A data dependant Fed

We are moving into a very interesting market situation as the Fed is now well and truly ‘data-dependent’.

US Flag
Source: Bloomberg

Data strength:

  • The non-farm payrolls had its strongest read since November 2014 and third strongest month since May last year. It smashed estimates and came in the shortest month of the year.
  • Unemployment fell to 5.5% - the lowest level since July 2008 (pre-Lehmann Brothers)

However wage inflation remains a concern:

  • Average hourly earnings fell again - rising only 0.1% from 0.5% previously and well below expectations
  • Labour force participation remains at late-1970s, lows of 62.8%

Having seen a shift of language from the Fed form ‘considerable time’ to ‘patient’, Friday’s non-farm payrolls data has the Fed in a situation where it really is a meeting-to-meeting situation - only adding to the USD strength. The debate in the market is how much will inflation stave off an early rate rise, and by early I mean when the Fed had originally expected rates would rise. The market has been positioning itself for a rise in October – Friday’s data suggests June or July is a real possibility; this is going to really ramp up if inflation is inline.

The speculation is putting real pressure on the overvalued internationally exposed US stocks. With over 56% of revenue on the S&P 500 coming from overseas, the appreciating USD is severely impacting on earnings. This was perfectly highlighted by the Q1 earning season, as the likes of IBM saw a $300 million FX impact.

What is also interesting from an investment point of view is the response from corporates to continue to attract investment. February was the busiest month for share buy backs on record in the US - US$180 billion was given back to shareholders. Showing the thrust for cash returns for the risk of investment is not a just an Australian-centric idea - the US is seeing similar moves form corporates.

What is also happening is the USD strength is forcing more money into US domestically focused cyclical plays. The issue here is that valuation in these cyclical plays are now overstretched, leaving the S&P precariously placed for a further pullback. The reaction from the US market on Friday shows no one is really positioned for moves in the Fed funds rate – the rush for the exit will be rapid when it does shift.

The next question from an Australian perspective is does the USD strength give the RBA room on rates? The AUD was slashed on the back of the US jobs report, the technical pattern in AUD/USD is a bearish flag and there is a possibility of a test of the mid-76 cent handle in the next week - will the falling AUD give the RBA further space?

Will this see the yield trade ending sooner than expected? The unwind in that trade was very quickly at the March rate announcement.  Will the AUD/USD move see a more sustained unwind in yield equities? The bottom line is, there is a genuine fear the January - February 600 point move was based on rate expectations. If that evaporates - and investors begin to focus on the fundamentals in market - the ASX 200 is in for a pullback.

Based on Saturday’s close of the futures market, we are currently calling the ASX down 54 points to 5845. What is likely to increase the slide is Victoria, South Australia and Tasmania are all on respective public holidays making volumes lighter than usual.

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