Thursday is now shaping up to be very significant for the markets. Thursday – the day after the Fed meeting – should restore clarity to the investment and trading community and perhaps cause the headline risk that is bringing the algo traders out in droves to retreat.
The overnight article in the Financial Times showed just how sensitive the market is to headline risk not just from central bankers, but now journalists through newspaper publications and Twitter. Of course the major point of contention is whether the board is prepared to tolerate low inflation, as long as it is seeing a sustained recovery in job creation. However, the question seems to be whether the Fed will use this meeting (or should we say Bernanke press conference) to detail the exact month of the ‘next several meetings’ statement with regards to tapering implies; although this will come with additional caveats for economic data points which will need to justify this view.
Conversely, will the Fed push back on the expectations, bringing down the long end of the yield curve? The fact that the US homebuilder’s index had the largest jump in May since September 2002, during the month of the giant spike in bond yields and subsequent mortgage rates, certainly suggests the Fed could feel the market will be OK with higher yields; and therefore could edge on the hawkish side. It now seems universal however that the Fed Chairman will use the meeting to highlight the difference between curbing the pace of asset purchases and an increase in the funds rate.
One thing we do feel confident predicting is that Ben Bernanke is going to come out all guns blazing; bringing a certain slickness we usually associate with the US President rather than Ben Bernanke. In doing so he will try to bring a sense of calm to a communication channel which many are questioning at present.
With a stronger US market it’s interesting to see such an underperformance from Asian markets. The ASX 200 started on a firmer footing, but gave up as Chinese equities fell away. AUD/USD found buyers at 0.9500, and despite clear divergence on the daily charts continues to frustrate those looking for a technical bounce. Today’s minutes from the RBA didn’t really give us much new ammunition, however it was interesting to see at least three paragraphs dedicated to yield spreads and the exchange rate. The key take-away from a currency perceptive though is that while the RBA acknowledges the AUD has fallen, both against the USD and on a trade-weighted basis, it is still high relative to the terms of trade. This information isn’t new as it was in the initial statement; however the bank feels there are downside risks to the currency if terms of trade decline which in turn could have positive ramifications for the economy; thus we feel the bank is still keen to promote a weaker currency.
On a side note we think June 28 will be an interesting day for currency traders of all types, with the IMF revealing the size of reserve manager’s holdings in AUD and CAD. The key issue here is around capital flight and the exact level of foreigners’ holdings. In June 2012, 76.9% of all Aussie government bonds (ACG) were held by foreigners – although that figure has fallen to 68.9% in Q1. With Japanese investors seemingly repatriating funds back by the day, there are a number of traders who feel there are sizeable risks to the level of foreign holdings of AGBs. In theory, a good number could bring stability to the AUD, with clarity restored.
As mentioned, China has moved firmly into the markets spotlight, partially on the slight rise in leading indicators and foreign direct investment, but also another blockbuster rise in Shanghai and Beijing property prices; up 10.2% and 11.8% in May respectively. The property numbers are especially worth highlighting, and anyone hoping for a cut to banks’ reserve ratio requirements (RRR) are clearly going to be thinking twice about that call. Of course the key talking point right now is around liquidity and the lack of action from the PBOC to inject it into the money markets to bring down short-term rates.
This can now be seen across the curve with rates going parabolic in recent times, but the curve is seriously inverted now, showing the stress in the short term funding markets. The one-year swap rate is also at the highest level since September 2011 and it’s clear that the PBOC will need to do something soon. However, the PBOC is sitting pretty and seems hell-bent on promoting a more conservative approach from the banks and is happy to keep levels elevated to put more pressure on them. This is an area many will continue to watch and further upside in rates will almost certainly have negative ramifications for risk assets like equities and commodity currencies, which will see traders coming back into the JPY.
(current rates for set maturities for China’s short-term rates)
Our European calls are pointing to a risk-off open for the markets, although we are not only getting into the eye of the storm in terms of the tapering argument, but data in various locations also increases today. On the docket we get CPI for the US and UK, housing starts and building permits in the US, and in Europe we get the ZEW survey. EUR/USD continues to find buyers and it’s interesting to see a few in the market beginning to talk about the EUR as the new quasi-safe haven currency, with the single currency rallying on a trade-weighted basis even in times of equity selling. With a 2% primary surplus forecast this year by the IMF, it seems this is quite appealing to some, and with EUR/USD closing above the 61.8% retracement of the February to April sell-off at 1.3342, the ECB should be looking to increase the negative rhetoric on any further moves to 1.35.