Investing in a world of interventionist central bankers is fraught with danger. You never know what these clowns will come up with.
Last night, European Central Bank boss Mario Draghi disappointed the speculators. He ‘only’ dropped the benchmark interest rate by 10 basis points (to minus 0.3%) and ‘only’ extended the €60 billion per month QE program by six months.
Given Draghi spent the prior month talking up his fight against deflation, the market had already priced in a much stronger announcement. They left disappointed.
The German stock market, the Dax, plunged. It fell 400 points, or 3.6%. The Dow and S&P 500 fell sharply too, with both markets down nearly 1.5%. That means the Aussie market will have a nasty day today.
But this time, it’s the banks that will more than likely lead the market lower. (I say ‘likely’ because I’m writing this before the market has opened.) That’s because they’ve been stealth beneficiaries of Draghi’s coming QE hype.
I’ve written to subscribers of Crisis & Opportunity about this in recent weeks. The aim was to sound a warning about the recent bank rally. I didn’t want my readers to mistake the share price rally for a sign of fundamental improvement in the sector.
The link between European QE and Aussie banks might seem like a tenuous one. But as Europe is one of the world’s biggest savers, and therefore a creditor to debtor nations like Australia, it makes sense that the prospect of poorer returns on savings in Europe would send more capital to Australia.
And who are Australia’s largest borrowers? The banks, of course!
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When you go to borrow money from a bank to buy a house, the bank approves the loan, but then it has to get the money from somewhere. Australia is a debtor nation, meaning we consume more than we produce. That means we have to borrow the difference from offshore.
Banks borrow in the wholesale debt markets, and Europe is an important source of funds. So when Europe’s money becomes ‘easier’, the benefits flow on to our banks. Here’s what I wrote to subscribers on Wednesday…
‘…the ECB is giving our banks a major leg up by promising another round of QE when they meet on Friday Aussie time.
‘The important thing to watch for is the market’s reaction after the ECB announcement. It could be a ‘buy the rumour, sell the news event’. In other words, because of the strong rally on the expectation of stimulus, you may see profit taking and a sell-off at the time of the actual announcement.
‘Despite the recent strong rally, I’m still cautious on the banks. There are significant fundamental headwinds for the Aussie banking sector — the need for more capital, a slow growth economy, and a slowdown in housing investment lending…to name a few.
‘And the charts still point to the sector being in a downtrend.
‘Given the less than robust fundamentals for the sector, this makes me cautious on the ability for banks to sustain this rally.
‘The next test will come after Friday’s ECB meeting and the market’s reaction to it. The bank stock rally may run out of fizz in two days.’
The good old ‘buy the rumour, sell the news’ trade is a reliable one. Central banks talk a big game, but they find it harder to put these words into action. That’s because they know it’s more about confidence than anything else.
I mean, really, does anyone think that a little more QE is going to help the real economy or spur inflation? Of course it won’t. It will just create greater financial market volatility as speculators rush from one side of the boat to the other.
So expect a bit of reality to come back into the Aussie banking sector today.
And anyway, the last thing Australia needs is more cheap capital flowing in. It’s ruining our economy.
Let me explain…
In yesterday’s Markets and Money, I showed you how the mining sector ‘rescued’ the Aussie economy in the September quarter. A big increase in production led to ‘net exports’ providing a big boost to economic growth.
I also explained how misleading this was, and that the headline number didn’t take into account the prices actually received for this increase in export volumes.
Yesterday’s release of October trade figures reinforced this view. The trade deficit came in a $3.3 billion for the month. This was a 38% deterioration on the September deficit of $2.4 billion.
Thank goodness for the mining production boom, eh?
All those hundreds of billions of dollars of investment led to an increase in production that is…still generating massive monthly trade deficits.
The miracle in all this is just how the Aussie dollar is holding up? The fact that it has actually increased since the late August low around US$0.69 is impressive.
It tells you that despite our ongoing trade, current account and government budget deficits, we’re still pulling in ample money from offshore. The Financial Review has a decent explanation for what might be propping the Aussie up right now.
‘Corporate deals, driven partly by the weakness of the Australia dollar, have also helped the currency defy the relentless slump in commodity prices, according to Westpac.
‘The bank’s global head of market strategy Robert Rennie said foreign interest in Australian companies, recently shown again in last week’s $10.3 billion takeover of the NSW electricity grid Transgrid by a foreign-led consortium, was one of the factors offsetting the drag on the local unit by slumping iron ore and coal prices.
‘Another is a surge in demand for Australian government debt because of the securities’ yield spread over returns on most other advanced countries’ debt.’
If that’s the case, this is only a short term boost. Expect the Aussie to start falling again soon.
And it makes you wonder at what point lower interest rates might start to damage Australia. I mean, we’re only attracting offshore capital because of the healthy interest rate differential.
If the RBA cuts rates again next year, at what point would foreigners say Aussie rates no longer entice us? It’s an interesting question to ponder for a housing addicted, debtor nation like Australia.
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