How GDP will play into the US narrative

We seem to be in strange place in global markets, although the bulls still very much have the upper hand.

Federal Reserve
Source: Bloomberg

We saw a bearish reversal on Monday and after trading through Monday’s low of 2,107 yesterday to 2,094, we saw good buying coming back in and the index has closed back above 2,107. The bears had every chance to cause a real upset but failed. Today’s cash session promises then to hold a few answers around the psychology of markets, especially given the hugely disappointing price action in the markets’ structural leader – Apple.

One of the dominant themes of late has been around whether the USD can undergo a serious correction, or whether the 4% pullback from the March high is a good buying opportunity. The fact the US dollar index closed below the 26 March low of 96.17 has to be taken a bad sign for the USD bulls. But it is pretty clear the market is positioning themselves for a benign US Q1 GDP (22:30 AEST) with consensus expectations of 1%, although the range from economists varies from zero to 1.5%. The April FOMC meeting comes out some five and a half hours later, so we may see the GDP figure play into the narrative. But all-in-all the recent softer data should not have altered the Federal Reserve’s view.

We also get the RBNZ meeting shortly after the Federal Reserve meeting (07:00 AEST). Judging by the fact the NZD has been the strong underperformer against the USD over the last five days, with AUD/NZD rallying shy of four big figures since 21 April, the market clearly expects a markedly more dovish statement. I actually think NZD/JPY will be interesting to watch given the Bank of Japan also meet this week and a break of ¥92.00 would suggest a fairly rapid move to ¥94.00, although my preference is certainly to play this from the short side, with a stop loss at ¥92.50 for ¥90.00.

It promises to be a fairly hectic calendar full of event risk and as I write we are still waiting for earnings from 378 Shanghai, 87 CSI 300 and 6 Hang Seng listed companies. The latter carrying a 23% weighting on the index, so we could see some better volatility here. We also get earnings from Barclays and Volkswagen, while we also get 52 S&P 500 listed firms, so there is something for all types of traders.

China look at new initiatives

Asian markets are not really providing Europe with any real conviction and our opening calls reflect this. Chinese markets are reacting modestly to the further news that commercial banks can use local government debt as collateral to access cheap liquidity using the People’s Bank of China’s Pledged Supplementary Lending (PSL) facility. This is a definite positive as it could create demand from commercial banks to purchase debt when the local government come to issue this in the coming months. The fact the CSI 300 is up 1.5% highlights this measure has been well received, but traders know it has been put in place given the failure so far to create demand around the local government debt swap program.

Recall, the Jiangsu province had a recent issuance of RMB64.8 billion (of three, five, seven and ten-year bonds) postponed due to poor demand. Get the demand flowing by incentivising banks to buy local government bond debt and the authorities will increase the probability of the RMB1 trillion debt swap actually working, therefore creating greater efficiencies in the deleveraging process. This is not QE in the ECB, BoJ and Fed sense.

The ASX 200 attracting strong selling

In Australia, there has been a decisively risk-off feel. I suspected the ASX 200 could trade through 6,000 earlier this week and clearly I was incorrect. The market has been steamrolled today and the combination of the AUD breaking 80 cents, lower iron ore futures and swaps and a market that is feeling that the Reserve Bank could have ended its easing cycle is having a clear effect. Banks have been hit hard but I question if a report from Goldman Sachs on the potential for Australia to lose its converted AAA sovereign rating after a period of review is also in play. A loss of the rating could really have unseen consequences for the bond market and of course the local unit.

It’s interesting then that we have seen better selling in AUD/USD today, with a reasonable rejection of strong horizontal resistance at $0.8035. There’s been a strong trend of late, predominately driven by a widening of spreads with the premium the Aussie 10-year commands over the US 10-year treasury blowing out from 38 basis points (bp) to 60bp. A 27% rise in spot iron ore has helped, although if you look at 12-month swaps and today’s price action in Dalian futures we may well have seen the rally in iron ore abate.

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