Europe and the UK continue to show signs of recovery; the UK has been the star performer, with its services PMI at the highest level in six years. In the US, the services PMI hit a five-month high of 56.0 in July, which provides further evidence that the US economy is gaining traction and likely to ramp back to 3% growth in Q3. Again our call for a September tapering exercise from the Fed seems about right, especially as a breakdown of the services ISM showed continued expansion in the forward looking new orders sub-component (57.7), while the pace of employment within the index is still reasonable healthy at 53.2. There are some really positive improvements going on at the moment, and a look at a number of economic surprise indices (these mirror the actual data print relative to the economists’ expectations) shows solid improvement of late. On top of this, a recent survey by the Federal Reserve showed the total value of loans at US banks increased 2.9% over the year to $7.3 trillion, showing that credit is now getting into the real economy.
This general improvement should keep equities bid, although it has to be said that with US earnings now fading into the background, and just over a month until the September 18 meeting (September 19 at 04:00 in Australia), traders will have to start thinking more closely at how the market reacts to the Fed lowering the amount of US treasury purchases from its current pace of $45 billion a month. Of course, the next non-farm payrolls report on September 6 could really firm up the market’s belief of a September ‘tapering’ exercise, so volatility could heighten into this data point and it seems September is shaping up to be a key month, with the Australian and German elections also firmly in play.
Asian traders started the day off on a negative note, with Japan firmly the region’s underperformer, although coming into the latter stages the Nikkei has rallied and closed up 1%. The JPY continues to range trade, although USD/JPY should find support at 97.50, especially as the spread US treasuries and German bunds hold over Japanese government bonds remains extremely elevated and should continue to entice Japanese investors to buy overseas assets. Price action in USD/JPY lacks any conviction either way, and it’s almost like the pair has become the forgotten currency, with traders preferring to express their USD view against the AUD right now. As things stand our preference would be to trade the range, with 97.50 to 99.50 expected.
China is up 0.8% today and on a six day run, with the Shanghai Composite having rallied nearly 4% in the process. Volumes are low, but then again wherever you look in the global market this thematic is constant. HSBC was lower by 4% in UK trade, and its Hong Kong listing is faring a similar amount. China’s economy comes back to centre stage over the coming days and it’s interesting to see the correlation between Chinese exports and US/EU manufacturing PMI; one suspects that there are upside risks now to this week’s export figure, with the market already seeing a turnaround from last month’s 3.1% decline.
In Australia the ASX 200 had been held back for most of the day by offshore moves, and while some have said traders were sitting on their hands ahead of the RBA, we don’t fully subscribe to that argument. The market has had plenty of time to position themselves for today’s cut, with the swaps market pricing in at least a 70% chance of a cut for the last ten days or so. On the corporate side, Downer EDI (DOW) and Cochlear have kicked off the start of the Australian reporting season, with DOW hitting the mark, although on 8x 2014 earnings and gearing levels at 20.8% (well below expectations) this was enough to initially cause a 4% move higher, although came off towards the end of the day. COH on the other hand went the other way rallying into the close despite seeing a reasonable miss at an operational level, although this was offset to some degree by a lower-than-expected tax rate. The market doesn’t seem prepared to pay up for this name just yet, and although cost controls are helping, this is name that we’d look at closer to $57.11 than current levels.
All eyes were of course on the RBA, although prior to that we saw a poor quality trade balance print with exports down 1%, while imports grew 2%. With a falling AUD you may have hoped for better on the export side. The Australian house price index gained 5.4% year-on-year, which again could be construed from a positive and negative perceptive, although house prices should continue to be pivotal in helping with the transition to a pick-up in the non-mining sectors, with stronger house prices providing the confidence needed to really see increased levels of spending. With regards to the RBA statement it won’t shock anyone that it cut, however some are puzzling over the 30 or 40 pip rally in AUD/USD and even more pronounced moves against GBP and NZD. Clearly a cut was not only fully priced in, but there was a 5% chance of a 50 basis point cut. This was an exercise in positioning and expectations for both current and future policy. The statement itself had not materially changed from the July statement, although some were prepared for more dovish central bank, while the line ‘it is possible the exchange rate will depreciate over time’ is a slight downgrade from Glenn Stevens’ speech last week, in which he said he wouldn’t ‘be surprised to see a lower AUD’. We now wait for this week’s employment data and Statement of Monetary Policy (SoMP) for further clues on rates, but the RBA is now in wait and see mode and clearly a deteriorating picture over the next two months should see either an October or November cut materialise just in time for Christmas. We suspect there were some hoping for forward guidance from the RBA, although this seems premature to us at this stage.
In terms of European and US event risk on the economic data side we get reads on German factory orders (expected to gain 1% on the month), industrial and manufacturing production in the UK, while the US trade balance should narrow marginally to $43.5 billion. The trend in both the UK and Germany has been steady improvement and expectations on the whole have been met or beaten in most cases, so we would not rule good numbers again. EUR/GBP looks interesting, given its finding support at 0.8630 (the 38.2% retracement of the April to August rally). Given this week’s BoE inflation report, our bias would be long for a move higher; traders could look to place stops at 0.8565. In the US Chicago Fed president Charles Evans speaks in mid US trade and his comments will be closely followed, given his ‘visionary’ status in the Fed.