Is the yield trade over?

You always know when global markets are seeing moves from funds into cash and many of the year’s consensus trades are being unwound.

Source: Bloomberg

This phenomenon has played out again today, which is interesting after yesterday’s monster moves lower in the Shanghai Composite and the property sector. However, as we have seen on numerous occasions this year, when the index has seen regulatory concerns hit home, we see a nice snap back the next day.

I wouldn’t be surprised to see further consolidation in these markets before a move higher into June, especially given so many global money managers are underweight China and there is an increasing prospect that many China A-shares (315 stocks) could be added to the MSCI China benchmark this June. Of course, there will be further easing measures likely to be announced in the coming weeks as well.

Elsewhere the tone has once again shifted, becoming far more negative. The ASX 200 spent much of the session below the bottom of the multi-month range at 5739, with the 38.2% retracement of the 14% rally in January to the March rally at 5718 marking today’s low – I think this is interesting from a technical standpoint.

Momentum and trend indicators are breaking down and the once-almighty financial sector is eyeing a technical correction of 10%. Whether this pullback is enough to bring out the buyers is yet to be seen, but the fact that CBA has seen such aggressive downside after a trade update that was modestly under expectations suggests the market needed signs the banks valuation premium was deserved. Clearly, it isn’t.

Perhaps the bigger story today has been the huge selling in the bond market and the fact the Australian ten-year treasury is now eyeing the 3% level and is firmly above the level of headline inflation. Some buying has been seen at the 200-day moving average at 2.96%, but the fact the long end of the curve is being sold so aggressively is strongly subtracting away from the desire to hold banks for income. If you look at the inverse correlation between the Aussie 10-year and the ASX financial subsector, you can see the two are moving tick-for-tick (inversely).

So for those looking for answers on whether ‘the yield trade is over’ need to take a view on the bond market. Higher yields will result in lower financials, it seems. However, it also appears that the firms that have benefited from a lower AUD are finding life tough. Names like COH, which are trading over 10% from consensus forward price targets, are getting some attention from the short sellers.

AUD/USD looks bullish on the daily chart and a move to the April high of $0.8076 looks likely given the momentum of late. A break of the April high would open up an extension into the $0.8150-to-$0.8200 area, but yesterday’s huge bullish outside day screams further upside and short positions are ill advised at present until the momentum starts to wane.

AUD/NZD longs, however, have been the flavour of the week and pullbacks are almost certainly a strong buying opportunity for a move to NZD1.0800, in my opinion, with calls the RBNZ will cut rates twice this year after poor NZ employment data. Tomorrow’s Australian employment is expected to see 4000 jobs created.

Naturally, part of the move in AUD/USD has been USD-related and US growth is clearly in play. We get the next revision to the Q1 GDP number of 29 May and, after the huge blow out in the March trade figures, we should see the recent 0.2% print being revised down to -0.5%.

We then look forward to 30 July and the initial Q2 print and this will be key, with the market still calling for growth of 3%. Importantly, the Atlanta Fed’s growth forecasting model is estimating Q2 growth of 0.8% - recall this model was amazingly accurate in predicting the Q1 growth number. The Federal Reserve seems unlikely to raise the funds target rate in 2015 if growth misses their forecasts by such an extent, especially given the Fed’s recently dovish turn on the labour market.

On this point on the labour market, all eyes fall on today’s ADP private payrolls report and this should see traders position portfolios ahead of Friday’s payrolls report. Good expansion was seen in the employment sub-sector in yesterday’s services ISM report, so perhaps the balance of probability means we’ll see a good number today.

What’s impressive, though, has been the continued steeping of the US yield curve (I’ve looked at the difference between two- and thirty-year bonds), which has moved from 190 basis points in March to stand at 228 bp. This has been driven by a 26% move higher in brent and a 32% move higher in WTI oil, but almost certainly the massive sell-off in the European bond market is the centrepiece of the global capital markets.

If German bunds, Spanish, Portuguese and Italian yields continue to move up, then we should see global equities facing ever-growing downside pressure. However, is this a sign of funds expressing concern of increased Greek contagion or were bonds just very expensive given the economic recovery we are seeing in Europe?

Whatever the real reason, there’s no denying that the sell-off here has been super aggressive and clearly not in the European Central Bank’s playbook. Still, at least the pool of bonds it can buy with a positive yield is increasing!

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