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Brokers apply the brakes

Every broker headline I have read this morning has the same connotation – ‘hold your horses.’

USD
Source: Bloomberg

The moves in the USD have been so strong and so fast in the past week, it has actually reached some brokers’ year-end targets – in March. This will mean that some exposure has been taken off the table and some of the heat will need to cool to entice another leg lower.  

Fundamentally the EUR, GBP, JPY,CAD and AUD are all structurally weak compared to the USD and year-end expectations remain to the down side for each one. However, there will need to be a bit more force from the Fed next week to see new half decade or more lows are to be reached.

I continue to see 76.20 as the support level in the AUD; it was unable to hold below this level after Wednesday’s test which saw the AUD into the 75 cents handle for the first time since May 2009. If it is to hold this level, it will need to see the RBA move rates, the Fed gear up for rate hikes and oil slide. These are likely to happen over 2015 - just not in the next two weeks.

So for now the snapback looks appropriate as the employment read yesterday pushed rate expectations back out to May; 76 to 77 cents remains the range for the AUD.

The equity markets have finally swung back the opposite direction too;  after the worst two-day sell-off in over six weeks, the bounceback was expected as the Fed stress test is seeing a flood of capital moving into US banks on yield and capital dispersant promises.

With the current snapback, it gives us a chance to reassess some profitable pair trades:

The first pair has being long European banks and short the S&P 500. It has been a very advantageous trade up around 18% as the ECB’s QE program is bank supportive, and the USD strength is seeing the S&P underperforming after six years of out-performance. We continue to see this as a promising trade over 2015 on central bank divergence.

Domestically, the pairs trade of the past four weeks has been long the financial sector short the materials sectors, as iron ore and industrial metals collapse into the abyss and the yield trade ramps up on RBA expectations. We are reassessing this position as new entry points are likely to emerge over the coming weeks

The next move

The Fed speak will be key to the next leg in the markets. So what do we expect on Wednesday night:

- The ‘patient’ reference to be removed (despite the fall in retail sales overnight) – this means all Fed meetings from Wednesday onwards could see rate rises. ‘Early and gradually rather than later and steeply’ should be the mantra adopted.

- Referencing the strength of the USD – the amount of talk around the USD may mean that the Fed could talk down rate moves to moderate as the effect it is having on the domestic economy. The Fed wants to take the volatility in the currency off the table. Plus the equity market creates the wealth effect, so savage selling of the S&P will stop the US recovery in its tracks – something it doesn’t want.

- Inflation the Fed moderator – although ‘patient’ is likely to be removed, Chairperson Yellen continues at great length to point out that inflation is well below target – the goal here is to further moderate speculation of early moves.

- I expect cautious trade over the coming three days, as investors assess their positions leading into the meeting.

Ahead of the Australian open

Iron ore recovered slightly overnight to US$57.97 a tonne overnight, which may finally see the slide in materials abating today. I will point out there have been some very bearish calls in the past 24 hours on FMG – one note sees a 12-month target price of 89 cents.

After yesterday’s very strong performance on the back of the dip buying in the banking space, we are currently calling the ASX up eight points to 5858, which would see the ASX down just 40 points for the week rather than 150 as it was mid-week.

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