Overnight: Yellen The Trader

The Dow closed up 5 points while the S&P lost 0.2% as the Nasdaq fell 0.5%.

The Australian market was ultimately becalmed yesterday despite a strong lead from Wall Street. We may well be stuck for while around the 5500 level ahead of the August result season and yesterday there was specific cause for pause ahead of last night’s testimony from Janet Yellen, and today’s Chinese GDP result.

The minutes of the July RBA meeting, released yesterday, were never expected to cause any great surprise, and didn’t. The board did have a little more to say on the progress of the non-mining economy recovery. In June, the minutes suggested:

“The expectation of substantial falls in mining investment, below-average growth of public demand and non-mining investment remaining subdued for a time implied that the pace of growth was likely to be a little below trend over the rest of this year and into the next, before gradually increasing.”

And the July minutes suggested:

“There had been a gradual improvement in the pace of activity in the non-resource sector and forward-looking indicators suggested that further strong growth in residential construction was in prospect, despite some easing of conditions in the established housing market over recent months. After picking up through last year, household consumption growth appeared to have eased, while non-mining business investment was picking up gradually.”

A mixed report card, but ever so slightly more positive, one might suggest. Certainly no cause to expect the central bank is contemplating a rate cut.

Wall Street opened to the upside, with the Dow jumping 65 points on the open to smash through the previous closing and intraday highs. Street-beating results from big banks and Dow stocks Goldman Sachs (up 1.3%) and JP Morgan (up 3.5%) floated all financial sector boats.

But that’s where it ended. The world held its breath as Fed chair Janet Yellen began her prepared testimony to the Senate Committee and then moved into the Q&A session. Would Yellen offer any further clues as to when the Fed sees the first rate rise as being necessary?

As it was, interest rate talk was not the headline. What shocked the market was the Fed chair’s call that valuations on biotech and social media stocks looked “stretched”. As one might imagine, down went the Russell and down went the Nasdaq, with the former closing down 1.0% on the session and the latter 0.5%. Then the cries went out: What the hell is the Fed doing making trading calls?!!

Welcome to the new Federal Reserve. Gone are the days when the Fed played the role of omniscient but silent overseer, simply controlling capital flows through the banking system and allowing stock markets to find their own levels, as is the “free market” concept of price discovery. Now the Fed is a visible presence, prepared to control all aspects of the market through ultimate verbal power. The true free marketeers on Wall Street are having apoplexy. But there are many who believe the prevention of bubbles is a step forward in the post-GFC world. The Fed has come under a lot of criticism from free marketeers who insist relentless QE has nurtured a bubble on Wall Street, so now the Fed is responding. At her last press conference, Janet Yellen suggested the stock market was “fairly” valued. Last night she suggested perhaps biotechs and social media stocks looked “stretched”.

Half of Wall Street believes the Fed has no right to make trading calls. The other half is comforted by this benevolent hand. One thing we do know is that having come this far, the Fed is not about to clam up again.

By midday, the Dow was down 49 points. But it grafted back, as is often the case these days on any sharp drop, to a flat close. There are many who agree with Yellen’s assessment of the momentum stocks, but this does not apply to the blue chips. Social media stock Yelp, for example, is trading on a PE of 420x. The Nasdaq and Russell also recovered some lost ground in the afternoon nonetheless.

But what about interest rates?

Ultimately Yellen’s testimony did little to provide more clarity. The Fed could accelerate its plans to raise interest rates, Yellen suggested, if the jobs market continues to improve more rapidly than anticipated. But that time has not arrived, she qualified, given “considerable uncertainty” surrounding the economic outlook. In other words, NFI. Yellen has no more foresight than the market, and as such the US ten-year bond yield was unmoved at 2.55%.

The forex markets must have been expecting a more dovish insistence form the Fed chair nevertheless, given the US dollar index rose 0.3% to 80.38. In the context of the greenback’s near zero volatility of late, this is akin to a “melt-up”. And the dollar jumped despite the earlier release of the UK’s June CPI, which printed 1.9% when 1.6% was expected, up from 1.5% in May, and further underscored the likelihood of a UK rate rise sooner rather than later.

The dollar jump was not very helpful for gold, which tumbled through support at 1300 and is down another US$13.80 to US$1293.40/oz. But the Aussie fell (woohoo!), albeit only by 0.2% to US$0.9374.

The dollar jump likely also provided oil markets with a bit of a push. Having taken a breather on Monday night, last night the oils resumed their geopolitical premium reversal, with Brent dropping US84c to US$104.99/bbl and West Texas dropping US$1.04 to US$100.15/bbl.

When the WTI price falls below triple digits, Americans all feel a bit happier. It’s good for consumers, and good for the economy in general, bar, of course, the energy sector, which is a big slice of Wall Street’s market cap. It’s the perpetual yin and yang.

A fall in inventories sent aluminium up 1% in London last night but all other metals were steady ahead of today’s Chinese GDP and July data releases. Spot iron ore rose US10c to US$98.00/t.

The SPI Overnight rose 6 points.

So strap yourself in in preparation for China’s data drop later this morning as June quarter GDP is announced (consensus 7.4%) and July industrial production, retail sales and fixed asset investment numbers are released.

We may yet be looking at more controversy from The Hill, as tonight Yellen provides another testimony, this time to a House Committee. The Fed Beige Book is also due, along with US industrial production and housing sentiment releases.

Locally, Rio Tinto (RIO) will publish its June quarter production report today as will Iluka Resources ((ILU)). Fortescue Metals ((FMG)) will formally publish its report but having pre-released the major details last week, Fortescue is unlikely to provide any surprises.

Rudi will appear on Sky Business at 5.30pm. 

Greg Peel

About Greg Peel

Greg Peel joined Macquarie Bank in 1986 and acquired trading experience in equities, currency, fixed income and commodities derivatives, ultimately being appointed director of equity derivatives trading. He later published In With The Smart Money (a plain English guide to the mysterious world of financial markets and derivatives) and acted as a consultant to boutique investment funds. In 2004 Greg joined FNArena as a contributing writer. He is now a director and principal of the company. Greg compliments the journalistic background of the FNArena team with lengthy experience as a financial markets proprietary trader.

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