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With global central banks continuing to expand balance sheets and holding a huge number of assets, naturally investors are gravitating towards macroeconomics as an indication of where to invest. A very clear pattern at the moment is the divergence between the US dollar and its major global peers. This is (and is likely to continue to be) the most significant development in global markets, as the US continually reprices the timing of the first rate hike. Many analysts will now be expecting a hawkish shift in tone in next week’s Federal Reserve policy meeting, with a mid-2015 hike being a very realistic prospect. As a minimum, the market is likely to be pricing in the probability of the ‘considerable time’ reference being dropped. These hawkish expectations are likely to keep the greenback bid heading into the Federal Open Market Committee meeting. A recent development from fed speak was the acknowledgement that market reaction will play a key role in determining scope and pace of tightening. The mere fact that equities gained ground on Friday, despite the rampant jobs report, will be taken as a tick of approval by the Fed. In other words, investors seem to be coming to terms with the idea the US economy is ready for tightening.
New highs for USD/JPY and the Nikkei
The Nikkei was threatening to outperform as USD/JPY ascended to new highs driven by the surge in US jobs. There is no greater indication of policy divergence in the FX space than USD/JPY at the moment and the case is only growing stronger. There has already been some data out of Japan with the second GDP estimate released. The first estimate showed Japan had slipped into a recession and some analysts were expecting a mild recovery in this reading. However, this proved not to be the case as the reading showed a 1.9% contraction, much worse than the initial estimate. This saw the Nikkei stutter after having enjoyed a strong start which saw it trade through 18,000 for the first time since 2007. As far as the elections are concerned, traders will be hoping the coalition secures an absolute majority, which is at least 270 seats. This would be enough to drive further gains for the Nikkei and USD/JPY. China’s trade balance came in well ahead of expectations and was mainly driven by a sharp drop in imports. Exports also fell well short of expectations and overall this data is likely to drive stimulus expectations. Investors are hoping to see a reserve ratio requirement (RRR) cut and with a raft of releases out of China this week, any disappointment will drive these expectations higher.
Banks rally following Murray Inquiry
Locally, it’s been all about the financials today with the big banks all putting on over 1%. The weekend Murray inquiry has worked out to be a net positive for Australian banks as the amount of capital speculated that will need to be raised seems fairly achievable, with the end result being a more stable banking sector. It seems the major banks will need to raise $16 billion in extra capital to achieve the top quartile the Financial Systems Inquiry (FSI) has recommended. The banks can also look to go one step further and push for a 50 basis point buffer in which case the level of capital would be $23 billion. It also seems return on equity should not be affected given the likely re-pricing of gross loans. The Murray Inquiry had been a source of uncertainty for the banks in past weeks and with this weight lifted, there could be room for further gains.
Record high for the DAX
Ahead of the European open we are calling the major European bourses relatively flat after Friday’s big gains. The DAX is trading above 10,000 and at record highs remains the highlight as confidence continues to build that the ECB will take action. There isn’t much on the European calendar this week but trade data for Germany and France deserves some attention. Additionally, on Thursday we have the TLTRO of which a decent uptake will be good for equities. The single currency looks quite vulnerable though and while EUR/USD is just holding on to $1.2300, I wouldn’t be surprised to see this level breached again in the near term.