Market versus economists

Nine straight hours of gains for the AUD last night – AUD/USD crossed 80 cents and has continued to climb backwards to levels not seen since January.


Source: Bloomberg

That means the AUD has moved back to pre-RBA rate cuts in February. All the declines have now been absorbed as weakness in the USD flows through.

US confidence fell through the floor in April with lowest read since December last year, it was 7.3 points weaker than expected and saw the US back in pessimism mode. Expectations around tonight’s US GDP read is low – consensus is for 1% annualised growth; the main reasoning for the weak read being the weather at the start of the year. US data of late has been weaker and despite earnings beating consensus, in reality FX headwinds are remaining a drag on corporates and therefore US confidence.

The reverse is happening in Australia - Aussie data in March has been positive; employment and retail sales have been better than expected, CPI is in line with expectations and target levels and there are ‘signs’ the first cut in February may be filtering into the local economy. Although the majority of economist still believe the RBA will cut rates next Tuesday the market’s confidence in this call is disappearing by the hour.

The interbank market has moved further away from a 50% expectation of a cut next week to 47.03% at the close of the ASX yesterday. Glenn Stevens was at pains to point out he would not be discussing monetary policy at his speech yesterday. However, the market picked up on his comments around retirement and that retirees are now worse off than they were a decade ago as another reason he won’t cut rates further unless forced – and the current data to hand certainly doesn’t force anything.

The rate debate however is the dilemma in the AUD - Aussie yields remain globally appealing. The carry trade (particularly the JPY and USD) is too strong to ignore for international investors. If Stevens want to see the local currency sub-75 cents he needs to bring yields in Aussie bonds to 1% or less – in line with the rest of the world. This is not something he is willing - or able to do - as the distortion it would create in lending and investments is too great a risk. The market knows this – and it’s testing the resolve of the RBA as it believes 2% is indeed the terminal cash rate and yields will remain elevated.

Yes, the AUD is also benefiting from the 26% appreciation in the iron ore price and the fact China is moving to stimulate its economy which is adding weight to AUD/USD equation. But, in the main, the USD is back to being a funding currency for investment and the AUD is an easy target due to the current market fundamentals. (Even after terrible UK GDP reads, Cable gained ground – the USD is looking weak globally).

From an equity perspective, the AUD will be seen as negative. The ASX 200 has been backed by the yield trade since the end of January as rate expectations have been very much to the downside and the yields in defensives (banks, telcos etc.) has driven the market to six-and-a-half-year highs. If expectations of cuts slow, the narrowing yield trade will look crowded and hot money will exit if a second cut remains elusive. Interestingly overnight, WBC played down increases to its already elevated dividend. Further signs the ASX is under a pullback cloud as earnings expectations are low.

Ahead of Australian open

We are calling the ASX up just three points this morning to 5951 – however the momentum in futures markets appears to be to the downside. Iron ore futures are actually down since the spot price was released yesterday. Asian futures are also easing – today may end in the red rather than the green as the very positive moves from Friday and Monday start to wane. 

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