By Greg Peel

The Dow closed down 41 points or 0.4% while the S&P lost 0.3% to 1027 and the Nasdaq fell 0.4%.

Having been slammed through the 1040 support level on the S&P 500 via a big sell program on Wednesday, Wall Street was poised to begin the new quarter on a weak note. And economic data were always going to be crucial.

Ahead of tonight's monthly jobs report, weekly new jobless claims rose by 13,000 to 472,000. Economists had been expecting jobless claims to begin trending down by now but this is not the case. It is accepted that in order for the unemployment rate to fall, new claims must fall below the 400,000 mark, which still seems a distant dream at this point.

Economists had been expecting the ISM manufacturing index to drop from 59.7 in May to 59.0 in June, but it fell to 56.7. It is still a strong number by itself, given anything above 50 implies expansion, but after eleven months of numbers above 50 the trend is now slowing. A roll-over of the manufacturing PMI will often precede a stock market drop.

Having risen 23% from January to April, May pending home sales fell 30%. This number mirrors the 33% drop in new home sales in the same month. The number was not a shock, given the expiry of the government's tax credits in April and given previous data. But it does further highlight the fact the US is staring at a double-dip in housing assuming no reimplementation of government stimulus measures.

If ever there were an indication of a slowing of the post-GFC economic recovery honeymoon, it is in the latest round of monthly global manufacturing PMIs. While all were still positive, meaning expanding, all were showed a slowing of expansion from May to June.

Wednesday's release of the Japanese PMI showed a drop from 54.7 to 53.9, yesterday's Australian PMI fell from 56.3 to 52.9, and the official Chinese number fell from 53.9 to 52.1. HSBC's unofficial PMI measure for China fell more ominously from 52.7 to 50.4. We know that China is trying to slow its economic growth, but Chinese manufacturing is now at risk of contracting and that does not warm the hearts of global investors.

The result in the UK was a drop from 58.0 to 57.5 while the eurozone saw only a drop from 55.8 to 55.6. It is ironic that the supposedly most troubled region in the world is actually posting the most positive manufacturing numbers.

So put all of this together and, weak technicals or no weak technicals, a fall on Wall Street was always on the cards. Indeed, the Dow was down 153 points at 11am and the S&P hit 1010.

But 11am marked the end of the drop, and Wall Street then began to wobble its way back up to a much less sinister close. The impetus was a Spanish bond auction.

With Moody's having warned it may downgrade Spain on Wednesday, and with one-year ECB emergency loans expiring last night, markets have been braced for further potential nightmares on the European debt front. But on Wednesday the ECB received much less demand for its new three-month emergency loans than economists expected, and last night Spain comfortably put away an auction of E3.5bn worth of five-year bonds. The auction was 1.7 times subscribed.

While a similar Spanish auction in May was 2.4 times subscribed and settled at a borrowing cost of 3.53% compared to last night's 3.66%, in theory the situation became a lot bleaker over the month of June. Global markets thus took a lot of heart that a European collapse is not necessarily imminent. And that was enough to turn everything around.

The euro shot up 2.4% to US$1.2517. This was enough to inspire Wall Street to now consider stock markets to be oversold. According to market talk, mutual funds have been out of this market lately but hedge funds were all going short in June. With technicians talking doom and gloom and spooking markets further, and data showing a slowing of the US economic recovery, the bounce in the euro was a good enough signal for hedge funds to exploit stock weakness and take profits. Hence the afternoon recovery.

More marked than the reversal in stocks, after several days of little more than selling, was the reversal in gold. Hedge funds have also been playing the short euro/long gold trade for some time now with success. Last night saw positions unwound – possibly because the long weekend ahead signals the start of the summer break but likely, again, because the trade has run its course.

Gold fell US$43.00 or 3.5% to US$1199.40/oz – the biggest tumble since February. It was all euro-influenced, given the US dollar index fell 1.7% to 84.54.

For the last few weeks, the “flight to quality” trade has been back on. This means buying US Treasuries and gold and selling stocks. Despite its own debt problems, the largest economy in the world has been seen as the safe haven outside of a slowing Europe and a slowing China. The benchmark ten-year US bond yield has fallen below 3% having been threatening 4% in April, and gold has created new record highs.

But now the largest economy in the world is also showing signs of slowing. In the meantime, Europe's debt problems seem at least contained for now and while China might be slowing, 8% GDP growth is no great disaster. Last night was the first suggestion that the time has come to rebalance. It was time to take off those flight to quality trades.

As for whether a short-covering rally on Wall Street can morph into more of a relief rally, featuring real buying, is still debatable. There are many on Wall Street convinced the stock market must head lower and the S&P 500 should bottom out at 950. But as we know, when a lot of people all expect the same result, the opposite is often true.

While currencies and gold were playing their games last night, commodities were more focused on the weaker global manufacturing numbers. Oil fell US$2.68 or 3.5% to US$72.95/bbl while copper, nickel, tin and zinc all fell around 3% and aluminium fell 2%.

While such moves in commodities should bode poorly for the Australian market today, there are parochial factors at work. According to press reports the government is today expected to announce major changes to its proposed resource tax legislation. If the reports are correct, only energy, iron ore and coal will now be subject to a super tax. The energy sector already has the PRRT, but an RSPT on bulk commodities will also see concessions including a recognition of current book value of mines (ie not retrospective) and an increase in the “super” threshold from the government bond yield of around 6% to something like 13% to represent a more realistic cost of funds.

There may even be a reduction in the proposed 40% tax level.

On this basis, and noting the turnaround on Wall Street and weakness in the local market yesterday, the SPI Overnight is up 23 points or 0.6%.

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