If we can really surmise the last two years in financial markets, it has been to do the total opposite of the consensus, at least when a trade or view has become too hot or too pessimistic. The interesting aspect now is that being long on the USD, along with long US financials, was the clear consensus trade at the start of the year from strategists. And while banks have had their moments, the USD is trading at fresh yearly lows and there doesn’t seem anything resembling support holding it up.
With very little in the way of tier one US economic data this week, the moves in the USD will be driven by the ECB, or by various RBA members (we have RBA Member of Heath speaking today at 3:30pm AEST), who may look at suppressing the moves and that needs to be considered as part of one’s risk management.
However, the point is the USD may turn given we have such extremities of pessimism built in, but it won’t be driven by the USD side of the equation and while the elastic band is being stretched, picking to bottom seems a low probability trade, at least right here, right now.
The USD remains the story for now, and the moves have been pushed along by a reasonable bid in US fixed income, which in turn seem to have been assisted by the failed Healthcare reform bill, with a hit to the USD valuation. AUD/USD remains the poster child of momentum, trading to a high of $0.7943, but is now grossly overbought. Yield differentials between Aussie government bonds and US bonds have widened fairly aggressively in the last two weeks, which have also been assisted by a rampant iron ore price, where the spot price closed up a cheeky 3% (the highest level since 11 April) and Dalian iron ore futures on fire.
The fact the RBA see a nominal real rate of 3.5% has been the huge talking point, largely driven (in my opinion) by a surprise that we have some genuine meat on the bone. We’re far more used to the likes of Federal Reserve Governor Lael Brainard throwing out these sorts of numbers and not our own central bank. Either way, adjust the nominal neutral rate of 3.5% for the RBA’s own view on inflation and employment, apply a standard Taylor Rule and we actually see little change in the cash rate. Clearly, the market saw 3.5% and said: ‘crickey, the RBA is about to go nuts tightening.’ It isn’t going to happen.
Anyhow, look at our nearest trade partner New Zealand. One could argue their nominal real cash rate is higher than that of Australia’s, yet has the market started applying this thematic to New Zealand dollars. Nope. One can expect the RBA members due to speak (Heath, Debelle and Bullock) this week to hopefully clear this up, because if they don’t, then the AUD/USD will be above 80c. Also, bear in mind that when the minutes came out the AUD/USD was trading at $0.7680, so if they feel the market has misinterpreted, or at least over interpreted this, then they have the floor to smooth it out.
Let’s also not forget that the market is priced at a 20% chance of a hike this year and a hike is fully discounted through to mid-2018, and this seems about as rich as one can expect, that is unless we see a jump in the upcoming Aussie Q2 CPI data, which seems unlikely.
Another interesting dynamic is how the AUD is playing into equity portfolio moves. Of course, AUD sensitive stocks have been heavily traded as a thematic view, but we are seeing a strong pick up in traders who have bought into US equities. And while the share price may have moved in the right direction, they are getting hit on the USD exposures, so portfolio management and the neutralising of FX exposures by buying AUD’s has been in play and that seems absolutely prudent. It’s not just those holding US stocks, but GBP/AUD is trading now below £1.6500 and EUR/AUD sub-A$1.4600, so those holding UK and European stocks will be seeing a P&L hit from the FX translation.
Staying on FX market, and the EUR strength (EUR/USD hit a high of $1.1583), there have been interesting headlines on the wires that have jumped out. Specifically, ‘the ECB’s Frankfurt-based staff are examining scenarios for the future path of quantitative easing ahead of a Governing Council decision that is expected to take place in September or later, according to euro-area officials familiar with the matter.’ This won’t likely be explored in tomorrow’s ECB meet, but it throws the idea that perhaps Mario Draghi could set the scene in his now, highly anticipated speech at Jackson Hole symposium in August. It suggests that September is now red hot for an announcement in the September ECB meeting, whereby its QE program will be tapered in January.
So, aside from moves in FX and fixed income, US equities have closed again on a flat note, with outperformance from tech and the space has really regained its mojo again with flows into the QQQ ETF (Nasdaq ETF) pushing price up for an eighth consecutive day. There has been no love for the US financials, with the likes of Goldman Sachs and Bank of America not pleasing investors on earnings. IBM have reported after the close, although we are not really seeing too much of a move there.
Our call for the ASX 200 sits at 5683, somewhat outperforming the move in SPI futures overnight, which closed down 14 points and this set us up for an interesting open. As mentioned yesterday, the market has traded below 5675/80 a number of times in the past month or so, but has always closed the week above this level. So the ability for the market to close the week above 5675 is important (for me at least) and therefore one questions whether we see the buyers step in on today’s open.
The banks are obviously key and some support for energy and materials could come from higher oil prices (Brent closed up 0.9%, gold (+0.7%) and iron ore (+3%), but the banks are in a bad news cycle and the bid is certainly not as well supported as it perhaps once was.