Relief seen, but can it last?

A relief rally has been seen globally in all asset classes, however, was this simply a classic end-of-month/quarter story and a re-weighting into risks assets after a strong underperformance on the quarter?

Iron Ore
Source: Bloomberg

Modest buying has been seen in US fixed income so there is merit to this argument, with a number of investment banks talking about mutual funds having to buy over $20 billion of US equities to rebalance. This suggests we can write yesterday’s trade off as a partial artificial move, although money can still be made or lost in this environment. However, as part of the longer-term picture, yesterday’s trade shouldn’t change the perception around global macro.

The open in Asia is looking fairly upbeat, with Japan looking to outperform. The ASX 200 should open on a flat note and markets in Hong Kong and China are offline for National Week.

The two-hour chart of the ASX 200 looks quite interesting and we are seeing stability above the 7 September uptrend. A move into 5100 to 5150 can’t be ruled out, but I feel this chart is given a fairly well-defined playbook on the future direction of the index – a break of 5000 should see a fairly quickly move into 4900.

Commodity futures have seen good short covering, with copper putting on 3.1% from the 4.00pm AEST cash close and nickle putting an even more impressive 4% on. Iron ore is up a touch and BHP’s American Depository Receipt (ADR) is suggesting an open 1.4% higher. If we use BHP as a proxy and put it in relation to our flat ASX 200 index opening calls, it suggests some underperformance from the more domestically focused plays. Yesterday’s poor Aussie building approvals has clearly not helped sentiment towards the Australian economy and the overnight downgrade from the International Monetary Fund (IMF) to Australia’s 2015 and 2016 GDP to 2.4% and 2.9% will not assist.

I would caution at reading too much into these forecast changes though, as they are still consensus and merely a rounding issue, although they have advised the Reserve Bank of Australia (RBA) to ease policy and therefore continue their self-imposed advisory role to the world’s central banks. Suggestions that Australian housing is 10% overvalued is clearly not going to shock anyone and the financial markets have shifted to ‘watching this space’ on Aussie housing – keep an eye on September RP Data house price index (released at 1000am AEST), especially in light of the negative reaction to the poor building approvals yesterday.

The IMF also re-iterated its view that the AUD is overvalued (making mention of 15%) on a real-effective exchange rate (REEF). This puts their medium-term view sub 60c. Given the RBA’s recent comments, this puts them at odds with the RBA’s own models.

Chinese equity markets will be closed, but that has never stopped the release of key economic data. With the world so sensitive to China’s growth prospects, today’s manufacturing and services reports could drive sentiment. The likes of copper, AUD and Aussie resource plays should be most sensitive to the NBS (official) manufacturing report, with the street expecting no change to the index at 49.7. This suggests manufacturing among the large manufacturers is still modestly in contraction, and while it would be a surprise, let’s not rule out an above 50 read which could send a positive message out at a time when sentiment towards China is so low.

Watch out for the new export order sub-component of these data points, as this would give an idea of the level of external demand China is seeing; as we’ve seen in prior reads (and statistics from Korea and Taiwan), this is hardly inspiring.

The greater concern around China is towards the drawdown of its FX reserves to offset the outflows from its economy. This has created a tightening of financial conditions and we simply can’t rule out further easing of the reserve ratio requirements or lending rates in the short-term.

In Japan (9.50am AEST) we get the Q3 TANKAN report, where the outlook for large and small manufactures and service industries may potentially deteriorate somewhat. CAPEX is also likely to be revised to a slower place (9.3% to 8.7%). Yesterday’s poor industrial production numbers have some traders talking about a negative print in the Q3 GDP report (released 16 November), so there seems little doubt that a weak outlook from corporate Japan will only add fuel to the calls for additional QE from the Bank of Japan (BoJ). Still, while consensus is calling for additional action, the BoJ governor is still upbeat and confident. This positivity seems increasingly misguided.

In US trade we will await the September ISM manufacturing (expected at 50.6 down from 51.1) and vehicle sales.

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