Market pricing for a rate hike at the Fed’s 16-17 September meeting is steadily being unwound; it now sits at 30%. This may see an ebbing of strength in the US dollar as this repricing plays out, and after its big gains during the volatility around China’s ‘Black Monday’.
However, all bets are off for what will happen on Monday with the reopening of China’s stock markets. The possibility of renewed volatility next week is leading to cautious trading in all markets.
After surprising with a negative close yesterday, the Nikkei is performing solidly today. Healthcare stocks have been leading the index, with the sector rising 2.4%.
The index is still looking very delicate, with a high likelihood of further downside risks. The gap between call and put options on the Nikkei has reached the widest gap since 2011, which is a strong indication of the prevailing negative sentiment on the index.
While the Nikkei has been performing better today, it’s meeting strong resistance at the 18,500 level. A renewed test of its lows last week around the 17,750 level looks quite feasible over the coming sessions. The Nikkei is yet to make any meaningful moves out of its downtrend.
The only major news occurrence that could support drive the Nikkei to a meaningful upward move is likely action by the Bank of Japan to increase its stimulus program. In the absence of this the index looks likely to trend lower.
There is also growing concern about the Japanese banking sector. In the face of poor growth prospects in Japan, banks aggressively began lending to emerging Asian nations. With the massive falls seen in emerging market currencies over the past twelve months or so, defaults on these loans have been soaring. This is likely to be a major headwind to the performance of the Nikkei over the coming months as well.
There was mixed Australian economic data today. Retail sales disappointed to the downside, growing -0.1% month-on-month compared to expectations for a 0.4% expansion. Household goods sales declined 1.9%, but it has been one of the strongest components of the index and was still up 8.6% on the year. The decline in retail sales is thought to be partly due to the pre-spending of the one-off small business tax package, with these effects dissipating in the coming months.
The trade deficit narrowed to $2.5 billion on the back of better-than-expected export values. This is pointing to a better contribution to GDP from net exports compared to last quarter.
The release at 11.30 am AEST saw the Aussie dollar drop 0.5% to $0.7002, before beginning to retrace half of that move. The big downwards moves in the Aussie this week (falling 2.1%) in anticipation of the poor GDP numbers may well serve to provide some stability to the Aussie around the $0.70 level.
Focus will now turn to the steady unwinding of bets on a September US Fed rate hike, which should put a pause on US dollar strength. Even a strong Non-Farm Payrolls number out of the US on Friday is unlikely to lead to a rate hike at the September meeting, with inflation still tracking below where the Fed would like it to be. This should see some consolidation for the Aussie at current levels, although the reopening of the Chinese stock markets on Monday could see renewed global volatility and downward pressure on the Aussie (alongside all global markets).
In the longer term, there is a high possibility that the AUD could end the year in the $0.60-0.65 range with the poor Australian GDP print increasing the pricing for an RBA rate cut and the likelihood the Fed will move on rates before the year is out. This does point to renewed gains for companies with US dollar earnings, which are the few bright spots on an otherwise uninviting [indices:AU200|.
Qantas (QAN) is well positioned to benefit from some of these tailwinds. It saw solid gains in the domestic market in its most recent earnings statement as a comfortable duopoly between it and Virgin begins to form, allowing both to steadily boost margins in the space. Qantas has also undertaken a proactive investment in new aircraft for its overseas operations, and this will be key for generating foreign currency earnings. With its P/E ratio sitting at 13.5, it is also looking fairly reasonable at the current juncture.
CSL has also taken a recent beating after forecasting lower-than-expected FY16 growth. But its core business of immunoglobulin sales in the US continues to be strong despite facing stronger competition in recent times. CSL is also the largest seller of albumin into the Chinese market. Despite China’s slowing economy, there is still huge scope for growth in the blood derivatives market, with Chinese albumin use estimated to be less than 20% of potential demand. CSL is also trading at a P/E ratio of 21.8, which is the cheaper end of its P/E range over the past 10 years and much lower than its average of 23.8.