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Disconnected markets continue to develop

Equity markets have certainly snapped back from their worst week since August last week, which is interesting considering the underlying conditions haven’t really changed week-on-week.

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Source: Bloomberg

What’s caught my attention this week

Fed minutes have been met with a renewed sense of ‘excitement’. December is now the base-case month for lift-off. The language used is strong enough to draw this conclusion and coupled with the majority of Fed members that have publically backed 2015 as the year to start ‘normalising’ policy, December is (as near enough as can be) a certainty.

The European Central Bank (ECB) released the accounts from the October meeting – it continues to lay the groundwork for further stimulation in December. Expectations of the cuts make the deposit and lending rate look near enough to negative and zero respectively for certain European markets to rally off the back of this.

Equities globally have responded positively to this macro picture as it still collectively shows that central bank policy can and will alter markets and economies. However, what would be a dire market-mover would be if the Fed breaks its December mantra and holds off (suggesting it sees something in the US economy that the market doesn’t). It would suggest that central banks have ‘lost control’ of markets and that would see very strong selling amplified by the December light volumes. This would be very bad for markets.

More importantly this week was the underlying copper story. The London Metal Exchange contract touched the lowest level since May 2009 and CME also fell to GFC lows overnight. The red metal has two dragging factors – the China hard-landing fear and industrial metal demand fear. The disconnect in equities this week to the underlying commodity prices is building as a real issue and I see this gap closing come first half earnings season in February.

WTI crossed the ‘OPEC’ demand line of US$40 barrel. Two weeks ago, the Saudi energy minister declared that US$40 a barrel is the level that will see high levels of demand. If this was to break down, I suspect it would see a production response that has been resisted by OPEC for the past 18 months.

USD short squeeze seems to be developing pair-by-pair. The sustained bidding in the AUD in the Asian session ramped up in the US session and saw the AUD crossing the 72-cent handle. Fundamentals would suggest this is overdone, however, risk currencies that have been savaged (ie CAD, NOK et al) look like seeing shorts being shaken out before re-entering ahead of the December Fed meeting.

Ahead of the Australian Open  

Iron ore has fallen to $45.35 which is the second lowest price this year. BHP’s ADR is pointing to a 1% decline. After its near 3% move yesterday, the cyclical firms look to be in for a return to lower levels next week.

Ahead of the open, we are calling the ASX up 11 points to 5253, however after index option expiry yesterday that saw mass buying of the SPI, the ASX may actually ease during the cash session. 

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