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In a world where markets are driven on the perception of central bank action, we listen to what a central banker or statement has to say, then price it in and generally over exaggerate the moves. That seems to be the case in Europe and the US, where expectations of European Central Bank (ECB) easing are rich, the markets’ pricing around Fed hikes are looking fair. We’re left with limited opportunity – for now.
In Australia, traders have a less clear view on future Reserve Bank of Australia (RBA) action and expectations are moving around quite liberally. Last week a weak Australia Q4 CPI print (released 27 January) would have all but finalised a move to 1.75% in the cash rate by the Reserve Bank, however, today’s October employment print has seen the market lower the probability of a cut in February to 27% (from 56%). Taking this time frame out, the swaps market is pricing in a modest 18 basis points of cuts over 12 months. The bear flattening of the Aussie yield curve is a testament to the re-pricing of rates.
The trade-weighted AUD has flown today, specifically against the NZD, where the pair has printed a higher high. I would see this is the cleanest way to take a bullish view on the AUD. Trading the AUD against the USD is more troublesome, while I had been suggesting working AUD/USD shorts around $0.7150, I would be doing so in small sizes as London may continue to bid the pair up in the short term. It may be wise to look more closely at offers into the 72 handle. The employment print today was simply so strong that a large element of the market is in disbelief. Putting that into context of the size of the US population, many would say the Fed should have raised many months ago! Still, many will point to the annual total pace of trend employment growth of 2.3% year-on-year (+10 basis points from the September print) and the trend unemployment rate of 6.1% as more reliable ways of looking at things.
That fact is, employment is improving and from what we have seen, the RBA’s view that the ‘prospect for an economic conditions have firmed a little’ looks real and continues to point to a view where the Q4 CPI print really will hold many answers for Australian monetary policy. Still, there is much water to flow under the bridge. With the Fed likely to hike in December, if the market panics and we see another bout of emerging market-lead volatility, then this could weigh once again on the AUD. Of course, FX vulnerability is a potential issue that occurs to most countries that are running sizeable deficits and have a large percentage of its bond holding held by overseas investors. One has to feel that once the market has re-priced rate expectations and a number of economists push out their RBA easing call into Q2 (or even on hold for 2016) then the AUD/USD will be right back on the bears’ radar. The fact that the People’s Bank of China have eased the CNY ‘fix’ for eight straight days won’t have gone unnoticed either, although it’s hardly been aggressive.
It’s also fantastic to see investors and traders act rationally today, albeit after a little thought. Good news (ie Aussie jobs) has resulted in buying in the ASX 200, after an initial 11-point drop, which is exactly what should happen in markets. More employed people generally results in consumer spending and while a lower cash rate does lower bond yields and effectively makes the equity yield more attractive, surely the idea of a stronger consumption story is a more powerful force? Naturally, the better buying has been seen in the domestically focused names, with energy and material stocks sold. BHP traded to a low of A$20.22 and one could see the anticipation of traders rushing to buy BHP with a 19 handle, but alas buying has been seen and there is almost a sense that as long as the stock can hold A$20 then current levels are great longer-term buying. There has most certainly been an element of the market asking if the lows are in.
Technically, today’s candle on BHP looks bullish and whether you buy into technical analysis or not, what we have seen is basic demand vs supply, where demand has won the battle. Volumes have also been OK. However, putting my macro hat on, we have to ask whether anything has really changed? Looking at a daily chart of copper, iron ore and oil, there is little reason to buy – especially with copper and oil eyeing huge multi-year support levels. Fundamentally, the market seems to struggle to work out what is the correct multiple to buy the ‘Big Australian’ on.
We also need to remember that the Australian equity market has had a strong underperformance relative to global markets. We can see this in ratio analysis, with the MSCI world/ASX 200 ratio (converted into AUDs) increasing from 0.25x in 2011 to 0.46x currently. This is the highest level since Q1 2003 and shows massive outperformance of the MSCI World index. I am sceptical of whether this will reverse anytime soon, however there are certain red flags that global equities may soon face near-term headwinds. Certainly, the fact that credit is underperforming again is important, with both the high-yield ETF (HYG and JNK) eyeing the year’s lows, while copper prices are looking vulnerable. In my opinion, the USD remains a buy on dips and traders will be eyeing narrative from a raft of key Fed speakers tonight, with Bullard, Lacker, Yellen and Fischer talking about various economic factors. In Europe, Mario Draghi speaks on early European trade in Brussels, so expect short-term money market rates to heavily influence the EUR. This in turn could have ramifications on various equity markets, which at present look to open on a mildly weaker footing.