SCOREBOARD: Tough love

European stocks rallied strongly while Italian and Spanish bond yields slumped, suggesting austerity is working.

Economic data certainly wasn't great this session, but thankfully it was so minor (European PMIs remain weak, composite index unchanged at 46.5 in April) that the market ignored it. Most of the big action was over in Europe where stocks surged and we are talking very strong gains.

The Dax was up 2.4 per cent, CaC up 3.6 per cent; in Italy we’re taking 2.9 per cent and in Spain 3.3 per cent. There is some talk it was the weak PMIs that helped spark the rally as they are supposed to increase the odds for a rate cut. I don’t buy that myself and instead think that it had more to do with a Spanish bond auction. This is the real story, not the PMIs, which aren’t that good as indicators.

In all the talk about austerity, people who argue against it forget one critical fact: the European crisis was spawned from fear. Fear that debt in so many countries was unserviceable and unsustainable – a liquidity crisis.

You’ll note that some of the prominent voices arguing most ardently for an end to austerity were, during the crisis, fanning the flames of fear by telling us that the eurozone was going to implode, there was a 90 per cent chance of a Grexit and Italy and Spain would follow, because their debt was unserviceable and unsustainable. That these same people now suggest more debt is the answer to the debt crisis – and they do when they state austerity should be abandoned and growth should be the priority (deficits have to be funded) – is simply mind boggling.

Anyway, that’s why bond auctions like last night’s are critical, and recently they show that investor faith has been restored. The German Finance Ministry issued a statement last night in response to all the calls to end austerity, stating: "Through continuing our policies of growth-friendly consolidation we are systematically building up the trust of international investors lost in the crisis."

And they are right – analysts and commentators might be running around in blue-faced rage against austerity, but the simple fact is the market is telling you it's working. Austerity is working, and auction results like last night prove it.

In the secondary market we saw Italian and Spanish bond yields slumped. The Spanish 10-year fell 24 bps to 4.26 per cent, which is the lowest yield since November 2010. The Italian equivalent fell 12 bps to 3.91 per cent – also the lowest since that time. So this is pretty much the reason why stocks surged I suspect. Austerity is working and the crisis is easing.

Over in the US, we had had all that plus some solid earnings reports. At the close the S&P500 was 1 per cent higher (1578) and the Dow was up 152 points (14,719) while the Nasdaq rose 1.1 per cent (3269).

There was some excitement however after a fake tweet episode. A news agency’s twitter account was hacked and a tweet was sent stating that there had been explosions at the Whitehouse and that President Barack Obama was injured. At that point the S&P500 dropped 0.7 per cent (still only flat from the open), but once confirmation went out that all was well, the bid continued.

It seems that all sectors pushed higher, although financials, tech and energy stocks outperformed. Crude was flat at $88.8, but metals were mostly smashed again – copper down 1.5 per cent, silver off 1.7 per cent and gold, while not quite smashed, was down $7 to $1414.

Otherwise for the price action, the euro had an odd session, hitting a high of 1.3081 before dropping 80 pips to end at 1.30 (40 pips lower from 1630 AEST). The Australian dollar pushed modestly higher by about 30 pips or so to 1.0263; the British pound was a little lower at 1.5240 while the yen was sitting at 99.46 from 98.662.

Not much to say for rates really – US yields pushed modestly higher by 3 bps on the 10-year to 1.7135; the 5-year is at 0.698 per cent and the 2-year is at 0.23 per cent.

Bits and pieces otherwise – in terms of the data we saw US house prices rise 0.7 per cent in February after a 0.6 per cent rise; new home sales rose 1.5 per cent in March after a 7.6 per cent fall; and the Richmond Fed manufacturing index fell to -6 in April from 3.

For today, the SPI suggests our market should lift by about 1 per cent. Data-wise the main release for Oz will be the March quarter CPI. I spoke about this on Monday so won’t repeat myself here – suffice to say the market looks for headline lift of 0.7 per cent, which would take annual inflation from 2.2 per cent to 2.8 per cent.

Other things to look out for include the German IFO index and US durable goods.

Have a great day...

Adam Carr is a leading market economist.

Follow @AdamCarrEcon on Twitter.