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Volatility has predictably increased and the end result is a weaker USD and a bid in US treasuries and stronger equities. The last 12 hours or so were once again a full lesson in understanding positioning, as the events themselves (and the associated narrative) were relatively predictable, yet understanding that the market was significantly long USDs and short US treasuries would have served you well.
The FOMC minutes can be overlooked, and to be fair they have probably just caused confusion among the market, especially as they preceded the recent strong payrolls report and subsequent back-up in rates. However, if you were to put the meeting in isolation, you’d say the minutes were hawkish as roughly half of the board sits in the camp that believes purchases should stop by the end of the year.
The fact that the US ten-year bond pushed up to 2.68% despite a reasonable auction earlier in the day, gave the treasury bulls a chance to buy at more compelling levels and buy they did.
Price action in every asset class came alive on Ben Bernanke’s narrative; while his comments were clearly dovish, the key fact that he stipulated was that the Fed funds rate would not automatically rise when (and of course if) US joblessness hits 6.5%, and this has firmly dictated to the market that the 6.5% level is a threshold, not a trigger.
We have heard other Fed members bang a similar drum before, with Mr Kocherlakota recently saying the Fed could even move that threshold lower. Clearly his comments were aimed at the bond market, and while the benchmark ten-year bond closed at 2.62%, it gapped lower in Asia hitting 2.56%, taking the USD down with it. A simple look at the Fed funds future (expiring in December 2015) shows that the market had priced in the Fed hiking rates to 1.25% by the end of 2015, however with the sizeable moves that have occurred, that expectation now sits at 1%.
Of course the prospect of low rates for longer has helped emerging markets, which of course are highly sensitive to rising US yields, having seen strong outflows of late as investors chase higher return in the US. China is on a roll with the CSI up 4.5%, with the suite of Chinese indices at their day’s highs. Further rumours of a reserve ratio requirement (RRR) cut and other measures to keep growth above the key 7.5% level this year have made their way through to the market, and while we are pleased this index is gaining traction, we feel those buying on the prospect of an easing announcement from the PBOC could be disappointed.
Japan has been the underperformer, although S&P futures haven’t reacted and are still 1.0% higher from the cash close. USD/JPY has been heavily sold off with the low 0.9827, in-line with lower US yields. On the positive side, the weekly MOF fund flows showed solid buying of foreign bonds by local players, after eight weeks of net selling.
Clearly the higher yields on offer in the US and peripheral Europe have caught Japanese pension and life insurance funds’ attention. Later in the session the BoJ released its policy statement, keeping in-line with its usual path of announcing earlier in the day if no changes to policy are announced, with the bank unanimously continuing to target an annual increase in its monetary base of ¥60-70 trillion. Still, it always intrigues us why it chooses to announce when the equity market is closed for lunch.
There could still be further clues with the upcoming press conference from Mr Kuroda, while the BoJ has scheduled a meeting with key market players (17:00 AEST), which of course is part of their bid to improve communications; however these one-off meetings are usually called when they need to communicate something to the market, so there is a possibility of further news in the press conference, possibly even changes to its asset operations.
The ASX 200 has been a pillar of strength all day, taking its cues from China and the S&P futures. The index has now retraced over 50% of the 11.9% losses during May to June, and it seems we have a short-term uptrend in play. Traders are favouring materials and energy names, with the latter clearly helped by rising oil prices. We will trade with the trend where we can, and a move above 5000 should be seen in the short term. A rise of 10,000 jobs did little to alter the perception of an August rate cut, with the credit market unperturbed and continuing to price in a 60% chance of a cut, which we feel is about right. Of course, the fact that all the jobs created were made up of part-time jobs paints a picture of poor composition, thus should not alter anyone’s call on future rate moves.
European markets are shaping up to open between 1% and 2% higher. While the focus will be on readjusting portfolios post-Bernanke’s speech, it seems the market also has its eye on WTI which is on fire at the moment. Inventories have fallen a massive 5.1% over the last couple of weeks, although they remain above their historical average. With the price of the August contract approaching $107, it is just over 3.5 standard deviations away from its 50-day moving average - the most overbought since early 2012. As things stand, 71% of our client base (who hold open positions) are short and clearly see these levels as unsustainable.
Data is relatively light with the weekly jobless claims in the US the highlight and likely to show a modest drop to 340,000. Italy will tap the market in a series of short- and long-dated bonds, and one would think there will be pretty sizeable downside reaction (yields) in the European debt markets when they open, which will no doubt please both the ECB and BoE, who are providing forward guidance to try and distance their markets from that of the US. However, it will be day to hold growth stocks and expect the solid gains seen in Asia in the resource space to be replicated.