Central bank differentials still key

Having rallied to record highs over the past ten days on the ECB stimulus announcement, global markets have finally become concerned about the currency wars and the effect it has on corporate earnings – particularly in the US.

Source: Bloomberg

US earnings overnight were poor. That was first flagged after-market by Microsoft – down 4.5% in aftermarket trading, it finished down by 8.5% by the close. The main issue for MSFT was around business-licence sales but FX headwinds were also a major factor in the poor results. Last week, IBM flagged a US$300 impairment charge due to the USD strength. Other majors such as Procter & Gamble, Pfizer, DuPont and the car makers are also in this boat, with P&G seeing earnings down 31% due to the USD.

With the FOMC at the beginning of their first two-day meeting of 2015 today, the question now becomes when will we see a rate rise?

If corporates continue to feel the strain of the ever-strengthening USD on rate-rise speculation -which will lead to lower job creation and slower wage growth (which is already suffering) - will this stay the hand of the Fed?

Chairperson Yellen’s default position is to the accommodative line of thought. Will these issues see the expected rate rises postponed until late 2015 rather than mid-year?

The policy statement tomorrow will likely show that the board remains as one on the idea that rate rises will be ‘data-dependant’. However, this raises more questions than it answers – what happens if the data slides on concerns from the Street?

If unemployment begins to rise or inflation continues to undershoot (which is highly likely considering the oil price and wage inflation), will we see the USD strength reversing on bets the Fed will hold off? What will Japan, Europe and, in some respects, China do in response to the EUR and JPY moving higher? And what will be the impact on their economies as their competitiveness drops off again?

At risk of sounding like a broken record, I think accommodative central bank policy is here to stay and is likely to be even more accommodative by year end in most cases. Inflation – whether from oil, wages or stagnating consumer consumption – will mean monetary policy is formulated to the downside.

This is why central bank differentials remain my baseline point for strategy formulation. I do see positive cyclical risk in the second half of the year. However, the risks in the first half are glaring and, despite the positive rally over the past week, I remain positioned for increased volatility.

Ahead of the Australian open

Australia will be part of the global inflation read today as fourth quarter CPI is released. The market speculation around next Tuesday’s board meeting is mounting, with the market pricing in the probability of a rate cut at 40% - the inflation read today will move this speculation.

The market consensus is for a 1.8% year-on-year read as energy bites. Anything below 2% will only add to the ‘rate debate’ and will likely see the AUD testing the 79-cent level.

However, the currency and oil price are doing the RBA’s job for them as both are forms of stimulus for domestic corporates and consumers. I see next Tuesday’s meeting as a ‘no move’ event – the easing in the economy is happening organically.     

We are calling the market down 35 points to 5512 after reaching the November high yesterday on defensive stock surges. Iron ore stabilised overnight but is still in a downtrend – the actions in Fortescue Metals Group (FMG) show that major concerns remain over earnings. FMG’s production report today will be cold comfort for its share price as even increased production is likely to see disappointment due to an inevitable average price slide.

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