IG Markets: Notes on Australian markets today

Kyle Rodda, Market Analyst, Australia

The day's key takeaways:

- Growing number coronavirus fatalities brings questions about global growth

- The curious case of the reflation trade and the missing fundamental data

- Risk and growth assets stall as doubt emerges about a global growth recovery

- Tonight’s manufacturing PMI data to provide reality check for market participants

The run down:

The fatalities from the coronavirus continues to grow, and with them, at least amongst market participants, so does concern about the virus’ potential impact on economic growth. The headlines are becoming a little louder in the way they read, as the upward run in risks assets that’s defined the last 2 months of trading comes under pressure. Implied volatility is crawling off its lows, with the VIX trading into the 13 level overnight in Wall Street trade, seemingly as trader’s price in some greater level of uncertainty about the future. As it stands, there’s no empirical evidence that the outbreak of coronavirus will cause wreckage across the Chinese, let alone global, economies. But some impact will be felt, and the uncertainty that that’s eliciting amongst traders is bringing about a touch of risk aversion. If the virus continues to spread, and claim lives, the subsequent repositioning in the market could bring about the pull-back in global stocks many have warned about.

Not that any such sell-off in risk would be a perfect indicator of the likeliest effects of the coronavirus. Instead, it’d be the pin that pricks what is looking like a slightly frothy stock market. There is a pertinent, and deeper issue being exposed by the risks hurled up by coronavirus though, and it’s exposing a subtle, but important disquiet in the market about the prospects for this long-touted turnaround in global growth. Along with the flood of liquidity coursing through financial markets, traders have felt emboldened to take risks by the notion that some sort of marked improvement in global growth is afoot. This remains largely the default position for traders, and tentative signs in price action suggest that this ought to stay so, for the time being. However, the firm, fundamental evidence that’s been sort after and called out for to justify this view remains wanting. And it appears that this lack is beginning to generate impatience amongst market participants.

Less so in stocks, though the slowing upward momentum in equity indices is evident, price action in currency, commodity and bond markets is betraying a sense that, for markets, this “reflation trade” narrative is ambling at a cross road. Growth indicators have stalled. The Japanese Yen is back in the 109 handle. Copper prices are selling-off. Long term US Treasury yields, which never really joined the party in the first place, are falling. Emerging market stocks and currencies, which are forecast to be the driver behind this growth rebound, are dropping. Of most concern, is the US Dollar is looking reinvigorated. Now, the future can never be truly predicted from the lessons of the past. However, typically, a strong US Dollar and improving emerging market, even global, growth is generally incompatible. Likely, it’s got to go one way or another. The data and earnings turn as forecast, and the “reflation trade” pushes on; or it doesn’t, and global markets need to reprice.

An important piece of the puzzle comes tonight. A spate of manufacturing PMI numbers are printed, and will provide some level of insight into whether lower geopolitical risks, and the wave of monetary policy stimulus plied by central banks, is beginning to drive a meaningful turnaround in the business cycle. Evidence has been positive to date that his is the case. The global, aggregated manufacturing PMI gauge moved into expansionary territory at the end of last year, forming the bedrock of this global growth recovery story. The green shoots for the economic rebound are there. And even in the event that tonight’s data disappoints, barring a spate of major misses, the consensus view will remain intact. Nevertheless, at some point, global, and especially European, PMI will have to tangibly turnaround, to vindicate the “reflation trade”. If that’s not expressed tonight, then the result will be a slightly greater sense of doubt amongst market participants, along with a little lift in risk aversion.