Rate debate gathers pace

The ASX has somehow defied most global leads over the past seven trading session to log its longest streak since October.

Source: Bloomberg

That move has put the market within touching distance of the August high, which at the time was a five-and-a-half-year high.

Will we get an eighth straight day of gains? – No. China, US earnings season and the fact that the market has moved too far to the left in the rates debate, will see the ASX in the red today. Yesterday saw China logging its first manufacturing PMI contraction in over two years. Of particular concern, is that  the employment sub-component is at its lowest level since February 2013 - as are new exports.

The People’s Bank of China won’t be happy with the employment component and may look to continue its targeted measures of the past year to increase employment. However, the fact new exports are also declining is a big issue on a macro-level. It illustrates that the lower growth in the global economy is impacting consumption of Chinese goods and if China sees further headwinds here, it will be stoking the ‘hard landing’ fears that are ever present in market thinking.

So, the fact the ASX has managed to buck the concerns around China over the past week is a surprise. It has also managed to buck weaker than expected earnings from the US as the USD becomes a double edge sword for US corporates. However, it’s a very strong lead for Australian USD earners. You only need to look at the likes of Macquarie, CSL and ResMed for those that are having bumped moves on the USD differential.

Ahead of the Australian open

However, from a strategy point of view, my baseline starting point of: ‘return of capital is king’ is absolutely driving the ASX 200 over the past week. The market speculation about tomorrow’s RBA meeting is at fever pitch. Expectations of a rate cut have now crossed 50-50, with the swaps market estimating the chance of a rate cut is now 65%.

Economists are also lining up to change their views on rate cut expectations. However, they vary as to when the cuts will come into fruition. According to the 27 economist surveyed by Bloomberg, only six see a cut tomorrow with Barclays the latest to join this group. Come the March meeting, 12 now believe the cash rate will be 2.25% with Goldman Sachs now expecting a cut in March and May. By May, over 85% see the rate being lower than the current rate.

This means yield will be bid and bid well. CBA made four new record highs last week and crossed over $90 for the first time. It is now racing towards $100 a share and even with a 4 handle on its net yield read will still see bidding as investors hunt return of capital as the RBA lowers rates.

However, today may see some of the positive trade being trimmed; the AUD has moved too far to the left and is priced to perfection for tomorrow’s meeting. It has held above 77 cents and you may see some profit being taking and a slight squeeze higher as trades take some risk off the table. This may also translate into equities. The yield plays have been on a tear and are the main reason for the ASX to having appreciated 5.3% in seven days - It will be a day of positioning.

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