Australian dollar to the moon as it’s all good!

DXY took off last night as EUR lifted and CNY crashed:

Bizarrely, the Australian dollar rocketed back up:

Gold sagged:

Oil too:

Metals hung on:

Miners were flushed:

EM stocks remain at the cliff’s edge:

Junk jumped:

Yield curves were crushed everywhere:

Stocks repaired about half of the damage:

Westpac has the wrap:

Event Wrap

The slump in German business confidence extended yet further in August, the IFO survey slipping to 94.3 from 95.8, its lowest levels in seven years.

US factory orders for durables goods posted a healthy 2.1% gain in July but volatile transportation goods accounted for much of the upside surprise; bookings excluding transportation fell 0.4%. Meanwhile core durable goods shipments, a close proxy for business investment slipped 0.7% (est +0.1%) and the previous month was revised lower, signaling overall ongoing caution in capital spending.

Factory activity in the Dallas area picked up pace in August, the Dallas Fed manufacturing index rising to +2.7 from -6.3.

Event Outlook

Australia: RBA Deputy Governor Debelle speaks on “A Balance of Payments” in Canberra at 12:50 pm.

Europe: ECB Vice President de Guindos and BOE member Tenreyro speak on policy.

US: Aug consumer confidence index is expected to decline to 129.3 from 135.7 – a still above average level but trade policy uncertainty has tentatively started to weigh on household sentiment. Jun FHFA house prices and S&P/CS home prices data are released.

All thanks to a few words from El Trumpo, via Bloomie:

U.S. President Donald Trump said China wants to make a deal as he praised comments by the country’s chief negotiator for trade, offering a more conciliatory tone after escalating tensions in recent days.

“They want to make a deal very badly,” Trump said during a press conference from the Group of Seven meeting in Biarritz, France. “The tariffs have hit them very hard.”

Trump also noted remarks made earlier Monday by China’s top trade negotiator, Vice Premier Liu He. “He wants to see a deal made, he wants it to be made under calm conditions,” Trump said. “He used the word ‘calm,’ I agree with him.”

That there is no deal to be done does not seem to worry anybody, at least not today.

So, which is right? A crashing yield curve that is a very bearish signal for growth and profits . Or equities that just don’t care about the yield curve? Anatole Kaletsky has a go at it at Gavekal:

Now that my holiday is over, I must sadly switch on the news feeds. But what I find is that nothing much has really changed since a month ago, or even a year ago. The US and China are still engaged in trade war, but both of their domestic economies are doing fine. Europe is still sinking into stagnation and political paralysis, but nobody is even thinking about a change of course. The US, Israel and Saudi Arabia are still trying to strangle Iran, but not quite succeeding. And Britain is still on the edge of a precipice, contemplating national suicide, but not quite willing to take the plunge.

What has changed since early summer is the market’s response to these chronic conditions. Since early June, 10-year bond yields have collapsed in the US from 2.1% to 1.5%, in Britain from 0.9% to 0.4% and in Germany from a ridiculous -0.2% to an incredible -0.7%. In roughly the same period, the pound has fallen against the US dollar by -4%, the euro by -1%, the renminbi by -2% and the oil price by -6%. One asset class, however, has not suffered at all: the S&P 500 is up 5% and Nasdaq by 6%, China’s CSI 300 has risen by 2% and even MSCI EMU is 0.5% higher than its close on May 31.

In my view, the equity market’s behavior makes good sense; the bond and currency markets’ rather less so. Specifically, it is worth considering the market responses to four unexpected events that happened over the summer: (i) the inversion of yield curves in the US and other bond markets, (ii) the prospect of a “no deal Brexit” rupture between the UK and its former European partners, (iii) the ratcheting-up of the trade confrontation between the US and China, and (iv) clear evidence of a recession in the eurozone to which the European Union authorities seem unable or unwilling to respond.

…Since there has been no major weakening in US economic data this year, and there is no reason to expect a weakening in the months ahead, especially given the reductions in interest rates, are other explanations possible for an inverted yield curve? The answer is obviously, yes.

These include effects from liability-driven investment, quantitative easing, bank regulation, demographics and negative interest rates in Europe and Japan. All these add up to produce what in technical terms is called a low or negative term premium. In simple language, the combination of LDI and QE creates a situation in which bond investors are only concerned about trading ahead of the next monetary policy decision, and neither know nor care what may happen to interest rates, growth and inflation in the next year or decade any more than the proverbial monkey with a dartboard. In other words, what matters for long-term bond yields is not the outlook for the economy, but market expectations about the decisions and statements of central bankers. And if the outlook for the economy is now of limited significance in determining bond yields, then by definition the behavior of the bond market must be a poor predictor of economic growth.

This brings me to the final, and possibly most convincing reason, why equity investors should disregard the bond market’s apparently bearish message. Let us suppose that all the arguments above are wrong—that bond markets really do know more than equity investors or economic forecasters about the economic outlook and that yield curve inversion actually is a reliable indicator of recession. In that case, the Fed and other central banks around the world are certain to keep cutting interest rates, or if their rates are already zero or negative are certain to restart QE. And, even more importantly, both short-term and long-term interest rates are certain to remain near zero for the next ten years or more. In that case, even if the world does experience a recession, the discount rates applied by equity markets to cyclically-adjusted corporate profits, the cap rates assumed by property investors and hurdle rates used by business managements, are bound to keep falling and will eventually end up near zero. In other words, if bond markets are right in predicting a world in which interest rates will stay forever near zero, then US equities on a cyclically adjusted price-earnings ratio of 29—equivalent to an earnings yield of 3.4%—are still quite cheap.

My own view is the reverse. That bonds are trading advancing deglobalisation risks that pose a massive deflationary shock if China is forced to go ex-growth, while equities are besotted with stimulus such as QE and all manner of unconventional monetary happiness.

I guess that such polarised interpretations are possible is why the AUD is proving to so volatile.

Even so, on a day when CNY crashes so, I can see no reason to so strongly bid the AUD.

Lower still to come.

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.

Comments

  1. We are in the first stages of the next financial crisis
    Nothing is going to make much sense now
    Moves are becoming irrational
    DXY might be tracking Dow showing big Euro players in and out of Dow, same with Chinese
    I believe dow is headed to 20,000 so we may see DXY lower before it’s starts it’s rise
    AUD maybe test 6840
    Don’t be surprised to see 70s again in AUD
    Keep an eye on USDCNY DXY and the Dow
    If lower Dow, drags USD lower might push AUD up
    It’s probably consistent with market positioning
    Good luck next 12 months trying to predict moves
    I’m glad I don’t get paid to forecast
    Re Equities cheap, I agree but you are going to buy them even cheaper
    Wait for the Xmas sales to buy equities

    • I tend to agree that all this up and down volatility is leading to the next financial crisis. Nothing makes any sense to me. Daily changes are best ignored. The overall trend is what I’m watching which is why I’m long cash. If $AUD goes up to 70 cents I’ll convert to $USD and hunker down. My real concern is stability of the big 4. Might spread my cash amongst smaller banks, but not sure they offer $USD accounts.

      I remember when cracks appeared in 07/08 – Northern Rock had a bank run. 12 months before the big crash.

      • “Nothing makes any sense to me.”

        Jeez, I was at that stage about 4 years ago. Welcome to the club.

      • One note Gav – $USD accounts in Aus banks are not always protected by the deposit guarantee scheme.

      • Gav
        Think FX accounts are way to dangerous first thing they’ll confiscate.
        Think equities on dips, gold silver
        I’d prefer to have AUD just in a big 4 cheque account, they can’t starve and freeze pensioners. Political suicide. They’ll have to protect up to $250k, not sure you’ll be able to spread btw accounts, my guess it’ll be guarantee per person
        Not sure how to do it but buy 90 day to 1 year US treasuries for US exposure, can’t see US Gov defaulting in next few years
        I like US equities on a big sell off.
        Think Aussie gov bonds, but in the next 6 months I’d be moving from any long end to very short end, 6 months to 12 months maturity
        I don’t even want to even test the likely hood of what the banks will do.
        I am staying as far away as I can

    • Query:

      “Think Aussie gov bonds, but in the next 6 months I’d be moving from any long end to very short end, 6 months to 12 months maturity”

      Why do you think this?

      • Too much interest rate risk.
        Don’t care about yield or capital gain.
        Just want my money back.
        if interest rates blow out at the long end you have to wait 5 or 10 years to get your money
        At some stage next couple of years, these bonds are going to be a disaster.
        I’d prefer to be in a large liquid ETF Corp Bond Gov Bond, so I can just exit out easier.
        Can’t see the point being so far out, huge risk.
        Anyway that’s just my opinion

  2. Nothing goes down in a straight line — technicals ensure otherwise.

    Slightly OT: if China is keen to ensure Trump doesn’t get re-elected they have the power to ensure that outcome. Come September / October 2020 they could devalue the CNY multiple times ensuring all sorts carnage in the financial markets as well as make a lot of very unhelpful remarks about taking the trade war nuclear and refusing to ever co-operate with Trump.

    No Trump tweet could prevent the carnage

    • I think you are right
      CNY devaluation but your timing sounds more like it
      Not yet
      I think they want to get rid of him too.
      Don’t think they’ll get rid of him that easy
      He looks to be around another term
      If Chinese do devalue he will just blame them

    • I actually think a big Chinese escalation like that would help Trump re-election chances.

      • Probably right – Trump got elected on Nationalism, and an even more serious Trade War will be a great distraction for the Booyah!-mericans, and should increase Trump’s chances of getting elected. He’s pretty much just got to look strong and confident and the GOP followers will vote for him.

    • Not sure about that. I think Trump needs an external enemy to win the election. Last time it was bad hombres, this time it could be China. Any big moves by China will give Trump the ammunition he needs to get the USofA patriotism boiling.I’ll be surprised to see a deal before the election, but expect plenty more of this type of daily oscillations in hostilities…that said, I wouldn’t place any bets on anything Trump related.

      On USA domestic economic pain…if Trump can get the patriotism firing I think many average Joe’s will swallow the bitter medicine…if you believe that you’re taking a step back, it’s tolerable if you think everyone else is taking two steps back. MAGA by making the rest of the world worse off would be acceptable to your average Joe I think (clearly a bit of armchair psychology…)

      • The trouble with Yuan devaluation is that the average pleb in the street does not understand its significance. They just see the market plummet, so blaming the market tanking on Chinese devaluation and having ‘patriots’ understand what he means is a bit of a stretch. If he wanted to blame the Chinese he could blame them anytime he likes and for whatever he likes: pestilence, plague, earthquakes, you name it.

        In any event it’s probably academic as a recession is fast coming down the pike and it will arrive long before next year’s election