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Fed being heard loud and clear

There’s been some hesitation to push Asian markets higher today, although China is bucking the trend with a gain of 2%.

Federal Reserve
Source: Bloomberg

With renewed talk of the Federal Reserve raising interest rates this year, it’s interesting to see implied volatility (in various asset classes) falling and emerging markets showing limited concern. The Fed should be absolutely applauded for that and it shows its communication channels are working well.

Sure, we have seen weakness in most emerging market currencies this week, but that is a function of traders increasing their exposure in general to the USD and there has been no real panic in the selling. On the equity side, I’m even seeing a compelling opportunity to be long the Nifty 50 (India), where price action looks really bullish on the daily chart and having broken through the June highs is eyeing a move into the 8,800 (currently 8,610).

It’s not just the Fed getting traders excited about rate hikes. The Bank of England is also laying the foundations for normalisation. This has made currency trading fairly straightforward over the last couple of weeks. That is; buy currencies where the central bank is openly talking about rate hikes (regardless of the pace of moves) and sell currencies where the central bank is actively easing. The obvious trades being long USD and GBP and short NZD and CAD and this is trading central bank divergence at its most simplistic.

Whether these trades still have more juice in the short-term is debateable given what is priced into the interest rate markets. But the trend here has absolutely got to be your friend, so the biggest headache for traders isn’t so much direction, it’s about how deep a pullback one expects in USD/CAD, GBP/CAD or GBP/NZD before entering the trade. With the swaps market pricing in a 10% chance of a 50 basis point cut in next week’s RBNZ meet, it shows that traders have become just a touch too dovish on rates and while I think a 25bp move is assured, a 50bp would send fairly clear message of the level of concern they have.

However, it has to be said that a 5% rally in GBP/NZD rally over the last five day (pre-leverage) is absolutely huge and akin to BHP Billiton moving 30% in a week!

Still, I think we can applaud both the RBNZ and BoC who aren’t just waiting around for the Fed to do the heavy lifting to bring down their currency. They are pro-actively striking while the proverbal iron is hot and taking a stance. In effect, these banks have become momentum traders, something many would like to see from the Reserve Bank of Australia over the years.

AUD/USD has taken somewhat of a backseat to the NZD and CAD of late, although the trend is down and if you look at an ultra-basic short-term FX valuation model (Australia versus US swap or yield spreads) the pair is loosely around ‘fair value’. We continue to see good inflows into the quasi-currency plays in the Aussie equity market and CSL and MQG both look attractive for a potential break-out. My money would be on MQG for a move above the 27 April high of A$84.19 and I would be adding to core long positions on this development. If a stock is trading at all times highs this is very bullish and should be traded as such, especially if one’s trading focus is short-term in nature.

We have also seen another 6.4% decline in implied volatility in the ASX 200, which should be good for income strategies. It seems we have seen some modest lightening off positions in the financials today, after what has been a fairly good week to be long banks. However, the trend is higher and a break of the neckline of the inverse head and shoulders pattern for the financial sector at 6,650 could see the sub-index target another 7%. As goes volatility, as goes the banks and, given the weighting, the broader market too. If you want income then the ASX 200 is the place to go for an international money manager and this could be a key reason why we have seen $111 million in inflows into Aussie equity funds this week, arresting last weeks A$49 million outflow.

Banks in general are looking like the sector to be leveraged to. I suggested being long Citigroup on Tuesday and this trade is working nicely, with price breaking through the year’s high yesterday on a result of fine quality. I would be moving stops to break even and riding the trend here as the bulls will continue to pay up for these earnings.

On the subject of earnings, the corporate calendar focuses on General Electric today. These results are always worth watching, even if you don’t trade equities given its reach is into economics so broad. Recall, GE have missed seven of the last eight earnings reports. However, they have offset this by a consistent outperformance on the earnings line. The bulls will hope for a good result here though, in effect adding to the recent momentum where earnings (fairly predictably) are coming in above the street’s low ball with 71% of the S&P 500 corporate having been beaten on the EPS line and 52% on sales. It seems only a matter of time before the S&P 500 joins the NASDAQ in making a new all-time high in my opinion.

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