By Greg Peel

The Dow closed up 4 points but the S&P fell 0.3% to 1092 and the Nasdaq also fell 0.3%.

In Tuesday's session, a weak existing home sales number for May eventually tipped the S&P 500 through its 200-day moving average and into a thin volume abyss. Given the May new home sales number was due at 10am on Wednesday morning, there was every chance a bad result could spark more definitive selling.

Economists were braced for a bad figure. Tuesday's existing home sales number was expected to show a rise of 6% given contracts settled in May would have been initiated in April and thus enjoyed the last month of stimulus tax credits, so a fall of 2.2% was a big disappointment. In contrast, May new home sales are initiated in May and thus no tax credit would have been forthcoming. On that basis, economists had expected a substantial 21% fall.

While the absolute number of new home sales is much less than that of existing home sales each month, a fall of 33% in new home sales was another kick in the teeth for the US economy. This was the biggest monthly (year-on-year) fall since records were first kept in 1963. It is thus of little surprise the Dow plunged 66 points on the news.

Yet weakness was short lived, and Wall Street managed to graft back up to the flatline by 2pm, ahead of the release of the Fed's June monetary statement. Given technical support for the S&P 500 is recognised at 1080, the brief fall to 1085 may well have brought the bargain hunters in.

There was nevertheless some good news accompanying the shock home sales number. In the first quarter, US mortgage delinquencies fell 7.5% from the fourth quarter - the first quarterly drop in two years. Is there some light at the end of the housing tunnel? We first need to consider that we will complete the second quarter next week, so one quarter's drop is not yet enough to assume a trend. Delinquencies in the first quarter were also still up a whopping 36% from the first quarter 2009, and foreclosures in the first quarter 2010 were up 18.6%. It would be a pretty dull light.

On the release of the Fed statement, the Dow jumped up 75 points. It was an interesting reaction which lasted about five minutes, as by 3pm the average was back at the flatline and there it basically finished. There was no late sell-off last night.

In the earlier months of 2010, improving US economic data had led to speculation the Fed might be ready to move off the zero-0.25% funds rate range. But month in, month out, the Fed pointed to disinflationary pressures as justification for maintaining “exceptionally low rates yada yada”. This is despite the fact that in each successive month, the Fed gradually ticked up its outlook for the US economy.

Last night's statement represented the first time in 2010 the Fed has actually cooled its US economic outlook, suggesting the recovery was “proceeding” as opposed to “strengthening” as had been the case in the previous April statement. The Fed noted “financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad”.

In other words, Europe is weighing on the world. While this was construed as an economic “downgrade” from the Fed, it was of little surprise. Obviously a hamstrung Europe will impact in varying degrees on all major world economies, and central banks across the globe, including the RBA, have recently been acknowledging that reality. Nor was it a surprise the Fed left its funds rate where it was. Whereas most economists previously believed the Fed would stay on hold throughout 2010, some now suggest it will stay on hold throughout 2011 as well.

So why the 75 point jump in the Dow, even if for only five minutes? Well possibly it represented the reverse psychology effect – a weaker economic outlook means cheaper funds for longer which in theory is good for corporates. But then a weaker economy is not so good for corporate earnings, so it's a bit of a yin-yang.

What is nevertheless now concerning many observers is the growing disconnect between US second quarter corporate earnings expectations and US bond yields. Average earnings growth expectations remain in the double digits, and in some cases better than 20%, while last night the benchmark ten-year bond yield fell to 3.11% to be near its lows for 2010. If there is such high expectation of positive earnings numbers (which should directly translate into higher stock prices and possibly raised dividends) why then is the world increasing its demand for low-yielding Treasury bond investment?

Low bond yields in general were also reflected in last night's auction of US$38bn of five-year Treasury notes, which settled at 1.995% - the first yield below 2% in 17 months. Yet demand was not as strong for the fives as it was for the twos auctioned on Tuesday, and foreign central banks only bought 35% compared to a running average of 42%. Demand at the short end reflects risk aversion – safe haven buying. Lack of demand at the longer end represents monetary inflation fears, or more directly concern over the massive US deficit. Europe's deficit woes have drawn the spotlight away from the US budget in recent months.

With a weakening of the Fed's economic outlook, the US dollar index ticked down 0.4% to 85.81. While the Aussie responded by ticking up 0.2% to US$0.8738, commodity prices bucked the US dollar move.

Gold fell US$1.30 to US$1237.30/oz while base metals fell 1-2% in London (with the exception of zinc, up 2%) on the back of the weak US home sale number and Fed downgrade. Oil responded similarly, and also took on board the weekly inventory numbers which showed a bigger than expected jump in crude supply. Oil fell 1.9% or US$1.50 to US$76.35/bbl in the new August delivery front-month.

The SPI Overnight was up 8 points or 0.2% after the weak session yesterday.

Note that no less than 27 All-Ords stocks go ex-div today – many small, but a handful from the ASX 200 – which will have an impact on the absolute movement of indices. Note also that the end of the financial year is next Wednesday, and as such there may be a bit of tax-selling going on.

And today may be a day in which Australia finds itself with a new prime minister. The mining fraternity will be hoping so, given it supports the Coalition which in turn will do whatever the miners ask. Obviously that includes scrapping the RSPT. But if Julia Gillard is prime minister by the end of today, it is not a change of party. What the mining fraternity will be hoping is that Gillard's successful spill will imply a Labor Party perception of poor policy decisions from Rudd, and as such she will begin to distance herself from such policies, including the RSPT.

But then Gillard is supposedly left of Rudd, so it's not a clear call. Nor is a clear call that Rudd would lose a spill. In theory, Gillard is a reluctant usurper. Nevertheless, were Rudd to be deposed the local stock market would almost definitely stage a rally as its first reaction.

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