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Hawkish Yellen puts talons out for December rate hike

Hawkish comments by Janet Yellen and strong US data saw many currencies weaken overnight, although this did not seem to worry most Asian markets.

CBA
Source: Bloomberg

Chinese markets did not seem all that concerned that the Shenzhen-Hong Kong connect is not imminent as they continued to rally. Japanese markets also continued to be buoyed by the strong performance they saw yesterday after the big jump in Japan’s biggest IPO of the Japan Post group. The ASX did not seem to get the memo, and USD related pressure on commodities and concern about the banking sector saw strong selling in the index.

The likelihood of a rate hike in December was given further credence with Janet Yellen’s remarks overnight. Yellen was keen to emphasise that if the economy continues at the current rate as the Fed expects then “December would be a live possibility”. Her comments led to a strong move in the front-end of the yield curve as the two-year yield jumped five basis points to its highest level this year at 0.816%. The WIRP bond market probability of a December rate hike moved up to 58% from 52% the day previous. The dollar index rallied 0.7% and gold fell to its lowest level since 2 October.

Markets have moved very strongly in the direction of a December rate hike since last week’s Fed statement, with markets largely ignoring any of the poor or mixed US data this week and instead focussing on the good. The question now is whether the USD and the treasury market is primed for a bit of a pullback after such a strong rally. The bar for Friday’s Non-Farm Payrolls number to meet market expectations has been significantly raised, with a number much below the 180,000 consensus figure likely to spark a bit of a selloff.

Reserve Bank of Australia (RBA) governor Glenn Stevens’ speech has probably removed the probability of the Aussie dollar moving over US$0.73 for the rest of the year. In his speech he made it explicit that, “Were a change to monetary policy to be required in the near term, it would almost certainly be an easing, not a tightening”.

The RBA statement on Tuesday left the door open to a rate cut in the coming months, and Stevens’ speech today has sought to further emphasise that possibility. Nonetheless, considering the RBA decided to leave rates on hold in November they are unlikely to see a substantial change in the economic data that would warrant a cut in December. However, bond market pricing for a rate cut at the RBA’s February meeting is now at 71.5%. The disappointing Q3 CPI data does really seem to have been a game changer for the odds a future rate cut, and with speculation rampant about a Fed December rate hike it may not be long before the Aussie dollar dives back below US$0.70.

China

Mainland Chinese stocks clearly enjoyed their National Week holiday at the start of October as they have returned with a renewed vim and vigour after their horrific 43% selloff from the middle of the year. The Shanghai Composite (SHCOMP) has now gained 20% from its Black Monday low in August. So it seems as if China’s aggressive and heavy handed state intervention has quelled investor fears about the stock market. Your average Chinese retail investor is popularly referred to as the Chinese dama (middle-aged women speculators), akin to Mrs. Watanabe in Japan.

So the question is, what has brought these Chinese dama back to the market? While the SHCOMP has gained 15.6% since the start of October, there has been a corresponding 7.2% increase in outstanding margin financing – an almost perfect 2:1 ratio. Alongside that we have also seen some stability in China’s economic data. Retail sales data and the Caixin Services PMI continue to point to the robust health in China’s tertiary sector. China’s manufacturing PMIs released earlier in the week also indicate China’s monetary easing and fiscal stimulus are starting to have an effect in supporting Chinese growth as we approach the deadline for achieving the 7% GDP growth target.

ASX

The ASX did not respond well to Yellen’s hawkish comments overnight or the leads from Wall Street. The potential for higher US interest rates next month clearly concerned the Aussie market. While the strong gain this induced in the US dollar hurt USD-denominated commodity prices weighing on the energy and commodities sectors.

CBA released an unaudited glimpse into its Q1 earnings. Earnings were largely in line with estimates, but this did not seem enough to halt investor concern over the Big Four. Results from all of the banks over the past week and a half have been relatively in line with expectations, but they have nonetheless seen heavy selling. Increased regulatory requirements for capital holdings, a slowing housing market, shrinking margins and slowly increasing bad and doubtful debts are clearly putting a lot of investors off the banks. The banking sector as a whole was the worst performing on the index today losing 1.5%.

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