ICAP AM REPORT - reposted by andre di cioccio

Last night’s session started off badly enough after Goldman’s reported an 83% drop in earnings (partly due to one off expenses like the civil fraud settlement) and weaker than expected revenues. Following a mixed session in Europe then (major indices between -0.7% for the Dax and +0.07% for the SXXP), US stocks dropped 0.7% on the open.

A weak housing starts report initially aided that price action - starts down about 5% in June after a revised 15% fall in May (was 10%). Starts are now at their lowest since October. This is clearly not a good result, but due to distortions created by the tax credit it’s difficult to really draw any conclusions from recent results - To determine if the market is recovering or not. But and ultimately this uncertainty helped the market bounce back.

You see building permits actually rose, and they rose by much more than expected (+2.1% v +0.2%) which tends to suggest starts will recover. By itself, this wasn’t sufficient to spark up risk appetite. But when it was combined with rumours that the Fed may stop paying banks interest on reserves (currently 0.25%) – it was enough. There is a veritable ocean of money being held on account at the Fed. The problem of course is that paying interest acts as an incentive for banks to hoard cash. The argument is that if the Fed stops paying interest, the cash will hit the streets (assuming here is the demand for it).

So stocks went bid and spent the rest of the session on an upward trajectory. Generally positive earnings – eg from Harley Davidson didn’t hurt either. At the close, the S&P500 and Nasdaq were up 1.1% (1083 and 2222), while the Dow rose 75pts to 10229. Elsewhere the SPI also increased 1.1% to 4428. Leading the index higher were basic materials, energy and industrials although all sectors outside of health bounced, including financials which were up 1.2%.

The thought of all this cash hitting the market proved a boon to commodities with copper up 2.9% in New York and crude bouncing 1.2% ($77.4). It wasn’t just free cash helping crude though. A tropical storm is brewing in the Gulf of Mexico and the API reported a drop inventories.

On the rates side, activity was again subdued and trading ranges were comparatively narrow (2-8bp). The major treasury yields fell slightly (1 or 2bp) with the 2yr at 0.59%, the 5yr at 1.68% and the 10yr at 2.95%. Aussie futures bounced around on a 10 and 8 tick range to finish down about 6 ticks on the 3s (95.22) and 10s (94.72). That move seems fair enough after yesterday’s minutes. Still, markets appear to be underpricing the chance of a rate hike in August – about 30% currently from 20% yesterday. It wouldn’t take much for the RBA to hike again, especially when CPI (out July 28) is looking like it could be problematic. Note also that the RBA highlighted market sentiment as the key worry. Not the actual data. When you take a step back and read through the data, it’s actually been quite good on the whole. So look at the chance of a high CPI print, look at the good data and look at how rapidly sentiment can and does change. Realistically market pricing should be at least 50% for another hike.

Data and news flow otherwise included a report from the ICSC suggesting US retail sales remain ok, rising 4.2% in the week to July 17. Then in Europe, German producer prices rose more than expected (+0.6% v +0.2%). The Bank of Canada hiked 25bp to 0.75% as expected but was concerned that the domestic and global economy would be slower than expected (I have to point out that this doesn’t mean they expect a double dip recession).

Very little out today. Kiwi visitor arrivals at 0845, Westpac’s leading index at 1030 and then tonight we get mortgage applications and Bernanke’s monetary policy report to the senate.

Have a great day…

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