Australian dollar jumps as Shanghai Accord 2.0 takes shape

DXY was whacked Friday night and has broken its uptrend line (though not necessarily its up trend). EUR leaped. CNY was flat:

The Australian dollar jumped to new highs above 0.7 cents but fell against the roaring EUR:

It was flat against EMs:

Gold firmed again:

Oil too:

But not metals:

And miners were only mixed:

EM stocks were stable:

US junk flew, EM eased:

Treasuries were bid:

Bunds bid adieu to the curve:

Aussie bonds catapulted to more all-time highs:

Stocks roared back again:

The trigger was US jobs which came in weak:

Total nonfarm payroll employment edged up in May (+75,000), and the unemployment rate remained at 3.6 percent, the U.S. Bureau of Labor Statistics reported today. Employment continued to trend up in professional and business services and in health care.

…The change in total nonfarm payroll employment for March was revised down from +189,000 to +153,000, and the change for April was revised down from +263,000 to +224,000. With these revisions, employment gains in March and April combined were 75,000 less than previously reported.

…In May, average hourly earnings for all employees on private nonfarm payrolls increased by 6 cents to $27.83. Over the year, average hourly earnings have increased by 3.1 percent.

Headline was soft:

Jobs growth is falling:

Unemployment was stable:

Shadow slack still visible:

And wages growth rolled over:

Not terrible but clear deceleration. Fed hikes are just a matter of timing and quantity:

But that’s only the beginning. Once the Fed eases, the PBOC will almost certainly follow, as it hinted at Bloomberg:

In an exclusive interview with Bloomberg in Beijing, People’s Bank of China Governor Yi Gang also signaled that he’s not wedded to defending the nation’s currency at a particular level, and stressed that the value of the yuan should be set by market forces.

…“We have plenty of room in interest rates, we have plenty of room in required reserve ratio rate, and also for the fiscal, monetary policy toolkit, I think the room for adjustment is tremendous,” he said. Yi said the currency has been weaker recently due to “tremendous pressure” from the U.S. side but the impact will be temporary.

“A little bit of flexibility of renminbi is good for the Chinese economy and for the global economy because it provides an automatic stabilizer for the economy,” he said. “The central bank of China is pretty much not intervening in the foreign-exchange market for a long time, and I hope that this situation will continue, not intervening.”

As both central banks cut, it takes on the form of the shadowy “Shanghai Accord” of 2016. Whether any such deal actually existed between the Fed and PBOC for combined stimulus as the commodity crash of 2015 threatened a global shakeout is debatable. But there doesn’t need to be a deal. Once Fed tightening derails EM growth sufficiently for it to blow back into Wall St, the Fed must ease and the PBOC will always follow to prevent a rising CNY. It’s the same dynamic at work in American-led trade wars.

BofAML is worried about a stocks blowoff ensuing:

Positioning: investors are extremely bearish, with the BofAML Bull & Bear Indicator plunging to 2.5, a fraction away from “buy” signal level of 2.0; and equity investors very bearish – as the latest BofA FMS survey revealed, investors are most hedged since Jan 3rd equity lows. The weekly flow data suggests the same: $17.5bn into bonds (2nd biggest week of inflows ever) offset by $10.3bn out of equities; YTD $183bn into bonds, $155bn out of equities as nobody wants to have anything to do with stocks (despite the S&P being just shy of all time highs again).

Profits are about to trough: the Global PMI (highly correlated with global EPS) was 49.8 in May, i.e. on “boom-bust” border; makes stocks a one-decision market…”sell” if PMI heads toward 45, and “buy” if PMI heads toward 55. However, providing a somewhat bullish take on this series, is the ratio of orders/inventories which leads PMI by 2-months and has turned higher. At the same time, US/China financial conditions are easing via liquidity/lower yields/lower oil, and assuming no material escalation of trade war, BofA thinks that PMI troughs next 3 months, resulting in a rebound in EPS as well.

Monetary policy is already max bullish and exhibits clear parallels to the Shanghai Accord ’16, ahead of the Osaka G20 meeting. As a reminder, the Shanghai Accord saw global coordinated policy easing coinciding with extreme pessimism & trough in profit expectations. In its aftermath, the S&P500 & ACWI multiple jumped 1.5-2x in next 3 months. Fast forward to today, when in the run-up to Osaka G20 big global monetary ease underway, investor sentiment is likewise plunging. At the same time, a key catalyst is already in play – there is a big global monetary ease underway for 1st time since Q2’17 as 9 central banks cutting rates and Fed/PBoC/ECB/BoE are all turning dovish while there are rate cuts in Malaysia, New Zealand, India, Philippines, Australia; additionally if Trump changes his mind and there is no U.S. imposition of 25% tariffs on remaining $300bn of Chinese goods policy will be max bullish for risk in H2; however, the narrative can quickly flip to trade war, leading to 2019 playing out like Asia crisis ’98.

In other words, all else equal, the foundations for the S&P rising to 3,000 in the summer – which is BofA’s base case (before the S&P slides back down in the second half) are already there. In light of this, the risk is that the Fed does precisely what the market now expects with certainy, that it cuts rates as soon as July.

This is shown in the chart below, when in the aftermath of the Asian crisis of 1998, the Fed cut rates only to cause the dot com bubble… and its subsequent bursting and the plunge in rates from 6%+ to just 1% as the first 21st century bubble popped.

It is this risk that threatens markets now as well: an overly easy Fed cutting rates, only to create a historic meltup just ahead of the 2020 election, and eventually bursting the biggest asset bubble in history.

There’s more: the Fed could cut and join the ECB and BOJ among those central banks that are losing credibility, as a result of it “patiently” flipping from hikes to cuts with no material change in macro: after all, in the past 6 months US CPI is unchanged, and, as BofA notes, the US unemployment rate down.

Under the circumstances, the Australian dollar is doing well to not to skyrocket as it did under Shanghai Accord 1.0. Higher ahead in the short term.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the fouding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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  1. Australia’s terms of trade have fallen back since their peak in May and look vulnerable with iron ore elevated by speculative positions. The rate differential on a ATWI basis has collapsed this year and looks set to deteriorate. Asset market volatility and uncertainty is high. So… the only fact that’s really supporting the A$ is US$ weakness.

  2. GeordieMEMBER

    A long, slow tightening when compared to previous episodes and 2.5% is too much for the US economy? She’s one sick chicken, doc! When are the people running this cage farm going to realise they let everyone borrow too much for too long, and we’re going to have to deleverage – one way or another – as it is the debt that is choking everything? It just doesn’t make sense.

    • You lack creativity.

      How much more demonstration do you need that the solution is not deleveraging, but more debt. Cheaper debt.

      • – With low or zero interest rates you end up with:
        1- no effective hurdle rate on investments = misallocation of investment and the squandering of capital
        2- zombie corporations that do not deserve to exist
        – There is no point in history when an asset/debt bubble hasn’t ended in tears – why make it bigger?

      • The Traveling Wilbur

        It’s amazing how other people manage to continually confuse what should happen (according to reason) with what will happen (because it has, time and again).

        Genuinely surprised when paying members do it.

    • DominicMEMBER

      We will indeed have to deleverage — it just won’t be via the regulation route of voluntarily paying back one’s debts. It’ll be via that age old favourite of governments through the ages: debauchery of the currency (or ‘inflation’, as it’s politely known).

      But don’t worry at all because the monetary authorities are so clever they have ‘full control’ over inflation at all times 😉

      • Inflation is the least painful solution (they all involve some pain) but that is a bitter pill to swallow for our right of centre true believers in the Liberal Party.

        The ALP would have been perfectly happy running a fat fiscal deficit, a few national wage cases and cranking up wages to get a bit of inflation pumping through the system (the AUD would adjust downwards, interest rates will rise and debtors will pay down their debts) but the Libs?

        Can you really see the Libs pumping up wages with/ without a fiscal deficit and watching rising interest rates decimate their ‘base’ of leveraged asset price fanciers?

        Not a chance.

        That is why they are busily blowing as hard as they can to re-inflate asset prices.

        They simply cannot do what needs to be done so it is more of the same.

        The state / private monetary cartel days are numbered but it will go down fighting.

        Which is probably why the shiny stuff is proving popular.

      • Except at the moment all the CB’s don’t know where the inflation is lol More like they don’t want it yet…

  3. Back above 70 cents?

    But the RBA only “smashed” the AUD a few days ago with their interest rate cut troll hammer.

    They just don’t make troll hammers like they used to!

    Considering the endless stories about Chinese ghost cities with billions of empty apartments and trade wars shouldn’t they be buying less iron ore…… some point?

    Or are they building giant iron ore stock piles ( next to infant formula and dodgy degree stockpiles) just to force the AUD upwards in preparation for letting it collapse?

    • @007… you know what the impact of each 25bps drop in IR’s on people saving for a house, and also what’s the impact on Gov revenue given that IR earned is taxed? No inflation so gov can’t inflate away it’s debt, so any ideas on the big picture?

      • afund,

        Do I know what effect a 0.25% cut has on someone saving for a deposit?

        It has no effect unless you are referring to earning less interest on their savings and taking longer to achieve a deposit? Or that the cut is likely to increase house prices (as lower interest rates make larger loan sizes possible) and make their savings task a bit harder as the required deposits increase in size.

        Is that what you were getting at?

        As you would know I don’t support our state/private bank cartel and the asset price pumping they engage in which results in lots of inflation in assets but not much productive economic activity.

        For the big picture try 🙂

    • @007 thanks for that. Yeah that’s some of what I was interested in. Asset prices will go up with IR’s going lower and the combination of savers taking longer to buy, and for the general economy, the savers are not spending and the whole M2V thing is bad for the economy. Skewed to the rich; I’m not sure of the overall effect on the economy as we get sqeezed more. I have lots of questions, but can’t really put it all together; my overall gut feeling is it’s all bad as imported demand for housing and services is never going to stop.

  4. DominicMEMBER

    Quiz question: how many Shanghai Accords will it take to send gold beyond $1,900?

  5. The behaviour of the gold market last week was bizarre. The USD barely fell, bond yields barely moved, asset volatility actually fell and my model is screaming that gold is over bought. ETF added 42.5MT – the largest build since 2017 – and non commercial futures positions doubled. Technicals suggest gold is over bought and sentiment is through the roof.

    I was long, flipped short Friday.

    • Makes sense in rational terms. But could it be a bubble already, or just about to really launch?

      (are Uber drivers talking about buying gold yet?)

  6. BrentonMEMBER

    After a decade of monetary stimulus, there came a multi-year tightening cycle. All the excess that grew from the stimulus is terminally exposed during the tightening, dragging the real economy down into recession. A story as old as time. A story that wasn’t at play during the 2016 reflation trade.

    Trade War is icing on top.

    • BrentonMEMBER

      Who to believe?

      The equity guys that are still floundering up near all time highs, wondering why they’re so nervous? Or the bond guys, who see that the Fed tightened too much and will have to cut into a slowdown (recession)?

      • Bond investors may be boring, but they are multiple steps ahead of equity investors.
        Equity investors can turn on a dime, so I wouldn’t be looking at equity markets for guidance.

  7. This whole charade can’t collapse quick enough.

    Us market now wholly dependent on the criminal fed