The macro risks
- Greece is T-2 days away from its first tranche of debt repayments due in June
- Bond markets are starting to get excited by a possible deal in the Grexit situations while also eyeing up the possibility of an early end to European QE – which could see an unwind in European equities
- The Fed appears to be pushing back on expectations around rates – creating confusion and artificial risk taking
- The VIX index remains in a range of 10 to 14 (however, it is ticking higher)
- Complacency in the US markets remains solid despite concerns growth is tracking below consensus and inflation expectations are sub-trend.
Although the macro risks are to the downside the momentum in both the US and European equity markets remains to the upside, so the market is still against my views. However, this divergence only adds to my short term pessimism. The justification for another leg higher is wafer thin at best yet the markets are grinding higher.
The EUR dilemma
There is also an interesting development coming out of the investment banks around the EUR. They describe the current conviction levels around the EUR’s 45 degree decline as ‘as low as we can remember’. They agree that the single currency is likely to trade around currently levels with the current accounts, WTI and valuations the fundamental reasons for participant’s ‘not seeing a new leg lower’.
The EUR’s plight faces another issue as traders are growing increasingly wary that central bank divergence theory is starting to break down.
Having published its ‘Survey on the access to finance of small and medium enterprise’ which showed for the first time since 2009 an improvement in the availability of bank loans and that inflation expectations are clearly on the rise (measured by five-year swaps) brings the market to the belief that the ECB’s QE program is actually working.
The fact the ECB is having to publicly state it does not intend to unwind its QE program till September 2016 on the back of these numbers is a headache it doesn’t need. If Grexit does play out as expected will that too give a brighter outlook to the common currency?
It also brings continental equities into sharp focus – the narrowest trade in market has been to be short EUR, long bunds and long European equities. The unwind in the bund market was clearly signalled by traders back in late April. The unwind in European equities, however, is not as clear as this. The DAX and the CAC have moderated their paths after rapid gains in Q1. However, both would appear to be under further threat if the short EUR trade unwound. The risk is certainly building if this trade does begin to unwind.
Surprisingly good news from Australian data today. GDP grew at 0.9% quarter-on-quarter and a 2.3% annualised rate both 20 basis higher than the consensus reads.
The figure was bolstered by the solid gains in net export, something that surprised the market yesterday after the release of the current account that saw a 0.5% increases with add 50 basis points to GDP. Inventories were also ahead of expectations and coupled together, they offset the dead flat domestic demand figures.
However, exports and inventories are a temporary element of GDP and you can not escape the fact annualised growth decline and is a long way short of the 3% figure expected in 2015. The better than expected figures are encouraging and yes they knocked out the uber bear expectations but the poor CAPEX figures from last week show business demand is still a way off and that growth might get worse before it gets better.
The interbank market however has taken the GDP read as another sign the RBA is over its easing cycle all along the short term curve to December not one is above 30%, with Melbourne Cup Tuesday the highest read, suggesting there is a 28% chance of a 25 basis point cut on Tuesday November 3. The reaction in the AUD is also a clear sign that domestic monetary levers are unlikely to eventuate and that the Fed’s ‘lift-off’ point will have to the saviour of the RBA’s desire to see AUD/USD at sub 75 cents.