Positivity spreads through global markets

Judging by this morning’s October Federal Open Market Committee (FOMC) minutes, the Federal Reserve will raise rates in December and the bar for ‘lift-off’ is set very low.

Federal Reserve
Source: Bloomberg

However, despite relatively explicit guidance around lifting interest rates next month, the capital markets look upbeat and resilient. Limited moves have been seen in the S&P 500, and despite the Fed’s guidance on policy it looks likely to head into the 2080 area – even new all-time highs. US treasuries, Eurodollar and Fed funds futures have barely changed and the USD remains a buy on even the most modest pullbacks.

It seems the argument has moved on from when the Fed will raise rates to how many we will see in 2016. Looking at the Fed funds futures curve, we can see 60 basis points, or just over two hikes, priced in throughout 2016. This is the best guide for trading the USD. If you believe the Fed will lift the funds rate more than twice, then carry on buying USD’s with a longer-term view. But with a further widening of the US treasury/German bund yield spread, the odds of traders buying the USD ahead of the 16 December FOMC meet and then selling once we get confirmation of the hike seems elevated.

Taking the time frame out 16 months makes things a little more interesting. My thesis is that as we enter Q3 2016, politics will dominate global markets. Like we saw in 2011, 2012 and 2014, market strategists will suddenly become well-versed in political issues and the impact of sentiment on markets. Specifically, we need to pay attention to the UK referendum and the French elections in 2017 and the polls ahead of these events will dictate risk appetite. Neither a UK exit from the European Union (the so-called ‘Brexit’) or a Marine Le Pen victory look like a base case for most strategists, but they are definite possibilities. A European Monetary Union without France is no union. In fact, the project would be firmly over and make no bones, this will result in a strong deflationary shock. With the central banks of developed markets effectively having limited room to manoeuvre on policy, one questions how far global markets could fall on a major shock to confidence – 50% or even further?

There has been some deleveraging occurring at a household level in Australia and in major economies and for this very reason, quantitative easing (QE) and negative rates have failed to drive real economics. However, leverage and total debt-to-GDP levels on the whole have risen sharply since 2008. It doesn’t fill me with any confidence that there is no support network if we do see a strong deflationary cycle unfolding on political issues.

It’s always prudent to look at the longer-term event risk and while politics will dominate in 2016/2017, we still need to look at China as this is what’s pushing commodities lower. Today, though, these risks can take a back seat as the short-term price action is undeniably positive and we see an open on the ASX 200 closer to 5200. In terms of leads, moves in the S&P 500 have been very constructive and as long as the bulls can push the market through 2079, then there is a realistic chance of testing the May (and all-time) highs of 2134.

The ASX 200 gains should be broad-based today, akin to the S&P where 96% of companies finished higher on the day on fairly average volumes (volumes on the S&P were just 1% above the 30-day average). This positivity should be replicated in Australia, while Japan and Hong Kong should also find buyers. Japan specifically will be of interest, with the Nikkei approaching 20,000 and the strongest levels since late August. Today’s Bank of Japan (BoJ) meeting shouldn’t produce any new news, so traders expecting easing or hints of future easing may be disappointed.

The fact that USD/JPY implied volatility (derived from weekly options pricing) is currently 11% below the year’s average suggests the market is not seeing today as a major event risk. Beware of the dull market!

In Australia, watch SPI futures. The 20-day moving average is flat and upside seems capped here which looks key for today’s trading session. The 14-day RSI is at 51 (mid-range), so this does increase the importance of how price behaves around the 20-day average at 5184. A firm upside break should see a potential move into the top Bollinger Band at 5375. Naturally the ASX 200 would come along for the ride.

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