did not impact on the US dollar index, which was up 0.1% at 93.89, gold rallied US$10.10 to US$1287.70/oz.

The SPI Overnight closed up 22 points or 0.4% on Saturday morning.

The Week Ahead

It’s a quiet week ahead for US data releases until we get to Friday, which features retail sales, business inventories and fortnightly consumer sentiment.

The eurozone will release a first estimate of March quarter GDP on Friday.

The Bank of England meets on Thursday night but nothing is expected, especially ahead of the Brexit vote.

Beijing will release Chinese inflation data for April tomorrow.

It’s now game-on in Australia, with a double dissolution election confirmed for July 2. We knew that anyway, but confirmation still removes uncertainty.

Local data releases this week include ANZ job ads today and Westpac consumer confidence tomorrow, along with housing finance numbers.

Commonwealth Bank ((CBA)) will wrap up bank reporting season today with a quarterly update, and we now shift into a new reporting mini-season. Orica ((ORI)) will report today, Incitec Pivot ((IPL)) tomorrow, CSR ((CSR)) on Wednesday and AusNet Services ((AST)) on Thursday.

Myer ((MYR)) will release quarterly sales numbers on Thursday and there’s a handful of AGMs to be held throughout the week.

ANZ Bank ((ANZ)) goes ex-dividend today and Westpac ((WBC)) on Thursday.

Rudi will appear on Sky Business on Tuesday, via Skype-link, to discuss broker calls. He'll be back on Thursday from 12.30-2.30pm and again via Skype-link on Friday morning, around 11.05am, to discuss broker calls. Later that day he'll re-appear as guest on Your Money, Your Call Fixed Interest, 7-8pm.
 

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