Equities bounce, bonds routed

Equity market bounces can be tricky to read – is the bounce for fundamental reasons, macro overlays or the dreaded dead cat?

Source: Bloomberg

Hindsight will answer this question. However, the bond market rout is still my best indicator for future equity direction.

What’s spiking my interest

  • Rumours President Obama possibly questioned the state of the USD at the G7 event is a big event – political interference is unquantifiable and something to monitor. It’s more interesting from the point of view the US has talked down the USD at $1.05 (EUR/USD), not at $1.13. That has been the level Germany and France tend to complain about, suggesting the pair is too high in the other direction.
  • Governor Kuroda’s comments around the JPY yesterday are also very interesting. He has described the JPY in real effective exchange rate (REEF) terms as ‘weak’ – signal short covering! The last time he stated the JPY was weak on the REEF metric it rallied 6%. Expect further short covering.
  • The JPY moves makes the Nikkei the market to watch now. The reaction from the JPY in the 18 hours after the statement will have been digested by equity investors - how they react this morning will be telling. The inverse correlation between the two (JPY to Nikkei) has weakened steadily over the past seven months but there’s no doubt it will pull on sentiment over the coming week.
  • Grexit (or the lack of it) is back in the headlines. The Germans appear to have blinked and lost the game of chicken they were playing with the Greeks. Rumours are mounting that there are to be concessions made around the terms of a refinancing debt program for Athens and that it is considering staggered debt payments. No official deal appears to be at hand, however.
  • Bond markets continue to their rout. Bunds are through 1% - that is 100-plus basis points of appreciation in six weeks. Staggering! I need to repeat what I said on Monday here:

    “The divergence developing between credit and equities markets (particularly US markets) is historically against the trend. History shows the credit and equity markets tend to move together (in direction). When there is a divergence like those currently developing, it tends to develop around big shifts in the macro cycle, ie. rate hikes or macro uncertainty. Currently both of these issues are in play.”
  • News from across the Tasman is also an interesting development; the Kiwis have cut rates by 25 basis points – the first time in four years. Inflation is low, as are milk prices and general demand, which explains the cut.
  • The RBNZ was the first central bank in the developed world to increase rates after the GFC but this morning’s cut was a surprise. Only 6 out of 16 economists were calling for a cut and the market was pricing in a 46% chance. Positioning-wise most were caught short on this news.
  • AUD/NZD parity calls look over – the NZD/USD is now at the lowest level in almost five years. Governor Wheeler is clearly concerned about Auckland’s housing market but the state of the whole economy forced his hand. It looks and sounds very similar to the bind Governor Stevens finds himself in with Sydney and the rest of the Australian economy.
  • Iron ore popped overnight (as expected after Dalian futures jumped up 2% yesterday). Iron ore into Qingdao hit $65.39 – the highest read since January. This is the price level most believe the Chinese want it capped at. The next question is, can it punch through?
  • I think the employment read today will be retrospective – the May rate cut and the Federal budget could skew the employment change to the upside today. What I am waiting for is the employment rate for June and July when the CAPEX numbers filter into the real economy and the May rate cut effect filters out. Forecasts are still for the unemployment rate to be 6.5% by year end.

Ahead of the Australian open

We are currently calling the ASX up 47 points to 5525. Futures are pointing higher still at 5535. Is this the snap back we have been waiting for or a dead cat?

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