Is the ASX getting ahead of itself?

More bouncing in the Asian region – the ASX has rallied 174 points in two and a half trading days, the Nikkei 588 points.

More bouncing in the Asian region – the ASX has rallied 174 points in two and a half trading days.

The most interesting change during yesterday’s trading was the upswing in the market. Having seen the US markets down on Friday, the ASX opened up lower, and fell a further 42 points in early trade. However, momentum gathered and bargain hunting took over rallying all the way to close on the high of the day.

The uptake in the banks and defensives in general suggests the sell-off has hit the floor. Yield hunters are back and are not just after yield. Total returns are now key to these investors having seen three of the big four reach the heights they have over the last six months. The possibility of the banks recovering at least two thirds of what has been lost will see total returns in the order of 15% to 20%, as most fund managers look to beat the benchmark by 3% to 5% each year. This kind of return is a no-brainer, and is why the banks particularly are being snapped up.

However, there is one thing that is bubbling away on the sidelines at the moment, and that is the state of the Chinese economy and whether or not it is tightening. It looks like the central government has actually tightened indirectly over the last five months; the yuan has appreciated strongly.

The regulation on the Chinese currency is incredibly tight; it is only allowed to trade with a 1% swing either side of the fixing rate. However, of the last three months particularly, the yuan has moved to 6.1598 - that sees the currency up 1.7% year-to-date and is the strongest performer of the 24 currencies in the emerging currencies index. This is to take the hot money from overseas out of the market. China currently has an oversupply in foreign funds, and increasing the exchange rate will slow the fast money coming in.

Reigning in credit in the world’s second largest economy is something the central government is targeting on fear that bad loans are mounting. A measure of interbank funding increased to its highest level since 2006 this current month, as speculation mounts that China is growing increasingly concerned that bad loans are expanding.

It not hard to understand why this is a concern. Steel mills are generating tonnes, with margins in the cents. Housing is still expanding at about 20% per month (though it is slowing), while industrial demand and output remains sluggish.

This will impact on Aussie material plays, particularly FMG which has a major interest in steel production. 98% of its revenue comes from exports to China; credit tightening will flow through to the pure-plays in the end. The release of the Chinese leading index today, which combines total loans with raw materials, new orders, consumer expectations, export orders and housing should give an indication as to how the appreciation in the yuan is impacting these six key drivers of the Chinese economy.

So we are 48 hours away from FOMC-day, and the second most important day of the week is here. Today sees the release of the RBA minutes; expectations are for some guidance as to when another rate cut is on the way. However, we see the minutes as a non-event after the RBA statement on June 4 was the shortest statement in years; five paragraphs with pretty much everything we already knew. It’s later tonight that could drive tomorrow’s trade. German economic sentiment, US building permits and core CPI, and not to mention President Mario Draghi is speaking. This is more likely to drive global sentiment heading into the FOMC release; watch the EUR.        

However, this is again happening later in the week. Ahead of the open today, we are calling the ASX 200 up a modest ten points to 4836 (+0.2%). BHP’s ADR is suggesting the security will add 30 cents to be up +0.91% to $33.10 as the iron ore price continue to move higher. The banks will again be the drivers today; if we see sustained buying once more it could see the ASX snapping out of the current correction. We want to see the market jumping past the FOMC hurdle. As we stated yesterday, if the Fed holds the line and communicates this story clearly, the ASX will have clear air to recover the losses of the last four weeks.  

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