Angus Nicholson for Chris Weston, Chief Market Strategist at IG Markets
The release of the Fed minutes overnight has provided the impetus for a strong Asian session. The Fed minutes re-emphasised that conditions for a rate rise “could well be met” by the December meeting.
These minutes also refer to discussions held by the Fed before the incredibly strong 271,000 October non-farm payrolls number was released, which will only have strengthened their resolve for a rate rise in December.
While the reaction in the US bond market was relatively muted with positioning for a December rate hike already very strong, it was seen as very bullish for equities and in particular financial stocks which would see their margin improve from an interest rate rise.
Of most interest in the Asian session was broad-based pullback in the US dollar index. The Bloomberg Dollar Index, which is less heavily weighted to the euro and the yen than the DXY, fell 0.5% during Asian trade. This helped see a rise in US dollar-denominated commodities and a corresponding rise in materials sectors and commodity-focussed currencies.
The Kiwi dollar and the Aussie dollar rallied 1.4% and 1.1% respectively, their strongest one-day rally since mid-October. But the Malaysian ringgit and the Korean won also saw strong Asian session gains as well.
The expectations for the Aussie dollar to see further decline have been diminishing since the Reserve Bank of Australia (RBA) left rates on hold at their last meeting and we saw stronger-than-expected October employment growth. The other interesting development is the Risk Reversal (which reflects the relative weights of puts and calls in the options market) has been indicating that expectations for the Aussie to decline further has slowly been receding since their major move down after the Fed meeting on 28 October.
One of the key takeaways from the Fed minutes moving currencies seems to be the extensive discussion around keeping the interest rate rise far slower than had been in previous rate hiking cycles. The Fed minutes emphasised that the “longer-run downtrend in real interest rates” suggests that the optimal level of interest rates “would likely remain below levels that were normal during previous business cycle expansions”.
While this doesn’t diminish the likelihood of a December rate hike, it does call into question the very strong rally in the US dollar. The level of the US dollar is difficult to defend unless one not only expects a December rate rise, but also expects subsequent rate hikes to follow on its heels. The Fed Funds Futures are currently pricing in 2.5 rate hikes in 2016, implying the Fed Funds rate will be at 0.8% the end of 2016. The tone and the disputes some of the more dovish members were having in the minutes implies some pull back in the bond market or the US dollar as this reality dawns on markets. And it will be very interesting if we do see a further lowering of the DOT Plot rate hike expectations at the December meeting.
ASX
The ASX looks to have definitively broken out of its three-week downtrend. The index has now added almost 5% since it closed at 5003 on Monday. A strong close above 5216 will see the ASX at its highest level since 5 November, and the bigger question is how much higher can it go?
The banks have had a strong day as they were buoyed by rate hike expectations from the Fed minutes. The sector as a whole gained 1.6%, with NAB leading the Big Four to gain over 2%.
The materials sector also had a good performance as the weakening of the US dollar gave some support to battered commodity prices. BHP was given some respite gaining 2.2% after seeing its share price plumb GFC lows in the wake of tailings dam collapse at the Samarco mine. Gold miners also saw a bounce back after the US non-farm payrolls number saw them give back all of their September and October gains.
But it’s pretty clear from the sectoral chart that healthcare and IT are the sectors that have benefitted the most this week.