Overnight: Punching Clown

By Greg Peel

China Syndrome

As the week-long Chinese holiday was winding to a close on the weekend, China’s central bank snuck in a quiet -100 basis point reduction in its bank reserve ratio requirement (RRR), which has the effect of freeing up more funds for lending. It is the fourth time in 2018 the PBoC has cut the RRR.

The Chinese are facing a dilemma. On the one hand the government is trying to tackle China’s growing debt burden while on the other it is struggling with US tariffs. Much of the easing in lending policy this year has targeted specific industries, such as infrastructure building, that promote economic growth, as opposed to lending that fuels speculation. But it’s a delicate balance as China tries to prop up its slowing economy.

And that economy is now slowing at a faster pace, thanks to US tariffs. The impact is now being felt. The PBoC is desperately trying to prop up the renminbi and head off capital outflows. Which begs the question: Who tipped US bond prices over the edge last week? China is the biggest holder of US bonds.

Having had no opportunity last week, the Chinese came in swinging yesterday and sent the Shanghai index down -3.7%. The index is already down over -20% this year as the trade war has intensified. The next question is: Who else suffers from a slowing Chinese economy?

The ASX200 fell -1.4% yesterday and the hardest hit sectors were materials (-2.4%) and energy (-1.8%). Other than aluminium, metal/mineral prices were not a driver, and oil prices were only mildly lower.

The biggest index point contributor to the fall was financials, down -1.3%. But therein lies another tale.

ANZ Bank ((ANZ)), which is due to report full year earnings on October 31, issued a profit warning yesterday. The bank’s profit result will be tempered by -$374m in customer compensation charges along with -$104m in restructuring charges and -$55m in legal costs, all related to the RC. ANZ will also book -$206m in accelerated software amortisation charges.

The Royal Commission is the gift that keeps on giving. Stay tuned, no doubt there’s more to come. National Bank ((NAB)) and Westpac ((WBC)) will follow ANZ with their own earnings reports in early November.

The resources and bank sectors have been mostly playing off each other this year – resources up on stronger commodity prices, banks down thanks to the RC – but yesterday both were hammered. Indeed, everything was hammered. It was “Sell Australia” in action and not even the defensive sectors could hold up.

In fact, the “outperformer” on the day was IT in only falling -0.3%. This sector has already been weak in recent sessions under the influence of the Nasdaq.

The risk, as the bell sounded on Bridge Street yesterday, was that Wall Street, too, might succumb. But it didn’t. This morning the futures are down -6 points – still negative, but better than down -85.

Lazarus getting a workout

The Italian ten-year bond yield jumped to its highest level since 2014 last night after the EU criticised the government’s budget plan, confirming fears Italy is heading for a clash with the eurozone masters. The Italian stock index fell -2.4% and contagion spread to the UK, German and French markets.

And then on to Wall Street. The US bond market was closed last night for the Columbus Day holiday so Wall Street was flying blind on the US rate front, but the news from Italy and from China had to be absorbed. By mid-session, the Dow was down over -220 points.

But last night Wall Street picked up where it had left off last week – plunging early on rate rise fears before recovering at least some of that ground to the close. Last night the Dow did more than just recover, closing up 39 points, with the S&P similarly bouncing back to a 0.1% gain. Only the Nasdaq remained weak. Tech has run so hard this year that recent Nasdaq weakness suggests more of a “better to be safe than sorry” profit-taking exercise than an all-out panic driven by trade wars or any other factor. Growth tends to succumb to value when rates are on the rise.

Wall Street turned immediately after Europe closed. It was not a matter of a retreat in bond yields, as that market was closed, but commentators suggested perhaps that’s what we will see tonight.

On the subject of China, yesterday’s stock market weakness in the face of the RRR cut (and a first opportunity after a week off to sell) could be seen as negative, in terms of a slowing Chinese economy, or as positive, in terms of how long can Beijing keep this up for before it simply has to buckle to the trade war impact and wave a white flag?

Notably, the Dow has been the outperformer in recent sessions, and it contains those stocks most vulnerable to an extended trade war. There is a risk Beijing could fight back by selling its US bond holdings, which would potentially lead to a proper correction on Wall Street, but such a move would simply be mutually destructive.

Still, the Chinese do not like to lose “face”.

Looking at the US in isolation, the market remains split on whether rising US bond yields are a harbinger of doom or simply reflective of a strong economy. Higher Fed cash rates are necessary, many point out, to ensure that when the next recession does come – and it will one day – the Fed has enough firepower to once again step in and provide support through easier policy.

All eyes will be on the US bond market when it reopens tonight, notwithstanding whatever else might transpire in Asia or Europe in the meantime. Note that Japan was on holiday yesterday.

And then, come Friday, the September quarter US earnings season begins, kicking off with the big banks. Earnings will be back in the frame. And they had better match the hype, if bond yields continue to rise.

Commodities

The Chinese may have made a splash on their return to their own stock market but they didn’t much move the dial on London metal markets. Aluminium continued to slide on the Alunorte story.

Either gold had another one of its delayed reactions last night, in this case to rising US bond yields, or it is another asset a central bank could liquidate for currency support purposes.

The US dollar index has ticked up again but this time the Aussie has rallied 0.4%, showing no impact from yesterday’s stock market exit, possibly because it has fallen so far in the last couple of weeks.

Today

The SPI Overnight closed down -6 points.

In a quiet 24 hours around the globe economically, NAB’s business confidence survey is the only calendar highlight today.

On the local stock front, the only scheduled highlight is Reece ((REH)) going ex.