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You could also throw in a rally in gold and oil into the overnight thematic, but for us the big talking point now has to be the technical breaks seen in the developed market bond markets.
The first thing we looked at when seeing a continued push higher in the US treasury, UK gilt and German bund market, is inflation expectations. However, if you look at the US bond market’s preferred measure of inflation forces – US breakeven’s (which measure the difference between the US ten-year treasury and the treasury inflation protected securities or ‘TIPS’) – inflation expectations actually fell four basis points. It just seems that the world wants to limit its exposure to the fixed income market right now, and while central bankers try to anchor longer-term rate expectations, the market is not listening as much as they would like and is running away from them. In the gilt market, the 2008 downtrend has been broken; in the German bund market the multi-year range has given way to the top side; while the ten-year US treasury market has also clearly broken out.
Whether future moves in yields is now the key downside catalyst of developed stock markets is yet to be seen, but the bulls will point out that the economic data is fully justifying the moves, and clearly if you are going to see higher bond yields you simply have to have the growth to back it up. Yesterday’s data that showed a $66.9 billion outflow of US treasury holdings by foreign investors (the highest ever) may have been partially to blame, but this is data dating back to June and is therefore stale. However, when you hear that China has reduced its holdings by $21.5 billion you have to take note. Interestingly though, if you look at yield advantage that US treasuries command over UK gilts of late, the effective premium has fallen from thirty basis points on 1 August, to now stand at just seven basis points. Yield spreads play a vital role in currency valuations; thus you can clearly see why GBP/USD has pushed back the 200-day moving average (1.5524) and the short-term August downtrend.
Price action in the USD itself is not looking good at all, which is amazing given tapering is looming and the US will be one of the star performers in developed markets from a growth perspective in 2014. However, there are some interesting forces at play right now and thus the technicals need to be respected. Whether it’s a reflection that the market has fully priced out rate cuts in Australia and Europe and is in fact expecting two hikes in the UK by 2015 is one thing, but we also know the ECB’s balance sheet is fast contracting, while European banks are selling foreign assets and the IMF is predicting a primary surplus this year of 2% in Europe. Still, until we can see signs of a prolonged reversal in the USD, we will remain on the sidelines despite a longer-term USD bullish bias.
Given the big moves up in developed bond markets amidst a 1.4% fall in the S&P, we initially saw weakness in Australia, Japan and Asian emerging equity markets and one wonders how much worse things would have been had we not had the recent bout of better Chinese data. Global fund flows have shown a run of redemptions from emerging market debt and equities of late, and clearly this will only continue if developed market bonds continue to be liquidated and subsequently yields continue to push higher.
Later in the day however, Chinese markets turned on a dime and went crazy, which was interesting just as everyone was settling into a quiet afternoon. The Shanghai Composite rallied around 5.5% in a split second, driving the AUD/USD to 0.9177 and pushing metals higher. The rumour and intrigue that centred on the move was huge, with dealers phoning around the houses trying to work out exactly what occurred. Talk of an RMB 7 billion fat finger surfaced (eyes on Everbright who are now in a halt in China), while there was also talk of some very bullish news due to be released on the banks, which in theory would make sense why the volume in some of the mainland banks was extreme. There was also talk of a near-term RRR (reserve ratio requirement) wrongly placed ETF order, however one thing is for sure; it caught a lot of traders by surprise and we watch in anticipation on what exactly caused the move. Whatever the outcome these sorts of moves do not help confidence.
In Australia the market is down 0.8%, certainly not helped by a 0.2% fall in the Nikkei, although again; the Japanese market seems to be rallying into the close. The Australian index hit a low of 5101, although caught a bid as the algo's kicked in on the China market spike. The fact that ANZ is down 3.1% is not only subtracting a reasonable amount of points from the market, but is hurting sentiment towards the whole sector. The fact that margins are set to decline five basis points (half on half) is the main point of contention. However, if you extrapolate out Q3 cash earnings from the A$4.8 billion of cash earnings it made in the nine months to date of 2013, it leaves you with a figure of A$1.618 billion. While this figure is generally in-line with the street’s expectations, it was largely assisted by a much lower provisioning charge and thus the market feels the weaker pre-provision operating profit (PPOP) could suggest downside risks to the full-year numbers.
We also look to close the week with a weekly gain of more than 1%, which isn’t too bad given earnings are in full flow. As things stand 31% of ASX 200 companies have reported, with 49.1% having beaten expectations on the EPS line, while 33.3% have beaten on revenue expectations. We’ve also seen 2.4% revenue growth.
European markets look for a soft start today and despite the spike in the Chinese bourses our clients haven’t been overly impressed. Data is thin on the ground, with traders looking out for eurozone CPI, US housing starts, building permits and University of Michigan consumer sentiment numbers. As mentioned though, it will be interesting to see if we see further selling in the fixed income market and we will be keenly watching to see if the bulls step in the US market and defend the 38.2% retracement of the recent rally (from 1588 to 1709) at 1652, with the 55-day moving average just above at 1654. A break of these levels could see a deeper move to 1600.