US markets finished a whisker away from the all-time closing high of 1565 courtesy of some dovish rhetoric from Fed Presidents Charles Evans (voting member), Minneapolis Fed President Narayana Kocherlakota (a voting member next year) and Boston Fed President Eric Rosengren (a current voter). With the Boston President urging the Fed to keep the pace of purchases going right through the year, the market picked up nicely off the lows to close flat on the day. Recall the consensus in the market is for a slow tapering off in pace in November; these comments are clearly positive for those who are happy to be invested as long as the Fed is supporting asset prices.
It seems however that markets will face some headwinds on the open today, although our calls are pretty flat as it stands. US futures have come off through Asian trade and clearly this is a function of a Chinese market that is getting punished today. We highlighted earlier in the week that the swaps market was pricing in rate hikes for the first time since early 2011, but today the tightening aspect grew further momentum. On one hand local news flow is reporting the Shenzhen province is looking to raise down-payments on second homes, while on the other the Chinese bank regulator (CBRC) has moved to curb the growing power of the shadow-banking system. It has moved to curb the growth in wealth management products (WMP) that are marketed as high yield alternatives to bank deposits. Much of the money invested in these high-yielding products is being utilised to fund high risk loans, with SMEs expressing strong demand, and it’s this demand that creates both an explosion in credit (thus inflation), but real systematic risks
There is talk that we may hear more detailed guidelines on how authorities may curb property concerns in the coming month. However, while we feel this is clearly negative for the local banks; for other asset classes these measures represent a prudent and disciplined approach to what is clearly a growing problem for the Chinese.
The ASX 200 has closed out the quarter on a negative tone, with the index falling 0.6% on the day and 6.8% on the quarter. The quarter has been very strong indeed, although the same can’t be said for March, with the index falling 2%. Liquidity has been pretty scarce today given many traders have taken an extended break, however there just seems to be a feeling that the market wants to roll over, we just need the technicals to provide the green light. As things stand we are staying relatively neutral on the market, with some bullish factors still likely to play out in US which could support the Aussie market. It has to be said though, with the moves in Asia and some of the other European concerns, a 0.3% fall is quite positive.
Japan has found sellers as well, while USD/JPY pulled back to 94.00. The Nikkei is open tomorrow and will close out on its fiscal year-end, so position adjustment both in the equity and forex space is clearly materialising. The pull-back in US bond yields is also subtracting from the USD upside, despite still commending a very healthy premium to JGBs (Japanese government bonds). Next week will be key for the BoJ and it will deliver in our mind. The bank has laid out a number of factors that will either be firmly discussed, or implemented, and much of the measures are designed to kick start the markets expectations of future inflation, while aiding transparency. The key for our bullish USD/JPY call comes from the bank engineering negative ‘real’ rates. This is where inflation expectations push above the benchmark government bond yield. For so long the JPY had been the markets go to currency, not just because of its sizeable current account surplus, but because when JGB yields were discounted for deflation (which they’ve had for years), the Japanese still had the highest ‘real’ or positive yield in the G10 region (that mantra now lies with Australia). So, if the BoJ can engineer negative ‘real’ yields through inflation expectations exceeding that of JBG yields, then watch USD/JPY fly.
The European situation seems to be evolving by the day, and today the market will be watching unenviably at the droves of individuals who will be waiting in line to withdraw the small amount of cash they can to basically survive in Cyprus. The measures are brutal; there is no other way to look at it, not just from the capital controls that restrict the movement of everyday cash demands, but also the restrictions on current transactions which will limit everyday business activity. There will be limits on import/export activity, loan and interest payments, and one has to wonder about the longer-term implications on this tiny economy. It can’t be good, and we will go through this all again with Slovakia at some stage given the €7 billion of bad loans (around 20% of GDP) on its balance sheets.
Italy is of course our bigger concern, and the spread between bunds and Italian ten-year bond has blown out to over 350 basis points. German two-year bunds themselves have worryingly gone negative again, so European investors are paying for the privilege of the German treasury looking after its money. Italian Democratic Party leader Pier Luigi Bersani meets with President Giorgio Napolitano today, and it’s looking more and more likely that either a technocrat government will be formed or new elections will take place later in the year. Keep an eye on the ten-year yield which has pushed back above 5%.
So, in upcoming trade, market participants will be watching US Q4 GDP (final), US PCE, Chicago PMI, with German retail sales and unemployment also in focus. Our calls are flat at present, but it does have the feel of a potentially risk-off session ahead.
A happy and safe Easter to you all.