USD weakness gathers pace

Anyone focusing on the leads for the ASX 200 would think that the last ten hours or so have been a fairly drab affair, but that is not the case looking at G10 FX, commodities and fixed income markets.

Source: Bloomberg

Saying that, the S&P 500 is hardly providing local investors with inspiration, with S&P futures currently 0.5% lower than 16:00 AEST (the ASX 200 close). We have seen strong client business in the post market in Netflix, which is currently down 7.5%, although they have recovered from being down 15% at one stage. Eyes will fall on numbers from Goldman Sachs and Citigroup tonight.

Our ASX 200 opening call is only down a tick or two, and will likely find comfort from the upwards momentum into the close. Interestingly, BHP’s American Depository Receipt (ADR) suggests an open 1.7% higher, despite iron ore futures falling 0.9% in overnight (electronic trade) trade. Oil is largely unchanged and copper is nearly 1% higher from yesterday’s ASX cash close. These need to be priced into the corresponding stocks.

The highlight of today’s session will undoubtedly be the Aussie September employment report, with consensus sitting at 9600 net jobs having been created. Economist’s calls range from 25,000 to zero net job creation, with the unemployment rate maintained at 6.2%. Expect the FX market to be the most sensitive asset class here – I would not expect too much reaction from the equity market, with some modest volatility seen in domestic cyclicals, although this will depend on the print itself.

AUD/USD to $0.7500?

AUD/USD found good buying from yesterday’s session lows of $0.7199 and has reclaimed the 73 handle. The prospect over the coming days of a re-test and break of $0.7382 (12 October high) is a real potential, despite a number of high profile economists saying moves from Westpac to lift home loans makes a November cut from the Reserve Bank a distinct possibility and the interbank market is pricing a 57% chance of easing by year-end. A poor jobs number obviously carries sizeable ramifications given the labour market has been a source of positivity of late, but the hawks will point out that one number doesn’t make a trend.

The strength in AUD/USD has been a clearly function of USD weakness though, and this can be seen by the fact AUD lost 1.4% against the NZD and 0.7% against the sterling. AUD/NZD is highlighting an increasingly bearish trend, although the pair has found good bids at the 50% retracement of the April to June rally at NZ$1.0736 (on the daily chart). The USD bulls are having all sorts of issues at the moment. My view is that the USD will have its time in the sun again, but for now there are some strong reasons to feel further losses may be in store.

A poor retail sales report (the retail control group declined 0.1% versus expectations of +0.3%) has lowered the bar again for Q3 GDP (announced 29 October) and this seems likely with a print closer to 1%. Today’s US September core inflation print could really spice things up if we see this announced at 1.7% or lower.

A number of traders have pointed at the so-called ‘death cross’ on the US dollar index (DXY), showing that the medium-term trend (50-day moving average) has fallen below the longer-term (200 day moving average). The last time this set-up occurred was September 2013 when the DXY lost 1.5%. While this phenomenon doesn’t always suggest a major trend change, it does paint a story where the USD is out of favour. This is having ramifications in a number of other assets, particularly gold, which has broken above the August highs and is looking to move above $1200.

The Fed’s dove’s having much greater control

The implied probability of a rate hike from the Federal Reserve in the December meeting has dropped to just 28% and below 50% for the March meeting. Some focus has also been placed on a research piece released from the San Francisco Fed this week, arguably the most respected research hub of any the regional Reserves. The research piece suggests that given current financial conditions, the natural interest rate for the US is actually -2.1%! This plays into Tuesday’s comments from Fed official Leal Brainard that current tight financials conditions (largely as a by-product of USD strength) have actually been akin to two rate hikes. With the likes of Evans, Kocherlakota, Tarullo and Rosengren all pushing back on near-term tightening, it does suggest that rate hikes are off the table for this year. Saying that, given the level of cash parked on the Fed’s balance sheet by overseas banks, the possibility of negative rates seems very low, and theoretically almost impossible to implement.

This all makes watching the central bank and the possibility of how they counter a dovish turn from the Fed  very interesting and  it will completely drive the capital markets. Specifically, at what levels will the European Central Bank (ECB), Reserve Bank of Australia (RBA) and Bank of Japan (BoJ) start feeling that the recent currency strength is starting to become detrimental to economics? However, one could argue that currency weakness (of EUR, AUD, and JPY) has not had the impact these central banks would have liked on their economy, but we can’t rule out a re-test of the 24 August highs in EUR/USD ($1.1714). This would certainly concern Mario Draghi, despite his belief that ECB quantitative easing (QE) is working.

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