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Efficient market hypothesis dictates that financial markets will price in all known news. In these days of comparatively predictable central bank policy, resulting in subdued implied volatility (across all asset classes), central banks will often float an idea some time before the actual event. This time around the idea is to let the markets explore, react and ultimately feel comfortable when the time comes to concerted tighter policy.
With that in mind, in recent times we have heard upbeat commentary from the Bank of England, with the market now pricing a 60% chance of a hike by November. Various Bank of Canada (BoC) officials have spoken of late and the market focus is on their 14 July meeting with market pricing close to an 80% chance of a hike. One just has to look at Canada’s bond market, where two-year bond yields moved 21 basis points in the week to see the re-pricing of expectations.
The ECB has also been in the mix, with the result being a sizeable 21 basis point sell-off on the week in German and French 10-year bonds. The premium demanded to hold US Treasuries over German Bunds has narrowed sharply of late and has been a strong catalyst for EUR/USD to appreciate, and it’s hard to feel this reverses in any great degree.
EUR/USD closed out the week testing Thursday’s high of $1.1445 and finished off what has been a super strong quarter. One just has to look at speculative positioning, where we saw the market starting Q2 net short of EUR/USD futures to the tune of $9 billion, with positioning now net long $8 billion. A truly unbelievable turnaround. We can also see Japanese bonds joining the sell-off in DM, but obviously to a far lesser extent. JGB 10-year yields are even getting close to levels where traders may start to test the BoJ’s resolve and whether the bank rigorously defends the 10bp ceiling they have set under its ‘Yield Curve Control’ regime. I like USD/JPY into ¥114.00 here.
Another debate traders are asking and expecting a resolution this week will be seen front and centre amid moves in Aussie fixed income, rates and the AUD. With all the talk of a hawkish turn from DM central banks traders are speculating whether the RBA join the party. There has been a strong sell-off in Aussie fixed income, but traders are still only pricing in seven basis point of hikes through to March 2018. No one is expecting a hike at this Tuesday's meeting, but some feel we are seeing something in the language that is more upbeat.
We can certainly see there has been a pick-up in AUD/USD one-week implied volatility, with some who feel that the RBA may follow the ECB, BoE, BoC and Federal Reserve, although there is seemingly far more to gain from the RBA keeping its statement largely unchanged, which is my base-case. With the AUD/USD hitting a high of $0.7712 on Friday the bulls are in firm control here and the pair is testing the April 2016 downtrend at $0.7724, with supply also seen into the 21 March high (and key outside day reversal) of $0.7749. An unchanged statement may disappoint.
As I say, the RBA has little to gain in being more hawkish at the margin, especially with Q2 CPI just around the corner.
The lead for the Asia is somewhat positive, with the S&P 500 etching out a 0.2% gain, although this masks what was a fairly whippy ride, with the buyers once again supporting moves below 2420. The focus on Friday was on US core personal consumption expenditures (or PCE - the Fed’s preferred inflation print), which came in at a lowly 1.4% yoy and this won’t enthuse the Fed one bit. Interestingly though, we also saw the June Chicago PMI coming in at the strongest pace of expansion since May 2014 at 65.7, relative to market expectations of 58 and this puts upside risks to this week’s national (aggregated) manufacturing data point. Reverting back to central bank action and we can now see January 2018 Fed fund futures sitting at 1.31%, thematic of a 60% chance of a hike by December.
It’s another big week for US markets, culminating in Friday's payrolls, with the key focus on hourly earnings (consensus +2.6%). This comes ahead of core CPI (ex-food and energy) on 14 July and Janet Yellen’s congressional testimony two days prior. On the week, I will be paying close attention to the TLT ETF (iShares 20+ Treasury), where price made a bearish outside weekly reversal (i.e. price traded above the prior week’s high and closing firmly below its low) and whether we see follow through selling over the week. The US dollar index is in a wedge pattern and this can be seen quite prominently on the weekly chart. A weekly close above 9716 is a stretch, but it would catch a lot of traders offside and suggest between days for the USD – one to watch.
It’s the start of the new month and quarter, but it starts on a soggy note, with our call for the ASX 200 open sitting at 5715, suggesting a small drop on open. A look at price action on the weekly chart of the ASX 200 shows clear indecision from market participants, who just have such limited capacity to push the index through 5800 with any conviction.
On the downside, the buyers step in every time the market falls below 5675 and until we have a weekly close below this level I am a fence sitter and hold a firmly neutral bias. Oil looks interesting here and energy stocks should outperform, with US crude closing up 2.5% at $46.04, having retraced over 38.2% of the May to June sell-off. Interesting, for the first time in 24 weeks the US oil rig count fell by two rigs to 756. One week does not make a trend, but this could be a small, yet significant turn in the oil supply dynamic.
Spot iron ore closed up +0.4% at $64.95. Iron ore futures have also made small gains, but it’s copper that is looking perhaps the more bullish commodity to trade, with price pushing higher and hugging the five-day exponential moving average.