‘It Would Be Folly to Cut Rates Here’

Symbols of percent on falling red cubes.
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The most anticipated US employment report since the last one — and before the next one — was a bit of a fizzer when it hit the wires on Friday morning, US time.

The expectation was for jobs growth of 180,000 in August. The actual number came in at 151,000. This takes the prospect of a September rate rise firmly off the table.

The market was obviously happy with that. Both the Dow and the S&P 500 increased 0.4% on Friday. Gold responded immediately. It spiked up to US$1,330 an ounce on the news, retreated, then rallied again.

Gold closed the US trading session at US$1,323 an ounce. Whether this means the correction in gold is over or not, I don’t know. But it was positive to see the bounce occur right on support, as you can see in the chart below.


Source: Optuma
[Click to enlarge]

My guess is that gold is simply consolidating its big move throughout June and July. During those two months, gold rallied from a low of US$1,200 an ounce to a high of US$1,380 an ounce.

That’s a decent move in just two months. Following an advance like that, it generally takes a few months of sideways movements at the very least before the market keeps going…or breaks down to new lows.

But Friday’s price action was a win for the bulls, as the price bounced off support at US$1,300. Still, I wouldn’t get too carried away just yet. It’s early days.

The broader US stock market is just as interesting at this point. Following the Brexit vote, the S&P 500 broke out to new highs on (what else?) stimulus hopes. But since the breakout, the market has been eerily calm.


Source: Optuma
[Click to enlarge]

There hasn’t been a great deal of follow-through buying (a bullish sign); and there hasn’t been a reversal (a bearish sign). Instead, the market has just gone quiet.

As Bloomberg reported following the release of the jobs report on Friday:

The long-awaited American jobs report did nothing to break the tedium of U.S. markets.

The S&P 500 Index hasn’t seen a 1 percent move in either direction for 40 days, the longest such streak in more than two years. Things are not that much different in the currency and bond markets. Treasury 10-year yields have traded in a range of 1.45 percent to 1.63 percent since mid-July, while a gauge of the dollar against its major peers is virtually unchanged from the average for that period.

This begs the question: Is the breakout to new all-time highs a genuinely bullish break, or is it a bull trap?

The lack of movement and volatility suggests a lot of indecision in the market right now. The bullish and bearish camps both have good arguments on their side. But neither argument is winning the day right now.

Markets don’t stay quiet for long. In the next few weeks, I’d expect to see a move out of this mini range. I have no idea which way it will go, because it all depends on the data and the anticipated response from central banks.

If US data continues to disappoint — but not by too much — stocks will take another leg higher. That’s because the Fed will be on hold, potentially reverting to stimulus measures again.

But if the data strengthens and signals a rate hike is in order, the market may remain weak or sell off sharply. Most recessions are a result of central banks tightening credit. So if the market thinks the Fed will tighten a few more times, the stock market may price in a recession starting in 2017.

That’s not how it looks at this point, though. The market has called the Fed’s bluff all year. It simply thinks it doesn’t have the guts to raise rates at all. And while a move in September is off the table, the interest rate circus will now turn to the December meeting.

In Australia, the RBA meets tomorrow in what will be Glenn Stevens’ last interest rate decision as governor. He passes the baton on to current deputy, Philip Lowe.

While there are the usual calls for the RBA to cut rates to weaken the dollar, my guess is that Stevens will leave rate on hold tomorrow. It would be folly to fire another interest rate shot in a war we simply cannot win. The RBA would be much better off conserving what little ammo they have, using it when they really need it.

As I’ve pointed out many times before, our dollar is strong because Chinese stimulus at the start of the year put a rocket under the iron ore price, which has a big bearing on Australia’s finances. While the perception of the Chinese economy remains strong, there will be a strong bid for the Aussie dollar.

Cutting rates by another 25 basis points will do little to dissuade foreigners from buying the dollar, especially when the options are to hold euros or yen (and having to pay fees to do so).

But another rate cut will impact bank margins, punish savers and knock confidence in an already fragile economy.

So a rate cut here doesn’t make any sense to me. But I should point out that I’m normally wrong about the RBA. Making sense doesn’t really come into it. Looking into the mind of a central banker is something I’m thankfully not particularly good at.

If you are concerned about the dwindling income you’re getting on your savings, I encourage you to check out my mate Matt Hibbard’s Total Income.

Matt’s an expert at digging out solid dividend payers that aren’t the usual suspects, like the banks and Telstra. And often, you’ll get a nice bit of capital growth to go with it. It certainly beats 2–3% in a term deposit. You can check out Matt’s work here.

Cheers,

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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