By Greg Peel

The Dow closed down 130 points or 1.0% while the S&P lost 1.1% to 1342 and the Nasdaq fell 0.9%.

It was last Wednesday night when commodity prices really began to teeter in the wake of the Bin Laden execution and Thursday night saw commodity carnage when the ECB failed to raise its cash rate. The speculators left the building but since then commodity prices have had bounced back fairly sharply, albeit one sensed their vulnerability was still apparent.

Oil has led the bounce-back on the very real supply-side issue of a flooding Mississippi River and its impact on refineries, pipelines and oil transport. Given the refinery shut-downs, one might have expected inventories of gasoline to have reduced in the US, particularly as we approach the summer driving season.

It's been a while since I've mentioned the weekly US oil and oil product inventory numbers because basically they are very volatile (a bit like weekly jobless claims) and analysts invariably get them wrong. However last night's numbers were a shock that sent oil traders running for the exits once more. Analysts had expected US gasoline inventories to fall by 300,000bbls but instead they increased by 1.3mbbls. Crude oil increased by 4mbbls when a 1.6mbbl increase was expected. Suddenly there was very real evidence that four-dollar-a-gallon petrol is killing demand at the pump.

Before these numbers were even released, commodities were open to weakness given currency movements. For the second time this year, a general strike was called in Greece and everything shut down. A mass protest in Athens against imposed austerity measures began peacefully enough but soon turned ugly and the tear gas came out. At the same time ratings agency S&P was warning that Portuguese banks may yet need more financial assistance from the government, which is itself now operating under a bail-out.

European risk was back in the frame, and once again the euro headed south in a hurry, dropping 1.5% to under US$1.42. This sent the US dollar index up over 1% to 75.35 to place pressure on commodity prices. An they began to fall – sharply.

To top things off, the CME had announced that as of the close of trade, margins would be increased on oil and oil products futures. Irrespective of the pressure of currency and inventories there was forced selling anyway as commodity funds reduced their positions in line with the new cost burden. When gasoline futures subsequently dropped 9% they were “limit down” and thus the CME halted trading in all of gasoline, heating oil and crude. There has not been a trading halt on the exchange since the heady days of 2008.

The stock market had begun stoically enough, with the Dow down only 50 points for most of the morning led by energy sector selling. Department store giant Macy's had put out its earnings report and it was such a strong beat that Macy's shares closed up 8% on the day against the tide. This provided encouragement for the “rotation trade” in which investors switch out of risky cyclicals including commodity producers and into defensives including healthcare and consumer staples such as Kraft and J&J. Prior to tonight's action, there had been much talk of taking profits after a long run in commodities and getting back into laggards, which even includes financials.

But Wall Street lost its bottle late in the morning on collapsing commodities and after lunch was down 180 Dow points before some late buying steadied the ship.

When the dust settled, gasoline was down 8%, West Texas crude down 5% or US$5.05 to US$98.75/bbl and Brent was down 4% or US$4.40 to US$113.23/bbl. While last week oil had been vulnerable to silver's tumble, this time silver capitulated on the oil move and lost 8.7% to US$35.13/oz. Gold chimed in with a 1% loss, or US$14.80 to US$1501.60/oz.

London had already been nervous on the open when traders awoke to the news of higher than expected Chinese inflation in April and lower than expected industrial production. So base metals didn't need a lot of encouragement from oil or precious metals. Everything was down 2-3%.

The US Treasury seems to have had a knack lately of picking just the right day to hold important bond auctions. Under the circumstances, which included more euro-fear, the auction of US$24bn of ten-year notes met with better than expected domestic demand, sending the yield down 5bps to 3.17%. It was only last month that the US Congress was wrangling over debt levels, so perhaps the rest of the world is tiring of lending more money to Americans at low yields. Demand from foreign central banks for this auction dropped to 47% from a running average of 54%.

It is none too surprising that the SPI Overnight fell 56 points or 1.2% on commodity price movements, wiping out yesterday's physical market gains (assuming the prediction is accurate). However there is a silver lining as silver tumbles, in that the Aussie fell 1.25% to US$1.0700.

If the commodity price correction filters through to iron ore and coal, Wayne's US$3.5bn surplus in FY13 is looking a bit dodgy. The local unemployment numbers for April are out today, which might be interesting.

We then move through to industrial production numbers from both the UK and eurozone tonight, and then retail sales from the US along with the first monthly inflation data in the form of the PPI. Given we had another “risk off” session last night, we may see more volatility.

On that note, the VIX unsurprisingly jumped 7% last night but only to 17, around which it has traded since mid-April. No one is panicking just yet.

On the local stock front, SP Ausnet ((SPN)) will report full-year earnings today, Suncorp-Metway ((SUN)) will provide a quarterly update (post floods) and ANZ ((ANZ)) goes ex-div.

Rudi will appear on Lunch Money on the Sky Business channel at noon.

[Note: All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts in the Cockpit and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.]

FN Arena is building the future of financial news reporting at www.fnarena.com . Our daily news reports can be trialed at no cost and with no obligations. Simply sign up and get a feel for what we are trying to achieve.

Subscribers and trialists should read our terms and conditions, available on the website.

All material published by FN Arena is the copyright of the publisher, unless otherwise stated. Reproduction in whole or in part is not permitted without written permission of the publisher.