This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
Earnings estimates have actually been revised lower for some months and the continued strength in the USD will not be helping net interest margins. However, as long as CEO’s are taking advantage of the easy money conditions and undertaking capital management, then investors will support shares. The trend of late though has been to look at Europe as a destination to issue debt as both corporate and sovereigns can borrow at outrageously low levels. In effect, the euro has become the funding currency of choice and this should keep the euro weak, with US corporate’s likely to continue to raise overseas to address capital management. In effect, this should mitigate the likelihood of a sizeable sell-off in US domestic stocks once the fed funds rate is increased to a new target range in June as corporates can still take full advantage of global liquidity.
We have heard from Federal Reserve member Loretta Mester and Richard Fisher in the last six hours or so, both detailing they are comfortable with a June hike and this seems to be putting further upside in the USD today. It seems the market and the Fed are aligning in their views and this is very positive for sentiment and negative for volatility, as everyone is singing from the same song sheet, with the Fed’s communication policy working beautifully.
Fed communication helping reduce volatility
Ben Bernanke introduced the idea of allowing freedom of speech for individual Fed members and this has allowed markets to price in major changes in policy much more efficiently over the years. Janet Yellen has continued this in earnest and there is a real prospect that we see a smooth transition into a new rate hike cycle (at least from a volatility perspective). That would certainly be the Fed’s ideal scenario, although the bond market holds the key here and an aggressive sell-off would hold sizeable ramifications for the USD. Subsequently, emerging markets, which have issued huge amounts of debt other the years are the new canary in the coal mine as this debt is becoming more and more of an issue every day.
Asia has stabilised somewhat today with Japan and Australia finding better days, although China’s equity market is down 0.6%. Anything can happen though in China and as we saw yesterday it doesn’t take much to cause a 3% reversal. The worrying inflation dynamics seems to have hurt confidence somewhat in China and traders are acting, although buyers are creeping back in.
While the Chinese central bank is targeting inflation of 3%, today’s 60 basis point increase from the January print (to an annualised inflation rate of 1.4%) will naturally see real (i.e. inflation adjusted) interest rates lower and as a result financial conditions easier. This in theory means the PBoC are less likely to cut benchmark interest rates as quickly as traders would like to see, although I don’t think this inflation print should alter that perception. When you see producer prices fall 4.8% (yoy) then this has the added concern that corporate margins are being hit as the end product that businesses are producing is ultimately falling. Hence the equity market is under pressure today, although authorities are keen to point out the rise in inflation is holiday related and therefore potentially short lived.
USD – the gift that keeps on giving
AUD/USD has taken a hit on the back of the Chinese data and is eyeing the 3 February lows of $0.7626 eagerly. Various technical indicators are suggesting the pair is now targeting $0.7450, although it won’t get there in a straight line. Iron ore seems to be playing a growing influence in price and while Australia’s ten year bond yield premium over US treasury yields continues to fall, the price of iron ore seems a strong influence right now. This may well change as it often does, although there is no denying the underlying trend lower in the spot market.
FX markets in general are exerting some amazing trends and although short-term traders would dearly love increased volatility, we are seeing lower lows in a number of pairs. Asia-based traders are feasting on USD longs today, with the USD index up 0.5%. The upside move really is the gift that keeps on giving, with EUR/USD trading through the 1.08 handle and the trend continues, while USD/JPY is through the December highs of ¥121.85 and even had a look through ¥122.00 into afternoon trade. GBP/USD should be the next shoe to drop and looks good for a move through the January low of $1.4951. I feel shorts look compelling and would look at placing a stop just above the recent high of $1.5137.