SCOREBOARD: On credit

Concern over US earnings compounded Wall Street unease, despite another indication of exceptionally strong consumer spending.

This is the third session in a row now that we’ve seen stocks head lower and we all know the reasons. The news flow has certainly taken a turn for the worst lately and I guess there is additional concern over what the US earnings season might bring as well.

That was unofficially kicked off by Alcoa after the bell and the results weren’t good. Revenue was down about 9 per cent, driven by an 18 per cent decline in prices. Prior to that result the major indices had all closed weaker – the S&P500 was down 0.2 per cent (1352), the Dow was off 0.3 per cent (12736) and the Nasdaq fell 02 per cent (2931). Amid all the gloom the news wasn’t all bad, as the trusty US consumer again showed why you can’t write off the US economy – I appreciate that not everyone will think this is good news though. Anyway, US consumer credit surged again in May, rising $17.1 billion after a $9.9 billion increase the month prior.

This is exceptionally strong growth and is consistent with other data – car sales, and retail sales more broadly – showing US consumer spending on a solid rebound. It won’t stand in the way of QE3 though. Recall that the quantitative easing programs conducted by the BoE and the Fed are more about monetising debt, or accommodating fiscal policy, rather than the growth or inflation outlook per se. If the Fed was sincerely worried by growth and inflation, QE would be conducted via the household sector, not banks. You would wake one day to find a certain amount of dollars in your account and off you’d go and spend it. And we'd have growth and inflation just there. But households don’t buy government debt or treasuries in the case of the US. So, QE3 will come and the PR has been going on for some time, preparing the market. We’re even starting to hear some primary dealers (banks who deal exclusively with the Fed and profit enormously from QE programs) give a figure: $500 billion.

Against that backdrop, commodity prices pushed higher and in New York trading we saw gold put on another $9 to $1587. Silver was up 1.5 per cent and copper then rose 0.9 per cent. On the crude market, WTI was up about 1.5 per cent to $85.68 and there is support here from a couple of other events as well, including Iran obviously, and also Norway. Apparently there is the prospect of disrupted oil production from Norway (1.2 million barrels per day) following a labour dispute.

On the European front most of the major indexes were lower, with the Dax down 0.4 per cent, the CaC off about the same and the FTSE100 down 0.6 per cent. The news here wasn’t too bad. The Greek government apparently lost another minister (junior labour), who cited his disappointment that some welfare issues weren’t placed on the discussion table with the troika. The government highlighted that this doesn’t make sense as the discussions haven’t even started yet. Most likely someone slipped him a few bucks to step down – destabilise the government and all that.

In any case it looks like the Greeks are set to embark on some privatisations as required under the bailout terms. The Greek government acknowledged that they had already received significant help from the EU and IMF – €500 billion apparently – and the government noted that "without that money, the quality of life would have returned to about where it was in 1960". That’s an important recognition, because recall at this point the argument presented by many economists that Greece would be better off outside the eurozone (to devalue and print money). This is simply not true and it is good the government realises this.

Unfortunately, Spanish and Italian bond yields are still pushing higher (with the Spanish 10-year bond yield up 10bps to 7.06 per cent and Italian yields up 6bps to 6.08 per cent), which is incredible when you note that some German, Dutch and French yields are in negative territory (ie you pay them to buy their bills/bonds). So Germany sold €3.29 billion of six month bills at a yield of -0.0344 per cent. The French then sold 13 week bills at a yield of -0.005 per cent. On the fundamentals alone (politics trumps all however) there is only a very low probability that either Spain or Italy will default. The math just isn’t there. I would have thought, especially with negative yields elsewhere, it would be a no brainer to buy their debt in a rational market. Yet as we know, markets just aren’t functioning properly. Fundamentals matter little right now – to central bank decision making and many market prices.

Depending on your view this will be good or bad news, but it looks like Spain is set to get an extra year to bring the budget deficit down at its two-day finance ministers meeting, which kicks off tonight (today AEST). They’re also going to set a up a ‘bad bank’ apparently – better late than never.

For the rest of the price action we saw the Australian dollar push a little higher – to $US1.0211. Similarly the euro is about 30 pips higher at $1.2318. US treasuries then rose a touch – with the 10-year yield down to 1.51 per cent, the 5-year is at 0.63 per cent and the 2-year yield sits at 0.27 per cent.

Elsewhere, just note that the global data flow was mixed. German exports (and imports) surged in May, rising 4 per cent and 6 per cent respectively, which was well above expectations. Switzerland’s unemployment rate then fell to 2.7 per cent from 2.9 per cent, with both data points showing that not all is bad in Europe. Chinese inflation numbers yesterday were then weaker – 2.2 per cent in June on the back of lower commodity prices – and Japanese machine orders slumped 15 per cent in May after a 6 per cent surge the month prior (it's a very volatile series). Annually, orders are 1 per cent higher following a 6.6 per cent annual increase.

Today, look out for NAB's business survey at 1130 AEST and Chinese trade data at 1200 AEST. UK industrial production and trade is also worth watching out for this evening.

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

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