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We Won’t Rescue The Market, Says Fed

FYI | Aug 01 2007

By Greg Peel

It was a happy morning on Wall Street. Following from Monday’s 92 point relief rally, the Dow shot up a further 140 points in early trade, spurred by a solid earnings reports from General Motors while Sun Microsystems had a similar effect on the broader market. With 67% of stocks now having reported, profit growth remains a steady 14.4%. Europe powered along, with the Dax up 1.7% and the FTSE up a whopping 2.5%. And the news came in that Rupert was set to snare Dow Jones as the Bancroft family capitulated.

Content quickly turned to despair, however, when large mortgage lender American Home Mortgage Investment Corp announced that it was no longer able to access credit lines. AHMI had been suspended for a day and a half after getting into trouble with “alt-A” mortgages – mortgages of a lesser quality than prime but greater than subprime. In other words, evidence of the contagion continues, and there are far more alt-A mortgages out there than subprime. When trading resumed in AHMI, the stock fell 90%.

At the end of the day the Dow fell 146 points or 1.1% to close near its lows. The S&P fell 1.3% and the Nasdaq 1.4%.

The selection of economic data released last night were generally not great. Personal consumption expenditure, which is a proxy for inflation, rose 1.9% in June. That’s inside the Fed’s comfort zone so largely a happy result. Personal spending, however, only rose 0.1% in June – its lowest rise in nine months. Amazingly, July consumer confidence jumped to its highest level in six years. Go figure. Meanwhile, construction spending fell and the Chicago PMI showed weaker than expected growth.

But on matters economic, the biggest news was a statement from St Louis Fed president Bill Poole that the Fed would not step in to rescue the stock and credit markets. While this is not really the Fed’s brief anyway, commentators pointed to former Fed chief Alan Greenspan’s propensity to do just that. What this means is the chance of a US rate cut for the purpose of reigniting credit has now diminished, although interest rate markets are still leaning towards a cut before year’s end.

On a more positive note for equity markets, it was revealed that the so-called “Blackstone Bill” – a push by the Democrats to end the low tax rate on private equity funds, hedge funds and the like – would not be supported by all Democrats and would likely not be passed. This bill has been a spectre hanging over the market for a while, but from a longer term perspective. The Dow hit its highs after the bill had been touted, and was focused on shorter term issues again last night.

Oil continued its relentless climb, rising another US$1.41 for September delivery to close at US$78.21/bbl – a whisker short of the high. The high oil price adds further fuel to the fire of despair, on the assumption Americans struggling with mortgage payments will also be hit by higher gasoline prices and subsequently curb their spending.

The oil rally was not enough to push gold any higher, as last night saw a return to carry trade unwinding in a session that was mixed for the US dollar. Gold fell US$1.80 to US$663/oz and one of the benchmark carry trade currencies – the Aussie – gave up yesterday’s half cent recovery to be sitting uncomfortably just above US$0.85 once more. The flight to quality also reignited, with the US ten-year bond yield falling back to 4.77%.

It was nevertheless a good night for commodities, with copper spurred on by talks of a strike in Mexico. The red metal jumped 1.6% in New York while nickel and lead both bounced back to strength. Commodity markets will likely help to dampen any significant fears on the local bourse today, and the SPI Overnight fell only 33 points after two grafting days on Bridge Street.

Rate rise fears have not abated however, and today will bring the June retail sales number. And we learn the June balance of trade, which will also provide the RBA with critical insight ahead of its rate decision.

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