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 Thursday 01 September 2016

AM Bulletin: Stock indices bounce back

 

 

Indices Update

European equities and US stock index futures were firmer in early trade this morning. The main reason appears to be the recovery in crude oil which fell sharply on Wednesday following an unexpectedly large build in US distillate stocks. Overnight China’s headline Manufacturing PMI bounced back above 50 indicating expansion in the sector. But the Caixin survey (which covers smaller companies) slipped back from the prior month’s reading, as did the Services PMI.

Investors continue to react to last week’s Jackson Hole speech from Janet Yellen. Dr Yellen said that the case for raising rates had strengthened over the last few months. In addition, she said that the US economy continued to expand and was near its targets for maximum employment and inflation. Taken overall, investors viewed the speech as hawkish, increasing the likelihood of a Fed rate hike before the year-end. The big question now is if the Fed decides to tighten monetary policy at its September meeting?

This is why Friday’s Non-Farm Payroll report is so significant. Maximising employment is one leg of the Fed’s dual mandate. The other is of ensuring price stability (inflation). The Unemployment Rate has been at or below 5% since November last year. This is at the lower end of the band which many economists consider represents the natural rate of US unemployment, or full employment. Yet it is the monthly Non-Farm Payroll number which holds investor attention and this has proved to be particularly volatile this year. Figures for June and July were much stronger than anticipated. But they followed on from a dismal reading for May. If we get a decent number on tomorrow (say, 180,000 or better) then this will increase speculation that the Fed may look to hike rates at their September meeting. A number of 140,000 or below would suggest the US central bank will wait longer.

The FTSE 100 ended the day 39.3 points lower at 6,781.5

The German DAX fell 65 points or 0.6% to end the day at 10,592.7

The US30 fell 53.4 points to finish at 18,401. The S&P 500 lost 0.2% to close at 2,171 while the Nasdaq 100 fell 0.1% to close at 4,771

Equities

There has been a raft of speculation that Deutsche Bank (DBK) may be considering a merger with one of its rivals. John Cryan, the CEO of the troubled banking giant said that there should be more consolidation within the German banking sector to improve profitability. However, he denied a magazine report that the bank was considering a merger with Commerzbank (CBK). Mr Cryan said that Deutsche was committed to implementing the five-year strategy he laid out last year on its own. However, the Wall Street Journal claimed that the two banks had discussed a potential merger earlier this month but concluded that it wouldn’t work. Deutsche Bank and Commerzbank ended up 2.5% and 2.3% respectively.

Commodities Update

Crude oil fell sharply yesterday, pressured by the ongoing dollar rally and US inventory data. The dollar has risen sharply since Federal Reserve Chairman Janet Yellen delivered her keynote speech at the Jackson Hole Economic Symposium last Friday. Dr Yellen’s speech was interpreted as being more hawkish than expected after she said the case for raising the Fed Fund rate had strengthened over the last few months. Typically, dollar-denominated commodities fall in price when the dollar rises.

On top of this, the American Petroleum Institute (API) released its latest update on US crude inventories on Tuesday evening. The API reported a crude build of 942,000 barrels for the week ending 26th August which was a bit below expectations. It also reported a 1.6 million barrel drawdown in gasoline which was bigger than the 1.25 million reduction anticipated. All this would have been bullish for crude. However, the API said that distillate inventory rose by 3 million barrels – well above the 275,000 barrel build expected. The news led to a late sell-off in both Brent and WTI.

The Energy Information Administration (EIA) released its own US inventory update yesterday afternoon. As with the API’s data, this showed an unexpectedly large build in distillates last week, and yet again investors rushed to sell crude futures.

Gold and silver made modest gains in early trade yesterday. However, both slipped back from their best levels later in the day as the dollar continued to push higher. The greenback has rallied sharply since Friday afternoon when Federal Reserve Chairman Janet Yellen delivered a keynote speech at the Jackson Hole Economic Symposium. The tone was judged to be more hawkish than expected as Dr Yellen said that the case for raising rates had strengthened over the last few months. She also said that the US economy continued to expand and was nearing the Fed’s targets for maximum employment and price stability. All this has given the dollar a lift and led investors to trim their positions in precious metals. The prospect of higher US interest rates increases the lost-opportunity costs of owning gold and silver as investors can get a “risk-free” return on interest-bearing assets.

Gold has now broken below support around $1,320 to trade at its lowest level in two months. If it breaks and closes below $1,300 then we could see it sell off further towards $1,280.

Forex Update

The US dollar has soared since Fed Chairman Janet Yellen delivered her Jackson Hole speech last Friday. This was interpreted as being more hawkish than anticipated. Dr Yellen said that the case for raising rates had strengthened over the last few months and that the US economy continued to expand. She added that the Fed’s targets for unemployment and inflation were close to being hit.

These are the two parts of the Fed’s dual mandate – to ensure maximum employment and moderate inflation. There’s another bit which concerns setting a reasonable rate of interest. As Dr Yellen suggested that this would probably end up being around 3%, the Fed is a long way from achieving this particular aim.

Concerning the dual mandate, the US Unemployment Rate has been at 5% or below since November 2015. This is at the lower end of a band which most economists believe represents full employment. By some measures the Fed has also achieved its 2% inflation target. However, the US central bank is known to use Core (excludes food and energy) PCE as its preferred inflation measure. The latest update was released on Monday and came in at 1.6% where it’s been hovering for a while now. This is still a fair distance off the Fed’s target rate, and a number of analysts reckon the Fed would rather overshoot this target before hiking again.

So even if we get a good set of employment numbers tomorrow, the Fed can still use the low inflation number as an excuse to hold back from hiking rates next month. And while a number of FOMC members have said that one or two rate hikes could be appropriate this year, only one out of ten voting-FOMC members (Esther George) actually voted to tighten monetary policy at the July meeting.

The current dollar rally shows that a significant repricing is taking place. Ahead of Janet Yellen’s speech, the Dollar Index was trading near the bottom of a trading range which has now held for eighteen months. Similarly, the EURUSD was approaching the high end of its own trading range while the USDJPY looked set to break below 100.00.

Yesterday Headline Euro zone CPI came in at an annualised rate of +0.2% in August while Core CPI (excluding food and energy) came in at +0.8%. This means that the ECB is still miles away from its 2% inflation target despite all its monetary stimulus measures. Euro zone unemployment was unchanged at 10.1%. The poor data could persuade the ECB to launch additional stimulus at its next policy meeting in early September. Despite this, the euro was little-changed on the day.

Upcoming events

Today’s significant economic data releases include Manufacturing PMIs from Spain, Switzerland, Italy, France, Germany, the Euro zone, the UK and US. Also from the US we have Challenger Job Cuts, Weekly Jobless Claims, Construction Spending and Total Vehicle Sales.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: AM Bulletin

Category: AM Bulletin


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