Australian dollar enters free fall as global recession builds

See the latest Australian dollar analysis here:

Macro Afternoon

DXY was steady last night:

The Australian dollar is in free fall versus all major developed economy currencies:

And emerging market currencies to boot:

Gold was stable:

Oil is very weak given the Iran situation and Saudi jawboning:

Metals were mixed:

Miners were hit:

EM stocks hung on:

High yield too:

The Treasury curve flattened:

And the Bund curve:

Aussie bonds sold:

As stocks firmed a touch:

Overnight US data was soft with the Empire Fed crashing and NAHB builder confidence off a little. Morgan Stanley sees it getting worse fast with a recession imminent:

Decelerations and disappointments are mounting:

  • Cass Freight Index
  • Retailer earnings
  • Durable goods orders
  • Capital spending
  • PMIs
  • May payrolls
  • Semiconductor inventories
  • Oil demand
  • Restaurant performance indices…

…and our own Morgan Stanley Business Conditions Index (MSBCI). Looking at the MSBCI in particular, the headline metric showed the biggest one-month drop in its history going back to 2002 and very close to its lowest absolute reading since December 2008.

This index has a tight relationship with ISM new orders and analyst earnings revisions breadth. Our analysis shows downside risk to ISM new orders (25% y/y), S&P earnings revisions breadth (6-13%) and the S&P 500 y/y (8%) if historical links hold.

Assuming this occurs in the next few months, that would give us downside to 2450 at the low end and 2650 on the high end, depending on when and if the PMIs fall and the market prices it. We think 2600-2650 is a good range to think about adding risk broadly.

  • 2019 was mostly about policy support – the Fed + China fiscal – and now the focus is back on trade risks but it could shift towards US recession risk;
  • while we think the price lows are in for this cyclical bear market, it’s likely capped and has some unfinished business – i.e., a deeper retracement than most are expecting;
  • the policy mistakes were fiscal + tariffs, not monetary – i.e., the Fed can’t ‘fix’ it. The negative knock-on effects of the US earnings recession are underappreciated;
  • US companies have a cost/margin issue that isn’t going away. Trade conflict exacerbates these issues and a ‘deal’ doesn’t remove them;
  • despite new highs for many markets in April, the internals never confirmed the view for a big reacceleration in 2H19 or 2020 that many investors were/are counting on;
  • we remain defensively positioned with some cyclical upside until valuations get more attractive and/or earnings risk has been removed via lowered estimates.

Meanwhile, on the other side of the trade war, things do not look much better as the Chinese industrial economy chokes:

Capital deepening ends:

As does reform:

And more tariffs will smash growth lower:

As our two great and powerful friends beat each other into recession, the Australian dollar is free falling towards the canvas.

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  1. proofreadersMEMBER

    So, according to the AFR today, Captain Phil is after making his first cash rate cut, getting angry letters from savers (and presumably, also fixed interest income reliant retirees). How hard is it for them to get the message as to what they have to do?

  2. A weakening world economy should not be a shock to anyone.
    Falling bond yields weren’t indicating boom times.
    Solving the trade dispute will only provide short term relief to the world economy.

    • Hussman is a guy always worth reading. Opens his latest letter with a quote:

      The received wisdom is mistaken on how recessions are made. They are not simply caused by shocks. They are caused by a window of vulnerability in the economic cycle where the cyclical drivers of the economy have weakened to the point where it’s susceptible to a negative shock. Within that window of vulnerability, virtually any reasonable shock becomes a recessionary shock. That’s how you get a recession.
      – Lakshman Achuthan, Economic Cycle Research Institute

      Hussman goes on to say:
      As a rule, long-term results in the economy tend to be predictably related to underlying long-term drivers. So for example, long-term economic growth is usually tightly related to the sum of labor force growth and trend productivity growth. Likewise, long-term stock market returns are usually tightly related to the initial level of market valuations and the long-term structural growth rate of the economy.

      Even when surreal distortions in the economy and the financial markets make crisis and speculative collapse inevitable, it’s not enough to know that those outcomes are baked-in-the-cake. Imbalances aren’t resolved sooner just because the imbalances are larger. The fact that I fully expect the S&P 500 to lose 60-65% of its value over the completion of this cycle doesn’t mean that intervening periods of speculation and uniform market internals can’t periodically defer that outcome. Instead, crises emerge seemingly out of nowhere, when a vulnerable window or a trap door swings open. That makes it essential to monitor those hinges. Decades ago, the late MIT economist Rudiger Dornbusch put it this way: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.”

      Notice that much of the growth that we’ve observed in recent years has been driven by a decline in the unemployment rate.

      Understand what low structural growth implies for the U.S. stock market. First, while Wall Street mechanically recites the aphorism that “lower interest rates justify higher valuation multiples,” that proposition actually holds only if the trajectory of future cash flows is held constant. So yes, if the trajectory of future cash flows is held constant, it’s fine to believe that lower interest rates justify higher valuation multiples. Even then, if you understand what those higher valuation multiples are actually doing, the proposition is identical to saying that that lower interest rates justify lower future stock market returns.

      The problem is that if interest rates are low because growth is also low, lower interest rates don’t justify any increase in valuation multiples at all. Normal valuation multiples would already be enough to produce lower future equity returns, via the slower growth of future fundamentals. If investors instead bid valuation multiples up anyway, subsequent returns are penalized twice, and can be driven to negative levels for years to come. That’s what investors have done here.

      The surge in profit margins we’ve seen in recent years is a direct reflection of depressed unit labor costs, largely the result of years of high unemployment and job market distress that followed the global financial crisis.

      Much more good stuff in here:

      • Hussman is always bearish. The bloke I’m thinking of has been bearish for the last 20 years. He is as bad as Marc Faber.

      • He’s not bearish. He has a value investing approach and looks at market internals. Has his timing been off? Yes? But as he says, once the speculative mania mindset turns it happens quickly, so position appropriately

      • mdsee, if you want to follow someone with poor timing, good luck.

        His timing has been out for 20 years.

    • International Bank of Matttress. Or, if you you are more if a drug dealer / pension rorter, you could put the notes in sealed up PVC pipes and bury them in the backyard. The PVC pipe option is a far more badass.

  3. The recent rise in AUD looks to be a perfect backtest of former support.

    Overcoming 70c and holding above there will take some doing now.

  4. BubbleyMEMBER

    A Global Recession is building… what will it take for the wave to crash?

    And any idea when the Tsunami will hit?
    (get out your crystal balls folks, I need answers)