Risk assets saw the light trade as a chance to bounce off the lows seen last week, but volume throughout the market suggests the bears where resting, rather than a conviction buy move.
Currency markets have been treading water for a week or more now, suggesting the carry trade is slowing and most are watching for clearer direction from central banks. Last night there seemed to be a slight break in status quo as the yen started to rally.
As the safest currency in the G10 and a place where the carry trade has flowed rather freely, the slowdown in the yen’s depreciation is an interesting development from a risk point of view of.
Market complacency has been a growing trend over the past 18 months and risk-reward trades have seen huge double digit returns. Since Mario Draghi’s ‘whatever it takes’ speech in mid-2012 and the initiation of QE3 in the US a few months later, the bull market has only accelerated.
However, from what I can see from a fundamental perspective is a macro environment that is guaranteed to change come October as the asset purchase program ends. Commentators point to the fact that accommodation will remain with the Fed funds rate being welded to record lows; however neither record low interest rates nor money printing has caused a key reason for accommodation in the first place – inflation.
Inflation is developing as a key area of concern globally; currently inflation can only be described as stagnate as it is well behind the Fed’s 2% target, and the same can be said for the BoJ’s 2% target. The eurozone would love to use the word inflation instead it is fighting deflation in the periphery. What is also clear is where inflation stagnation is occurring – wage growth.
This is becoming a global phenomenon: the US, Europe, the UK, Australia et. al. are all seeing wages flat lining and this is a major threat to credit and spending. Wage deflation was pre-warned from a bottom-up perspective as companies looked to consolidate and cut capex.
Wages, particularly service-based companies are the biggest contributor to capex and wages slowing down are the biggest risk to investment and credit spending. This why I see the complacency in equities as a developing risk that is likely to come to ahead come the second-half of the year. The trend hasn’t broken yet and I want to stay with the trend, but the fundamentals for a switch are there: market complacency, low to no inflation and a bull market that is approaching maturity.
Ahead of the Australian Open
We are currently calling the Aussie market up 16 points to 5425 on the 10:00am bell (AEST), however the developments in the commodity markets cannot be ignored. Iron ore has dropped to its lowest level in 20 months and is unlikely to slow its fall any time soon. The 70-point drop on the ASX yesterday was due to the huge downward pressure on pure plays and that is unlikely to slow down today. Yes there were positive leads from the US market that are being priced into the futures markets, but I see that being overrun by the development in iron ore and the fact it is now a double digit price of US$98.50 a tonne.