Everyone loves free money

It’s interesting to see how excited the world is getting over China’s CNY1.2 trillion (US$200 billion) fund release from the reserve requirement ratios cut.

Source: Bloomberg

Europe and the US picked up the China news and ran with it, having been routed on Friday and having had a poor week last week. There is currently a sizable lull in the markets. There’s no doubt the Chinese is story a very big positive but it may be taken as a bigger positive than normal considering where the markets find themselves.

Earnings season in the US is (as ever) going swimmingly, with over 70% of companies beating estimates on the EPS line. However, that is not especially impressive considering the consensus bar is low enough for a dachshund to jump over, which may explain why the S&P was unresponsive, even with the earnings numbers form Goldman Sachs, Citi and JP Morgan last week. From a strategic bottom-up perspective, this is positive. However, from a top-down perspective there is downside risk overriding the earnings news.

Commodities jumped in London and spot iron ore is now well above $50 a tonne (sadly not enough for Arrium to be making money) on the Chinese news. I fully expect Asia as a whole to be in the green today after a mixed reaction to the China announcement yesterday. However, I am still cautious for Australia – the 6000 point level has been defended and the market has broken to the downside after trying for four weeks to break through. The green may be very short lived.

So the lull looks like it will continue in the interim. The China news will dissipate quickly as portfolio managers continue to mutter about ‘valuations’, ‘price premiums’ and ‘yields’. I myself have been muttering similar things. My questions have included ‘What will cause a leg higher?’ and ‘Where can I get exposure outside of the banks that has conviction and isn’t asking for a large premium?’ There are a few but none that really excite me.

Which brings me to Governor Stevens’ speech overnight – everyone in the markets wants the post-GFC free money to continue in some shape or form. For Australia, that means further interest rate cuts.

Outside of the equity markets that feeling is not carried through - there is major concern about Sydney’s house prices and the fact that monetary policy is having to do too much of the heavy lifting.

We are three weeks from the May budget and the Treasurer is slowly inching away from straight austerity to a more ‘balanced budget’ – will fiscal policy finally support the economy – something monetary policy has been doing since 2013? I doubt it.

However, Stevens’ comments in New York last night have swung the pendulum back to a probable May rate with this line: ‘The Board has, moreover, clearly signalled a willingness to lower it even further, should that be helpful in securing sustainable economic growth.’

This pushed the AUD under 78 cents and saw the interbank market moving from a 49% chance of a May cut to 57%.

Sifting through the speech, though, there are signs that the Board is monitoring whether it should cut rates further – Stevens stated once again that ‘credit conditions are very easy’ and that ‘monetary policy has limits to its effectiveness.’ From what I can see, he has continued to play with a very straight bat and is giving nothing away. Tomorrow’s CPI figures are going to be key to a May cut in my opinion – and this may explain why banks have lost ground in the past week or so as the yield trade slows on risk of a ‘no move.’

Ahead of Australian open

We are calling the ASX 200 up 47 points to 5879, which would reverse all of yesterday losses. Miners in London were a major support to the FTSE and I would expect the same in Australia on the back of the spot iron ore price – however, be aware that iron ore futures are down 2.6%.

The banks are likely to snap back from the sell-off of the past two trading days as banks’ earnings season is now only 10 days away. Having said that, I come back to the risk around interest rates – no move will reduce the premium price they demand.

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