In a world re-adjusting for the potential for less aggressive US Federal Reserve action, the US central bank will clearly be happy to see the ECB and the BoE taking an easier stance, removing the emphasis off the US. Clearly the Fed would love to see asset prices supported with the capital markets taking solace from the Bank of Japan, ECB and BoE, with the stimulus baton firmly handed over from the US.
Momentum in Europe should be to the upside and our European opening calls have been modestly bid through the day, while client business has been biased on the positive side. It’s important to know that only 130 FTSE futures (September) contracts have been traded all day, with spreads in the underlying market extremely thin. S&P 500 futures have also only seen 190,000 contracts, which to be fair is not unsurprising given the Independence Day holiday, while there has also been a sense of uncertainty given the upcoming US payrolls.
We haven’t really seen a huge amount of cautious positioning expressed in Asia around non-farm payrolls, although it is a little unclear to us how risk assets will trade given the different outcomes that the payrolls could have on the perception of US monetary policy. It seems logical to us, and textbook theory would suggest that USD/JPY is the best guide on the market’s interpretation of the number. However, in recent times USD/JPY seems to have adopted the mantra as the cleanest ‘risk on, risk off’ trade out there, so there’s a possibility we could see USD/JPY actually fall on a number above consensus of 165,000 (even if US yields rise) as the prospect of a September tapering exercise increases and thus risk comes off the table.
For us though the US bond market is the higher form to which all other asset classes bow down too, and a number closer to 200,000 will no doubt push the ten-year treasury to test the recent high of 2.66% and see the USD momentum continue in earnest. It is worth highlighting the macro community will go into this meeting short carry, although a move higher in US yields will see funds added to longs and emerging market equities and currencies hit very hard.
It’s hard to see EUR/USD pushing back above 1.30 anytime soon, and we’d need to see a number closer to 100,000 in the payrolls to cause a major USD sell-off. Currency wars have been the talking point for so long, but the new actions of central banks are now fully focused on the bond market.
Of course the beggar thy neighbour action cannot really take hold in fixed income land as bonds are traded as individual instruments, where of course currencies are a relative game. However, it is clear the ECB and BoE are trying to persuade fixed income traders not to simply lump the gilt, bund or peripheral debt markets with that of the US treasury market, which of course they have all done since the market got a sniff of tapering. Forward guidance is of course a new, radical step by both central banks, and while both may look to make conditions even easier in the coming months through increased QE or a refinancing rate cut, it’s important to remember this is a first step, and still some way from the explicit guidance provided by the Bank of Canada, BoJ and Fed over the last couple of years. Still, with the Fed becoming less easy and the ECB and BoE going in the opposite direction, it’s hard not to see further downside potential in GBP and EUR, while gilts, bunds and European equities should stay bid.
As mentioned, Asia has seen solid buying, with Japan higher by 1.3% and the ASX 200 up a more modest 0.7%. The Nikkei has now retraced 50% of the 21.9% pullback through May, aided by a stronger USD/JPY, which looks quite comfortable above 100.00 as things stand. A move through the recent high of 100.86 should attract more momentum names, with talk that Japanese Trust names have also been buying today. The case for further upside in the pair is growing, with Shinzo Abe looking good for the July 21 Upper House elections. It is also important that the BoJ has done a good job anchoring volatility in the bond market, with the ten-year JGB trading in a modest five basis point (bp) range this week (85-90bp); this at a time when economic data is undoubtedly improving. It seems all that is missing is heightened clarity on the third arrow (structural reform) and increased inflation expectations.
China is flat on the day, although it is positive to see the credit markets in a better space, with the seven-day repo down another twelve basis points at 3.83%, now in-line with the year’s average. The PBOC and CBRC (China Banking Regulatory Commission) are due to release a statement at 17:00 (AEST), and one suspects it will centre on further reforms and liquidity provisions.
The ASX 200 looks set to close the week on a positive note, in what has been a tough week for both traders and investors alike. It’s good to see the bulls getting the upper hand, but we haven’t seen volatility and intra-day ranges like this for some time. All sectors are higher today, although it has to be said volumes are shocking at a$1.5 billion of value, with the year average at a$5.2 billion; clearly the institutional side of the Australian broking world have had enough of the turbulent week and is starting the pre-Lions versus Wallabies rituals early.
So, with strong European markets yesterday and reactionary gains in Asia, we feel European markets will see mixed fortunes today. Expect the Asian theme of light volumes to be reiterated in Europe early on, with tight ranges expected up until the US payrolls report. Staying nimble is key and there could be a solid bias to react, rather than prophesise ahead of the jobs number, although we hope markets act rationally and rally on a good jobs report, rather than sell-off on the increased prospect of September tapering.