Chris Weston, Chief Market Strategist at IG Markets
You have to hand it to the Federal Reserve. They look primed to put up the fed funds rate in September, perhaps December. Yet at the same time, equities looks supported and the yield curve remains unchanged.
If the object of its communication exercise is to ease the market into a normalisation process without causing a stir in capital markets, then you would give their performance a nine out of ten. We may even see USD upside curbed, despite growing central bank policy divergence – how many other global developed central banks are tightening monetary policy?
The prospect of an early lift in the fed funds rate would compensate and allow for a less aggressive, slower-for-longer stance, which should keep the US yield curve flat and ultimately limit USD upside. This is certainly something the September camp are keen to promote.
We also know the Fed have provided traders with a quasi-code word from which to take their leads. . The idea that the committee requires ‘some’ improvement in labour market conditions, suggests traders need to pay attention to this Friday’s Employee Cost Index (ECI), weekly jobless claims and the monthly payrolls reports on 7 August and 4 September, as these are the potential triggers for the US central bank to announce lift-off in the coming months.
Whether ‘some’ has become the new ‘considerable time’, in terms of forward guidance from the Fed is being talked about. One word is about as simple as it gets when it comes to central bank guidance and this proves they have lowered the bar somewhat. Still, there are many broad questions going forward that strategists are keen for greater clarity on, including: 1) the process by which they guide short-term money (i.e. the effective fed funds rate) higher. 2) How aggressive will they actually be in tightening policy in 2016? 3) At what stage will they allow the assets they have accumulated on their balance sheet (through the various quantitative easing programs since 2009) to mature and its balance sheet contract.
Certainly questions two and three are what gold bulls will be focusing on and if the Fed get this wrong then gold will rediscover its mojo in a big way. Until that time, selling rallies seems the way to go for the yellow metal, but in the Fed we must trust.
This, in a way, is a similar concept in China were the China Finance Corp have been actively buying domestic equities throughout July as part of the ‘stabilisation fund’. Similar, although in much smaller size and with no maturity date, the fund will need to sell its holdings at some stage and this will create a natural overhang in the Chinese market. It is something traders will be thinking about, but for now, China is flat on the day and seeing no real follow through buying after what was a bullish afternoon session yesterday.
Japan is leading the way in Asia, helped by a stronger USD/JPY and a solid June industrial production print. It seems that despite absolutely no move in US bond markets, overnight traders have been happy buying USD’s, even against countries that run sizeable current account surplus. All eyes will therefore fall on US Q2 GDP in upcoming early US trade and with expectations of 2.5%, an upside beat would be the perfect PR tool for the Fed to justify a move higher in September. This Q2 GDP print will be revised a couple of times, but we don’t get the initial Q3 print until 29 October and after the September meeting. USD/JPY looks like a buy on a closing break of the 21 July high of ¥124.47, for a move into the 5 June high.
The ASX 200 has built on yesterday’s rally and seems to be holding yesterday’s intra-day high of 5651. Good inflows have been seen into energy names as well (sector +2.1%) and this seems fair. The energy sub-sector has broken the June downtrend and it seems both WTI and Brent price have found a short-term floor. This is still a trading sector and we still have a further 4% until the April downtrend kicks in, so there is potential for further upside.
It’s interesting to see the short-term divergence between iron ore and AUD/USD. I like the idea of being long AUD/USD for a move to $0.7450, exiting on a break of last week’s low of $0.7259. RBA governor Glenn Stevens comments that capital markets should prepare for a world where China invests $400 billion a year offshore seems to have caught investor’s (and Australian property developer’s) attention.