Why fiscal policy is boss

In a world where central banks are largely offsetting government’s fiscal policy through easier monetary policy, the Japanese showed today why, when it comes to economics, fiscal policy is boss.

Source: Bloomberg

Q4 GDP was revised down 60 basis points to 1.5%, with business spending actually contracting on the quarter. On a positive note, private consumption was revised up a touch to 0.5%. Sellers have been seen in Japanese equities, which should have found stronger support from a USD/JPY that is testing the 7 December high of ¥121.85.

The JPY has seen some better buying against other G10 currency pairs, although ranges today have been fairly lacklustre. There is a risk-off feel to markets and what started as signs of vulnerabilities last week has evolved into something modestly more concerning. Chinese markets have fallen 1.5%, while the ASX 200 has traded nicely below 5869 and the level at which strong buyers came back into the market last Thursday. A move to the 12 February low of 5,739 could be on the cards, with the five day moving average really accelerating from the slightly longer-term ten-day moving average.

The fact the fed funds future is now pricing an 80% chance of two moves from the Federal Reserve this year is keeping the USD bid and the prospect that AUD/USD trades through the February low of $0.7626 could keep the Reserve Bank of Australia sidelined to May at a minimum. If banks have been bought on the idea of the compelling yield advantage (over other investments such as term deposits) then falling easing expectations could act as a headwind. A large 13 basis point upside move in Australian government bonds has also caused sellers in banks, while a downgrade from a US investment bank to the sector to underperform has helped push the financial sector down 1.1%.

US markets have an uneasy feel about them and much now hinges on the bond market and subsequently the USD. Since the mid-1960s there have been 15 times when the Fed funds rate has been lifted, but seldom have the Fed moved in isolation with other central banks easing monetary policy. Rarely will they raise rates when growth and inflation are as vulnerable as they are now and this is a concern. The USD index is also unstoppable right now and this is having a real effect on the S&P 500 and US tech 100 cash (NASDAQ). Record corporate buybacks and dividend growth are propping up markets right now, but with aggregate net interest margins falling 90 basis points in the recent reporting season (to a two year low of 9.1%) the trade of being long domestic exposed stocks and short stocks, which generate 60% or more in European sales, should continue in earnest.

Friday’s jobs report had its negatives, but on a net basis has probably solidified the idea that the March FOMC meeting will see the Fed lose its ‘patient’ stance on when higher rates will be targeted. This should keep the USD bid; gold, a derivative of USD, is heading to its 7 November low of $1131. Ultimately, all of this is driven by the US bond markets, which should start getting more attractive for funds on moves into 2.35% to 2.40%. The S&P 500 needs to hold support between 2,066 and 2,064 (the 38.2% retracement of the February rally and January double top) or the cries of ‘correction’ will be rife. A move to 2,014 would mark a 5% pullback from the recent high, which of course investors with cash would have dearly loved to see a week or so ago.


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