Australian dollar soars as trade war blows back to Fed

DXY sank overnight. CNY fell but EUR jumped:

The Australian dollar jumped against the US:

But was soft against EMs:

Gold confirmed DXY weakness:

Oil was smashed:

Metals were mixed:

Big miners rose:

EM stocks too:

US junk was hammered. EM will follow in due course:

Treasuries are on fire:

Bunds were bid:

Aussie bonds were belted yesterday but bid overnight:

High-beta stocks were slammed but eh broader market only eased:

The US ISM was soft:

“The May PMI® registered 52.1 percent, a decrease of 0.7 percentage point from the April reading of 52.8 percent. The New Orders Index registered 52.7 percent, an increase of 1 percentage point from the April reading of 51.7 percent. The Production Index registered 51.3 percent, a 1-percentage point decrease compared to the April reading of 52.3 percent. The Employment Index registered 53.7 percent, an increase of 1.3 percentage points from the April reading of 52.4 percent. The Supplier Deliveries Index registered 52 percent, a 2.6-percentage point decrease from the April reading of 54.6 percent. The Inventories Index registered 50.9 percent, a decrease of 2 percentage points from the April reading of 52.9 percent. The Prices Index registered 53.2 percent, a 3.2-percentage point increase from the April reading of 50 percent.

And the market is now pricing imminent Fed easing:

As the trade war blows back into the US economy:

The growth outlook is still OK:

But the cycle is very old:

The key question is what markets do now to the cycle. All things being equal, the US economy will plod on. But trade war escalations are clearly blowing back into the US stock market and if it corrects far enough then it will derail the economy. Always remember, markets determine the business cycle, not the other way around. It’s an old truth that has never been more important in the age of central bank liquidity projects.

Fed easing is now next to certain and, for now, that is hitting DXY. In turn that is providing some support to the EM and commodity complex, not to mention the AUD. That will not last if the stock market rout really gets going.

That said, the AUD is now back in the race to the bottom that characterised currencies in the post-GFC environment and I see little awareness of this among the Australian policy elite. If the RBA does provide a “dovish” easing today then the AUD is going to keep rising for now. Via Westpac:

Given the 100% consensus that the RBA will cut its cash target by 25bp, to 1.25% tomorrow, any market response will be driven by the tone and sentiment expressed in the Governor’s statement and also via the commentary provide by the Governor in a scheduled speech later on Tuesday evening.

Given that the market-implied terminal rate is around 0.80%, the question is what Dr Lowe could say to provide further bullish impetus to the market? While we are not particularly bearish, we have a sense that the market might be disappointed by the RBA rhetoric, even if the Governor makes some of his most dovish ever comments!

With that in mind, on page 5 we provide our expectations for the response of 3yr and 10yr bond yields under the most likely scenarios for the RBA cash target and associated bias. We think there is still some positive price action likely if the RBA delivers a clear easing bias, or even if it does not disavow the market of its belief in future rate cuts, as we expect. Under either scenario, however, we see any curve steepening as being only marginal and relatively short-lived.

There is also the following day’s Q1 GDP outcome to consider. Our analysis indicates that, even though this is a lagging indicator it is still an important driver of price action and sentiment. Our own forecast (+0.6qoq) is above consensus (+0.4qoq) and should we be proved correct, we expect it will provide an important headwind to any bullish momentum.

The RBA has missed its window to really sink the AUD. It’s over to market forces now.

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