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Trader thoughts - the long and short of it

The disparity between the Fed’s outlook for monetary policy through the remainder of the year and that of financial markets, continues to be a major source of potential volatility. The central bank continues to argue for another increase in 2017.

Market data
Source: Bloomberg

Traders are skeptical, with Fed Funds futures pricing in no further tightening until the calendar turns to 2018, and only one increase in the subsequent 12 months.

The final revision of first-quarter US GDP figures, as well as a look at the Fed’s favored PCE inflation gauge, will inform the debate this week. The former is expected to confirm a prior estimate showing the economy expanded at an annualized pace of 1.2% in the first three months of the year. The latter is projected to put the core inflation rate at 1.4 percent on-year, marking another step away from the Fed’s 2% target.

US economic news-flow has increasingly underperformed relative to consensus forecasts in recent months, hinting that analysts’ models continue to overestimate the economy’s vigor and opening the door for further downside surprises. If this translates into weaker growth and inflation readings this week, the markets’ dovish posture will be reinforced.

On balance, such outcomes are likely to translate into strength for higher-yielding currencies like the Aussie and Kiwi Dollars at the expense of their US counsin. Gold – the baseline anti-fiat asset – may also find support. The outlook for broader sentiment trends is a bit trickier as politics – especially in the US and the UK – continue to muddy the waters.

The risk that a worrying headline from Washington DC, London or Brussels hits the wires continues to be highly elevated. President Trump is still bedeviled by an investigation into his campaign’s contacts with Russian officials, while Brexit negotiations are gathering momentum on both sides of the English Channel. A sudden burst of risk aversion that sinks global shares and boosts the anti-risk Yen is now an ever-present danger.

Scheduled comments from ECB President Draghi, BOE and BOJ governors Carney and Kuroda, as well as former and current Fed chairs Bernanke and Yellen are all due to cross the wires throuout the week. Their assessment of current and on-coming economic trends may yet prove formative for price action across the asset spectrum.

Wall Street: US shares were little-changed in June, with a brief spike to a record high for the baseline S&P 500 index fizzling as quickly as it arrived. A clear lead may be difficult to come by this week without an obvious economic catalyst. Soft US news-flow may undercut the case for near-term Fed tightening but that is not as clearly positive for shares as it has been in the past.

Absent a political bombshell, the markets may be forced to reckon with the likelihood that the so-called “Trump trade” is unlikely to regain traction while the US President faces down allegations of campaign impropriety even as global growth momentum. That may be seen as broadly negative for earnings prospects and drive liquidation, although a trigger for such a move is yet to reveal itself.

China Growth Momentum Slowing? The official set of Chinese manufacturing PMI figures is expected to show that the pace of factory-sector activity growth slowed in June. Taken against a backdrop of political turmoil in the US and Europe, increasingly sluggish performance for the world’s second-largest economy sour broad-based sentiment, with negative implications for high-yield FX and share prices. The anti-risk Yen may benefit however.

Eurozone inflation slowdown: An early look at June CPI figures is set to show that price growth continued to slow in the Euro area as the impact of prior oil price gains is rebased out of year-on-year calculations. That may disappoint investors still holding out hope for near-term tapering of ECB QE asset purchases, weighing on the Euro.

Canada monetary policy outlook: Expectations for what may be the BOC’s next move will be informed by a speech from Governor Poloz as well as April’s monthly GDP figures. Recently hawkish rhetoric seemed to blindside markets and sent the Loonie sharply higher in the first half of June. It has since stalled, waiting for fresh fodder. If Mr Poloz echoes his colleagues’ optimism while growth accelerates – as is expected – the currency’s advance may be renewed.

Australia Dollar: The AUD launched a spirited recovery after four days of losses. Prices moved inversely of front-end US Treasury yields and alongside an advance in gold, hinting that soft US PMIs weighed against Fed rate hike bets that bolstered the relative appeal of the higher-yielding Aussie. More of the same may be on tap this week as data flow continues to undermine the case for futher tightening but external political jitters remain a potent downside risk.

ASX: With little by way of homegrown drivers on the docket, Australian shares are likely to fall in with the ebb and flow of global risk appetite. That means moves are likely to echo those seen on Wall Street, although a particularly sharp deviation from forecasts on Chiense PMI statistics may emerge as independent impetus for momentum.

Commodities: The Bloomberg Commodity Index – a broad-based benchmark for raw materials prices – rose 0.4 percent. The move seems to have a reflected a broadly weaker USD. The price of most key commodities is denominated in terms of the US unit on global markets. Gold rose as a disappointing round of US PMIs cooled Fed rate hike prospects, offering a lift to non-interest-bearing and anti-fiat assets. Crude oil continued to digest losses for a second day, after sinking to the lowest level in a year earlier in the week, edging fractionally upward.
 
Market Watch (23 June Close):
S&P 500/ASX 200 up 9.92 points or +0.17% to 5715.88

AUD +0.33% to 0.7566 US cents

On Wall St, Dow -0.01%, S&P 500 +0.16%, Nasdaq +0.46%

In New York, BHP +0.30%, Rio +0.52%

In Europe, Stoxx 50 -0.34%, FTSE -0.20%, CAC -0.30%, DAX -0.47%

Spot gold +0.52% at US$1256.40 an ounce

Brent crude +0.32% to US$45.54 a barrel

Iron ore 0.00% to US$54.73 a tonne

Dalian iron ore at 422.5 yuan, 0.00%

LME aluminium -0.27% to $US1865.00 a tonne

LME copper +1.02% to US$5800.50 a tonne

10-year bond yield: US 2.14%, Germany 0.25%, Australia 2.37%

 

By Ilya Spivak, Sr. Currency Strategist, Chicago

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