SCOREBOARD: European stir

European equities rose overnight ahead of the ECB's crucial policy decision later this week.

The Labour Day holiday in the US meant that markets over that way were closed, so all the action was in Europe. Fair to say that most of the price signals were good for the session and we saw decent rises across the equities space. So the Dax was up 0.6 per cent, the CaC 1.2 per cent and the FTSE was 0.8 per cent higher.

This is all very impressive given the apparent contraction in global manufacturing – especially the Chinese numbers we saw yesterday and the European PMI (final estimate) last night. This suggests European manufacturing contracted for the seventh straight month in August. Although we need to be very careful about the language we use and about confusing lead indicators for real data, with that data. So for instance a PMI might be below 50, but Chinese manufacturing isn’t contracting – global manufacturing more broadly isn’t contracting either.

In any case it wasn’t just the PMIs that I thought would have weighed on the market. In Spain, another region has requested emergency funding from the central government – Andalusia this time, in requesting a €1 billion advance. But even Spanish and Italian bonds managed to finish the session unscathed. Indeed the Italian 10-year yield fell about 5 bps or so to 5.68 per cent. The Spanish 10-year ended little changed at 6.82 per cent. Bunds and gilts otherwise sold off a little and 10-year yields were about 4 to 5 bps higher (1.38 per cent and 1.48 per cent respectively).

Mostly I suspect markets are just waiting for the ECB to print. Their meeting is this Thursday night and last night we got a better sense of what Draghi is planning. He is reported to have told the European parliament that the ECB would buy bonds up to a maturity of three years, because apparently this doesn’t constitute state financing – and so would be workable under Europe’s legal framework. He also reiterated that these purchases were conditional upon Spain and Italy first requesting aid from the European bailout funds (the ESM and EFSF).

That is largely the night’s events as they occurred, or the major stuff anyway. Price action outside of that was mute but it’s interesting to note that crude pushed higher despite the weaker Chinese data yesterday, (WTI up 0.6 per cent $97.05) with an early close. Elsewhere copper was 0.9 per cent higher in London and gold rose another $7 or so to $1694. A good sign that markets are brushing off lower tier indicators finally – hopefully some economists will now wise up. As for the Australian dollar, it sits at 1.0247 or about 20 pips lower than yesterday. Euro is then about 25 pips higher at 1.2595 while sterling is at 1.5886 and yen is at 78.28.

Looking at the day ahead we get the Australian current account balance today at 1130 AEST, which also gives us the net export contribution to GDP. The forecast is that net exports will contribute 0.6 percentage points to growth in the June quarter. The other important feed into the growth numbers comes from the public accounts so it’s well worth watching those number as well. The RBA then announces its decision and all economists expect rates to remain on hold and indeed the board itself signalled they were on hold for the time being. Which of course is the proper path.

That said, the risk is they will cut and this is the risk at every meeting. Why might they cut? Because of the slump in iron ore prices and maybe even because of that weaker data run yesterday. Don’t get me wrong, none of that provides a genuine economic reason to cut yet, as it’s by no means certain it will be sustained. But this is a board, like many economists in the market, that doesn’t need much of an excuse. They unthinkingly just want lower rates. Think of the inconsistency though – if a slump in iron ore prices and the turn of weaker data yesterday provides cause to cut rates now, then on the same logic, it should have provided cause to hike rates previously.

That’s why I don’t take a lot of dovish analysis seriously – not all of it is bad, there is some good stuff out there, but most of it just isn’t consistent or isn’t based on sound reasoning.

Outside of Australia the data to watch out for includes eurozone producer prices and then in the US we get the ISM manufacturing index. Most of the PMIs doing the rounds – flash estimate for China and the European PMIs aren’t worth anything and aren’t really useful analytical tools. The ISM is different, it is actually very good and so I take it seriously when it falls below 50. The question that remains unanswered at this stage is whether this is just volatility or a more ominous sign. I’m leaning toward volatility given some of the other data flow, but we’ve got to watch it closely.

That’s about the lot then, hope you have a great day…

Adam Carr is a leading market economist. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

@AdamCarrEcon on Twitter.

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