The USD could fly

Volatility seems to have subsided and with it we have seen modest intra-day ranges in various Asian asset classes.

USD
Source: Bloomberg

The ASX 200 is flat on the day despite being treated to good results from BHP and QBE, while banks have seen lacklustre price action even though there is a growing narrative around sizeable cuts to term deposits largely above the cuts to variable mortgage rates.

The mining giant has given cautiously optimistic commentary around
China (which it expects to recover moderately), while the mid-term outlook on crude appears ‘positive’. This is interesting as they are looking to cut back on the number of onshore rigs by some 40%, while as a group capex and opex is likely to be 15% below original guidance.

So shareholders are warming to the idea that management have got both capital management and costs under control in a period of heightened uncertainty.

Japan still looking attractive

Japan is flat on the day, but after the 11% run (in JPY terms) since 16 January, traders appear to be hesitant to push the Nikkei higher. As said before, there are many reasons to believe the market will trade higher over the medium term.

When you are seeing compelling valuations, an uptick in economic metrics and central bank liquidity, traders should have a favourable bias. What’s more, when the Bank of Japan, Government Pension Fund (GPIF), Japan Post and Post Insurance are all shifting into domestic (and foreign) stocks, you know there is going to be sustained buying over the coming years.

FX markets have been subdued as well, helped largely by a calming of sentiment on the macro issues of late and the fact markets have become quite au-faux with central bank easing. On this point, Israel yesterday became the 20th central bank to ease this year. In effect, over half the world’s population are now indirectly exposed to a central bank who is loosening monetary policy.

To put the volatility into perspective, AUD/USD and EUR/USD have traded in a 10 point range since 13:00 AEDT, while USD/JPY and cable have traded in 11 and 13 point ranges receptively. Things did get a bit more exciting after New Zealand’s two-year inflation expectations were lowered 26 basis points to 1.80%.

The 26-point fall in the kiwi dollar signifies the market now has RBNZ rate cuts in its sights. The earlier lack of volatility didn’t feel like nerves around Janet Yellen’s congressional hearing (02:00 AEDT) and has the feel that we could be in for a period of lower volatility, which will appease the investment community and frustrate individuals with a shorter-term horizon.

All eyes on Janet Yellen

The question is, will the Federal Reserve chairman rock the boat by giving a clear signal around future hikes in the fed funds rate?

There is perhaps an air of anticipation given the real momentum in the labour market of late, while we have seen Federal Reserve members Bullard, Williams, Plosser, Mester and Lacker all talking up the prospects of a normalisation of policy. Wages are the missing piece (as they are in Japan), but there are some positive developments materialising, and not just because the unemployment rate is headed towards full employment at 5.2% to 5.5%.

We have seen Walmart stating they will make quite a punchy increase to wages starting from April, while wage hikes have also been seen at the likes of Ikea, Starbucks and Gap. Corporate America is raising wages and the Fed will be cognisant of this.

Will this be enough, though, to spur Janet Yellen into giving a strong sense the Fed will lift the funds rate by mid-year? I am sceptical and so too is market consensus, which is looking for Ms Yellen to give the Fed some breathing room and an element of flexibility.

If ‘patience’ is to be removed one day (with regards to its statement of when rates should be increased), then it will be offset by a view that this would not indicate a fixed date, which means it will be purely data dependant. We know the leveraged FX community are long USDs to the hilt, but the bond market still holds the key for further USD appreciation.

We have already seen a 20% increase in the USD index since May 2014, so it seems logical we are going to need to see front end yields (ie. two- and five-year US treasuries) increase for this to push higher. It’s worth bearing in mind then that the fed funds future is pricing in the funds rate to be at 51 basis points by December. 

With this in mind, the USD could fly if we do get a clue that the board could raise this year.

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