US and Asian subdued after FOMC meeting

The big moves in a number of assets were predominantly based on position re-adjustment than anything else.

Source: Bloomberg

The talking point overnight was the sizeable moves in precious metals, with both silver and gold looking very good on the daily chart. Gold especially has been in focus, although whoever it was who caused such an aggressive move higher yesterday was a little late to the party and had to really think about the actions of the Fed, because gold futures started really motoring 18 hours after the meeting.

Still, gold has traded through the 55-, 100-and 200-day moving averages and the April downtrend. The weekly chart however seems more compelling to me and the downtrend drawn from the October high (at $1321) seems to be holding up play and is fundamental to the bulls cause. A close tonight above this trend would be needed for a more extended gain here, but the fact that traders have faded the metal at this level today is very interesting.

Janet Yellen detailed that wage inflation is pivotal in influencing when the Federal Reserve raise interest rates, even going as far as saying the recent increase in prices was ‘noise’. This was the trigger for selling USD’s and the bullish steepening of the US yield curve in the prior session.

With this in mind the most important chart to shape future Fed policy should be the Employee Cost Index (EYI), which is produced on a quarterly basis and has effectively been tracking sideways for the last two years. What’s interesting though is Small Business Compensation index is actually trending higher, and as we know SME’s are the life blood of most economies. So perhaps this could be a lead indicator for the ECI, although there is no correlation between the two indices over the years.

All eyes on US inflation

Headline inflation in the US may be above 2%, but this is actually has a fairly negative impact on the USD, as inflation adjusted bond yields (or ‘real’ yields) seem to be driving FX markets right now. So countries with high ‘real’ yields will always be in favour in a market where implied options volatility is at record lows. It’s also interesting to note that while the Fed may see ‘noise’ behind the recent bout of headline inflation strength, the market expects to see a 20 basis point increase in core PCE (personable consumption expenditure, the Fed’s preferred measure of inflation) to 1.6%, which is only 10 basis points (or 0.1%) from the average level of inflation since 2000. It is also at the top end of the Fed’s recently revised forecast. It’s also worth looking at US five-year breakevens which highlights the bonds markets expectations of inflation over the coming five years. Right now the bond market expects 2.07% to be seen over the coming five years and this is at the highest level since mid-2013, this suggests the market is starting to turn on inflation.

While assets like gold, developed market fixed income and the USD may have undergone a sizeable position re-adjustment, I feel dips we have seen could provide a good entry for USD longs. A pick-up in wage growth though seems to be the key behind future moves.

In Asia today the Nikkei has managed to find further gains and seems to be the market of choice again for money managers. There has been good outperformance in this market of late, despite USD/JPY pulling back below the 102 level. The market seems to be playing catch-up and momentum favours staying long here.

No follow through buying in Australia

The bulls will probably be a touch disappointed by the sell-off in the ASX 200. Financial stocks closed on their highs yesterday, but seem to be taking out the points today, although the main news here is around a ban on collecting commissions on sale of financial products. One has to assume there is some profit-taking from those who have been sitting on longs and thus have used yesterday rally to sell into. Materials have found sellers after yesterday’s euphoria, although gold stocks have found good buyers as you would expect.

European markets should see a flat open, with data on the light side, with German PPI and UK’s May public finances the central focus. FX traders will be looking at the CAD, with Canadian April retail sales and May CPI in focus. Brent has stabilised through Asia above $115 and again this commodity could be a key headwind for risk assets, so price action in Brent needs to be closely watched.

Sterling remains the currency to own against the USD, despite rate hikes this year priced in and GBP/USD continues to feed off momentum.  The move higher in the UK gilt market seems to be driving the pound and if you look at the sizeable underperformance two-year gilts have had over German bunds, Japanese government bonds, but also US treasuries you can see why the GBP is soaring. The two-year gilt is now double the yield of the US two-year treasury, which is also the highest premium since 2011, so as long as this premium continues then GBP/USD, GBP/JPY and EUR/GBP will move in correlation.

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