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Valuations in developed markets may now be at a reasonable premium to their long-run average, but this means less when we have the backdrop we currently have. Firstly, we still have around $100 billion a month in bonds purchased from the Japanese and US central banks, while Mario Draghi (in a weekend article) gave a more explicit view on a future QE program.
Mr Draghi’s ECB colleague Ewald Nowotny also detailed over the weekend (in a separate interview) that banks have unlimited access to liquidity until 2016, while also saying interest rates in the eurozone will not be going up until 2016.
Developed market corporates in fine shape
It’s not just central bank actions that are suppressing volatility, but the corporate world is in good shape as well. Globally we are seeing a wave of M&A activity, with corporates trying their best to drive growth for shareholders. Share buybacks are running at record levels in the US and Japan, while cash rich companies in Europe are joining in the fun, with Rolls-Royce and Nokia coming to market last week.
Janet Yellen’s comments that the recent gains in inflation were merely ‘noise’ has continued to be dissected by the market. Traders and investors are used to being fed code words by central banks - i.e. ‘whatever it takes’, ‘strong vigilance’ and ‘extended period’ - and it seems that as long as the Fed continues to hold this view on inflation, traders will continue to hunt for yield in various asset classes and volatility should stay continued and ultimately the S&P 500 could test 2000. The trigger then for better two-way price functions in equities, USD strength and for a more prolonged sell-off in the US bond market has to come in a future FOMC meeting, in which the word ‘noise’ simply is dropped. Traders will largely speculate around when this will occur.
Inflation – Is it really just ‘noise’?
The theme of US inflation is front and centre this week, with personal income and spending (out Thursday) expected to increase 0.4% and 0.3% respectively. Core PCE (personal consumption expenditure) is also due on Thursday and is expected to increase 10 basis points to 1.5%. We also get Fed hawks Charles Plosser and Jeffery Lacker due to speak throughout the week, so this could limit the selling in the USD. St Louis Fed president James Bullard also speaks and recall he detailed a couple of weeks ago that inflation is on the rise. Mr Bullard is a not a current voter, but his comments still cause reactions.
China seems to also be helping sentiment. Over the last couple of weeks we’ve seen a number of tweaks to reserve ratio requirements (RRR) that a select number of banks have to hold, while there have been funds deployed on a more fiscal level. What’s more, the economy seems to be moving in a positive manner, and whether this is being assisted by stimulus or other factors, economic data is improving. Today’s May HSBC manufacturing report may have seen the fastest pace of expansion since November, however the underlying quality was also good, with the new orders sub-index rising to the highest level since March 2013. We will have to wait for the official PMI print on July 1 to see if the same themes are playing out in the larger companies in China, and this will also be a better representation of the recent mini-stimulus.
Despite the HSBC PMI print coming out 0.4 index points above even the most bullish of forecasts, the Chinese stock market found no boost in sentiment, with the real winner being the AUD, which is eyeing the April 7 high of 0.9461. The ASX materials sub-sector gained 0.8% after the data point. A 2.5% gain in iron ore futures seems to have provided additional backbone, but it seems that investors have warmed to names like BHP and Rio Tinto again. With metrics like price-to-book still at a healthy discount to their five-year average and the bottom of their recent range, when you see good news like we have today you generally get a healthy move in the share price.
AUD/USD held the 20-day moving average as anticipated last week and remains a buy-on-dips candidate. Upside targets focus on the former uptrend drawn from the January low and the upper Bollinger band at 0.9488 and 0.9464.
European markets should find support, although the Nikkei is finding sellers into the afternoon and this is causing a few sellers to creep into the European opening calls. It promises to be a fairly busy week in Europe, with a raft of speeches from both ECB and BoE officials, including two separate speeches from Marc Carney. There’s been some attention on this week’s EU summit and notably David Cameron stance on Jean-Claude Juncker becoming the new European Commission president; however we haven’t seen much in the way client acting on the news.
Data is on the light side, with Chicago activity readings, while we also get manufacturing and service data compiled by Markit.