Are we seeing the end of central divergences?

Arguably the main talking point has been the moves in European fixed income markets and exactly what caused the massive 16 basis point move in the German bund.

Source: Bloomberg

Seemingly constructive and purposeful dialogue from the Greek creditors have caused a few traders to cover portfolio hedges deployed in case of a missed payment to the IMF this month. This could well be true, but in some ways it is short sighted, as even if Greece does receive the final €7.2 billion tranche of aid, the issue will resurface again come August, where we then need to go through the process of a third bailout discussion.

Still, a 16 basis point move would almost certainly have caused some bond funds pain (those that had been buying various European fixed income instruments since mid-May). Naturally, the EUR’s valuation became just that little bit more attractive relative to other G10 currencies as bond yield spreads narrowed with EUR/USD rallying 2% to a high of $1.1195. European equities naturally underperformed, although it’s hard to say price action in the US is overly positive either.

I think you have to look at the markets' judgement of the central bank divergence trade which has caused such strong trends in fixed income and currency markets for well over 12 months. Specifically, we have seen the first gain in real wages in Japan since April 2013, while core inflation in Europe rose to 0.9% year-on-year, which is now only 30 basis points lower than the Fed’s preferred measure of inflation (core PCE).

The European Central Bank have had to reinforce a message that they intend to carry out its QE program until September 2016, especially after the ECB published its ‘Survey on the access to finance of small and medium enterprise’ which showed for the first time since 2009 an improvement in the availability of bank loans. With inflation expectations on the rise (as measured in five-year swaps), largely as result of higher Brent price, it seems the ECB’s QE program is actually doing what it was intended to do!

Still, while there have been monster moves in fixed income and currency markets, we should see a fairly benign open in Asia.

Ahead of the Australian Open

The ASX 200 has clearly found a new trading range in the past six weeks; after moving between 6,000 and 5,800 from March to April, it seems to now look more comfortable between 5,800 to 5,600. There is clear yield support at 5600; the banks at this level find their net yields are between 5.4% and 5.9%. That is still very attractive considering the ASX is fast becoming an income fund with the structural nature of its listings.

The 200-day moving average at 5,590 seems to be the floor in this range and as we saw on 20 May, the market saw solid buying here, so we know someone is keen to defend this level.

Iron ore resumed trading after closing on Monday for a Singaporean Public holiday. Upon reopening yesterday it has jumped above $63 a tonne - a 1.9% jump on Friday’s close. Dalian futures are looking positive too and eyeing a break of the 6 May high of CNY447.5. Interestingly, iron ore inventory levels are now at the lowest level since December 2013 and have dropped 16% year-to-date and 25% since the highs in July 2014.

The open of the market today will be lively. The 1.72% collapse of the ASX on the back of the RBA not having an explicit easing bias (I think if you really looked you can find it) was a bit of an overreaction and the higher call in the SPI may be an underestimate of the moves today as bargain buying kicks in, intraday moves are becoming more and more volatile – the longer term outlook therefore is becoming clouded.

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