SCOREBOARD: Bernanke blues

Markets flirted with gains, but were brought back to earth on hints the Federal Reserve may stop the presses.

The news out of Europe was generally mixed overnight. The main positive was that Spanish and EFSF bill auctions were met with very strong demand and in the case of Spain, it managed to raise money more cheaply than last month. For the specifics, Spain sold €3.44 billion of 12 month bills at 4.050 per cent, which is down from the 5.022 per cent they had to pay to get them away in November. Cover was strong at 3.1, against 2.1 last time. They also sold €1.498 billion of 18 month bills at 4.22 per cent, which is down from 5.159 per cent in November. Again, bid/cover was strong at 5, albeit down from 6 previously. The EFSF then sold €1.971 billion of 3-month bills at a yield of 0.222 per cent with cover at 3.2.

Not a bad start, but still above the German equivalent of -0.01 per cent to 0.07 per cent. The next test will come when the Spaniards look to tap €2.5-€3.5 billion in 2016s, 20s and 21s tomorrow. German and Italian bond auctions are due over the next day or two as well. For the moment though, Spanish bond yields came in sharply at the short-end – 30bps on the 2-year to 4.17 per cent, while the 10-year was off 8bps to 5.7 per cent. The Italian 2-year yield was also weaker at 5.66 per cent from 5.84 per cent, although the 10-year yield rose 12bps to 6.68 per cent.

Not so positive is the fact that European banks are increasingly turning to the ECB for cash. In all €292 billion was taken up at the weekly tender (highest since June 2009) by 197 banks, who are in turn increasingly leaving cash on deposit at the ECB. It’s a problem, but the number of banks participating is still only about a quarter of what we saw in late 2008.

Now at this point, German and French equities were stronger, the euro was up smalls (compared to 1630 AEDT) and the S&P was just about at its high ( 1.1 per cent). All seemed to be going well until Merkel suggested, or rather unnamed sources in her coalition suggested, that Germany was opposed to increasing the size of the ESM (permanent bailout fund). The offer was on and the euro dropped about 2 big figures to sit currently at 1.3034. The Dax ended 0.2 per cent weaker, while the CaC was down 0.4 per cent. The FTSE outperformed that, rising 1.2 per cent on the back of support for energy and telecoms.

US stocks and bonds managed to avoid the worst of all that, after a reasonable retail sales report showed consumers still spending and given the Fed meeting and US 10-year Treasury auction ahead. Retail sales were weaker, at 0.2 per cent (market expected 0.4 per cent), but following strong gains in the two months prior, it isn't a problem. It was after the auction and FOMC that Treasuries rallied hard and the offer was put on stocks. It’s not that the Fed was especially bearish on the economy. In fact they were marginally more upbeat suggesting that, "Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth. While indicators point to some improvement in overall labour market conditions, the unemployment rate remains elevated. Household spending has continued to advance.”

The problem obviously is that this more upbeat assessment makes it less likely, in the view of the market, that Bernanke will fire up the printing press again. Me, I don’t think a marginally more upbeat economic profile will stop them. Look at what happened in 2010 when despite accelerating economic data, they still went on and pulled the lever.

In any case, the dollar index, which had been bid up anyway, was up another half a per cent or so, and equities fell. On Wall Street, the S&P lost 10 points after the meeting and closed at 1,226, or 0.9 per cent lower, driven down by financials, basic materials and consumer services. The only real bid was for energy and utility stocks and that’s mainly because of growing tensions with Iran. WTI and Brent were both up around 2 per cent ($99.9 and $109) after news surfaced that Iran is going to hold military exercises (denied by them) near the strait of Hormuz (gets lots of oil traffic). The Dow lost 66 points (11,955), the Nasdaq fell 1.3 per cent (2,579) and Australia’s SPI is off 0.3 per cent (4,172).

As for those Treasuries, the rally actually started about an hour before the FOMC announcement on a strong 10-year note auction ($21 billion with cover at 3.53, strongest since April 2010) and only extended modestly afterwards. Compared to 1630 AEDT yesterday afternoon, the 10-year yield is off 6bps to 1.986 per cent, the 5-year is down 2bps to 0.84 per cent while the 2-year is actually up a bp to 0.23 per cent.

Price action elsewhere then saw gold off about $20 from 1630 AEDT yesterday afternoon, copper is down just over 1 per cent and the Australian dollar hovers just above parity (1.0014), having lost about 70 pips from yesterday afternoon (1630 AEDT).

Otherwise economic data for the session showed UK CPI rising 0.2 per cent in November, as expected, with the annual rate still well and truly above target at 4.8 per cent, but down from 5 per cent in October. Core CPI is at 3.2 per cent year-on-year from 3.4 per cent. In the US, business inventories rose by 0.8 per cent, while shipments were up 0.7 per cent. Good growth on both counts.

Looking at the day ahead, Westpac puts out its consumer confidence measure (for December) at 1030 AEDT and the RBA’s deputy governor gives a speech at 1230 AEDT but there isn’t much else. Tonight, watch out for eurozone industrial production, UK unemployment and US import prices (alongside the usual weekly mortgage application figures).

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

Follow @AdamCarrEcon on Twitter.


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