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News flow is turning more bearish by the day, and from a fundamental standpoint sentiment really does play a big part in the allocation of capital and overall positioning in the market.
The fact is market consensus has been calling for an announcement in September with regards to lowering the pace of Fed bond buying programme for some time, while the first hike in the Fed funds rate is expected to take place in H1 2015 and we feel the FOMC minutes pretty much rubber stamped that view. The Fed said that ‘a number of participants’ suggested that the markets’ expectations for the on-going asset-purchase programme and the longer-term path for the Fed funds rate ‘appeared well aligned with their own expectations’.
This is the key take-out in a set of minutes that were generally low on definition and seemed to lack any real strong impetus to providing new forward guidance. To us, this was the green light for traders and investors to continue selling bonds, subsequently pushing bond yields through the recent highs. Asian traders have continued this rout and the US ten-year is now at 2.92% and eyeing the 3% level in earnest.
Asia has seen some signs of a turnaround after a poor open and this modest positivity can be largely attributed to China. The HSBC manufacturing PMI print came in nicely above expectations at 50.1, taking the small business space back into expansionary territory, albeit only just.
The positive thing here is both the larger (official) survey and the HSBC survey, which monitors around 420 smaller businesses, are both undergoing expansion and it seems the measures put in place by authorities in late June are doing what was expected. We look forward to the next official print on September 1 to see if this trend continues.
AUD/USD had seen some modest short covering coming into the print, but rallied to 0.9004 on the good data, although traders seem to be happy to sell into this spike. The global markets have had its China hard landing moment and are moving on; however, clearly there are still concerns, but this is not the area in Asia where the real immediate concerns lie. With a current account surplus of around 2.5% of GDP, our immediate attention continues to be on India and Indonesia, who run current account deficits of 4.8% and 3.2% respectively. Of course this means they both have a huge reliance on external funding, and with money fleeing out of the region it isn’t looking good. It’s worthy of note that the Indian rupee (INR) briefly traded through the key 65.00 level today, a level that many feel that if broken could see a relatively sharp move to 70.00 ensue.
You can also throw Australia into this mix as the current account deficit is even higher than Indonesia at 3.3%, and again requires strong external funding. Australian ten-year bond yields are up a sizeable thirteen basis points today at 4.10% (the highest level since April 2012), and given nearly 70% of Australian bonds are held by foreigners you have to think the recent selling is causing pension funds and investment banks to repatriate, in turn causing capital outflows of AUD.
Understanding who actually holds the underlying sovereigns bonds is key right now; for example while we are seeing selling of UK gilts, around 70% of these bonds are held by domestic funds, and thus even if they sell they don’t generally need to send the funds offshore, causing currency weakness. Indonesia is another country with huge foreign ownership of domestic bonds, with around 30% of bonds held offshore.
The other thing which is key here is the spike we are seeing in real yields (i.e. bond yields adjusted for inflation), and in Australia (like most of emerging and developed world) this is happening at a quick pace. This is all well and good when there is strong real GDP growth; however this phenomenon also has a negative impact on credit growth and thus hurts domestic demand growth. Of course the interest component on its debt to borrowers also increases, so without real GDP to back this up it is a dangerous recipe and represents a tightening of financial conditions.
In the equities space Japan saw good levels of selling on the open, with the index trading to 13,238 (down 1.4%), before staging a reasonable reversal as USD/JPY played catch up with US bond yields and rallied to 98.34. Pre-market we saw the weekly MOF (Minister of Finance) Japanese fund flows and after six weeks of buying foreign bonds we saw net selling of ¥903.8 billion. Clearly the buying spree which is so fundamental to Abenomics has come to an end as pension funds and portfolio managers buy domestic assets.
Still, with yields in the US now around 220 basis points above that of the same maturity in Japan, one questions if this is just a short-term affair. USD/JPY still looks lost and lacking direction, but the failure thus far to break 97.00 despite the risk-off thematic has been positive, and the fact that Haruhiko Kuroda (head of the BoJ) has suggested he will ease further if needed should support the pair too.
The ASX 200 hit a low of 5028, which, like the Nikkei on the open was down 1.4%, although buyers have come back into the market on the good China data. 24 companies have reported today and while the reports themselves have been quite mixed, the standout was Fortescue Metals, which has seen an 8.6% turnaround on earnings and the better China data. Clearly the results were helped by cost reductions, but the 10 cents seems to have well received as well.
European equities should extent their losses from yesterday, although could see buyers if the German and European manufacturing and services PMI continue to show solid improvement. It’s positive to think German manufacturing was falling deeper and deeper into contractionary territory, before basing out at 43.0 in July 31 2012.
That metric is expected to increase to 51.1 (above the 50 boom/bust level) from the preliminary read last month, while the actual eurozone composite should push to 51.7. Our EUR/USD flows today have generally been biased towards selling, but this could change on good numbers here; it seems that EUR and GBP have adopted somewhat of a safe-haven of late. US Markit PMI and Canadian retail sales will also be in play.