The last moments before the Fed

A solid snap back on all markets, particularly on the equities front – there was a very strong equities rally in Europe while the US markets added a further 1%.

Federal Reserve
Source: Bloomberg

That was the first back-to-back gain on US markets in 28 sessions – an event not seen since 1970, which should also be positive.

Bond and money markets capped off the night by completely pricing in the moves expected tonight by the Fed, settling themselves in-line with where the effective Fed funds rate will settle at 6am AEDT tomorrow.

Explaining exactly how the Fed raises and lowers rates would have this note balloon into a 100-page thesis but in short, the papers that need to move rates higher have moved rapidly in the past two weeks.

Short dated T-Bills, the commercial papers complex, the government collateralised (GC) weekly repo rate and the one-week LIBOR rate have all moved in unison by rapidly shifting their respective rates higher.

These instruments and components are what generate the ‘effective’ Fed funds rate when averaged out. Looking at the charts this morning, the GC weekly repo and the one-week LIBOR are sitting at 0.375%, having being at 0.18% and 0.12% on 1 December respectively. 0.37% is exactly what economists see the Fed funds rate being raised to, therefore it has been factored in.

Buy the rumour, selling a known fact

We find the price action across the boards all very interesting – however the market watcher in me keeps flagging a classic market adages – this has all the hallmarks of ‘buy the rumour, sell the fact’. This would be the most significant version of that adage if it does materialise.

  • USD is well-bid – DXY is at five-year highs. G10 currencies have seen the biggest ‘risk-on’ trade on the USD over the past 18 months starting in September last year, when the Fed abandoned forward guidance on its ‘data dependency’ mandate. The trade then ramped up in February as Fed member began to publicly express their opinions on rate rises. USD long trade is primed for a sell-off.
  • The front end of the curve in US sovereign bonds has been steepening all year on rate expectations – its move would be if rate expectations in 2016 are soft And it’s also primed for a trade reverse.
  • The bull run in US equities – which has been bingeing on the sea of cash from central banks globally over the past six and half years – has slowed to a crawl as the threat of rate rises build. The S&P is only 4.2% off a record all-time high on 20 May; more importantly, it is 2.4% off finishing 2015 in the black which would see the S&P bull run continuing into a 7th year – something it’s never done. But again, its mass appreciation is running out of justification.

All this momentum has the hallmarks of a buying rumour trade – we will find out tomorrow if there is indeed a sell the fact scenario.

 Ahead of the Australian Open  

The ASX closed exactly where the SPI and our opening calls predicted yesterday at 4909; however, as we stated yesterday, we see buying coming into the ASX. Iron ore added a further 0.77% to go with the 2% jump on Monday, oil also spiked again which should alleviate the pressure on cyclical names.

BHP’s ADR added 1.97%, its London listing was up 3%. We are calling the ASX up 50 points to 4959 a 1% jump on yesterday.

We did suggest it’s time to be bold on the market and we stand by that call. The ASX is oversold and has been thrown out with the global bathwater. We see a solid bouncing coming and an ASX closing in the 5000 point handle in 2015, and not the 4900 point handle.

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