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Staying long until proven wrong

Asian-based traders have been net sellers of USDs today, although perversely there has been good selling of US treasuries, with the US two-year up 4 basis points.

Markets
Source: Bloomberg

This may indicate fixed income traders this side of the world don’t believe Janet Yellen is as dovish as US traders, although silver and gold are pushing higher.

The idea of when the Federal Reserve lift rates has transfixed markets and rightly so; it is a big deal.  There are so many market dislocations and these will be exposed if we get the signal from the Fed that they are ready to start a normalisation process. Janet Yellen’s dialogue to Congress has been described as ‘vague’ but there is probably enough in the rhetoric for both the hawks and doves. The key point, though, is she seems to have added to the market’s road map on US rates and given us new information.

Traders selling USDs

At some stage the US central bank will lose its ‘patient’ stance with regards to rates, which is code to say every meeting after that is live. The trick is to remove potential volatility around this process and from that angle I feel she has touched on the issue fairly well.

Perhaps this is why Asian traders are selling US treasuries today, with the fed funds December future pushing up a touch as well. The eyes of the financial markets are therefore fully focused on the 18 March FOMC (19 March at 05:00 AEST) to see if the US central bank drops the ‘patient’ language reference. However, in the lead-up to this event we get views from six regional fed members (Lockhart, Fischer, Evans, George, Williams and Kocherlakota). Their views will add to the market’s perception around the upcoming March meeting.

My own personal view is that the Fed will change its forward guidance in March, making it sufficiently clear that rates will only go up when the data provides them with the confidence to do so. Pullbacks in the USD remain a buying opportunity in my opinion, although USD bulls will need to see US bond markets under pressure, with yield pushing higher and spreads subsequently widening relative to other bond markets.

Saying that, AUD/USD has seen good upside today, helped by a better-than-expected December construction print (-0.2% vs -1% eyed) and China’s small business manufacturing read, which pushed back into expansionary territory at 50.1. The Chinese equity market didn’t respond in kind to the HSBC manufacturing print and at the time of writing the CSI 300 is down 1%. However, we know the mainland markets are being driven on the idea of additional liquidity, so good news has been taken badly here.

It is interesting to see the strong correlation between copper and the AUD/USD of late, which makes some sense despite copper making up a very small percentage of Australia’s exports. One could make an argument that the 1.8% fall in iron ore futures today should have had a more prominent impact, but that hasn’t been the case.

Interestingly, the daily chart of copper (March contract) is looking quite bullish and, as long as it holds $2.63 (quoted as 26,385 on our web platform), then it can potentially squeeze another 4.5% higher into the $2.75 area. Could this lead the AUD/USD into the $0.8000 area, especially with a 38% probability being priced in for a March cut?

Global equities on fire

Equities continue to find buyers today, with the MSCI world index making a new all-time high today. Locally, I felt a move to the 5740 in the ASX 200 could be on the cards, but it seems nothing is stopping the developed market bull rally. Investors are paying no attention to traditional fair values (ie. the net discounted cash flow of future earnings) and are looking at equities earnings yields relative to that bonds and credit.

If we look at the 4% and 4.6% aggregate yield in the FTSE and ASX 200, this still puts equities at their most compelling point relative to bonds for many, many years. There seems to be an asset allocation trade going on around the world, although we are not seeing any major stress in bond market pricing.

There seems a real fear of missing out as well, with both institutional and retail traders seeing a barrage of new highs in various markets. I have been especially bullish on Japan and Europe and these markets continue to do well, so staying long until proven wrong rings true.

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