Australian dollar the Dodo of global euphoria

See the latest Australian dollar analysis here:

Macro Afternoon

DXY fell Friday night:

The Australian dollar lifted:

EMs were roughly stable:

The diminshed AUD short position lasted one week, alas

Gold fell:

Oil climbed on a big drop in the US rig count:

Metals sagged:

Miners jumped:

EM stocks too:

Junk was firm:

All bonds fell though Australia much less:

Stocks soared towards heaven:

Westpac has the wrap:

Event Wrap

US Oct. retail sales were relatively solid and close to estimates. Headline sales rose +0.3%m/m (est. +0.2%m/m). Although ex auto and gas missed at +0.1%m/m (est. +0.3%m/m), the important control group met expectations at +0.3%m/m. Oct industrial production headline fell -0.8%m/m (vs est. -0.4%m/m) as the impact of the GE strike added to trade tensions. However, the GE impact will unwind in coming months and the manufacturing side was slightly less negative than expected at -0.6%m/m (est. -0.7%m/m). The NY Empire Fed. survey, which had been decidedly volatile earlier this year, was only slightly lower (est. 6, prior 4). On the positive side, new orders and employment were a touch firmer.

Eurozone final Oct. CPI was close to its initial release. Despite a pullback in the headline (+0.1%m/m, preliminary +0.2%) the more important harmonized (+0.2%m/m) and core CPI (+1.1%y/y) were left unchanged. Sep. trade balance was close to estimates at +EUR18.3bn with neither release causing much market impact

Event Outlook

US: Nov NAHB housing market index is released. Fedspeak involves Mester at the University of Maryland.

So, US data was a little weaker and European a little stronger than expected which was enough to sink DXY and lift risk, along with the usual cheerleading about the trade non-deal. That lifted the AUD.

Morgan Stanley has embraced the notion of another late cycle mini-bounce:

2019 saw global growth weaken substantially, but very strong markets. 2020, we think, will see better growth but muted headline returns. After almost 18 months of decelerating global economic activity, Morgan Stanley’s global economics team expects growth to bottom in 1Q20 and improve thereafter. Recent easing by central banks is supporting this recovery, but importantly, we don’t expect any further action by the Fed, ECB or BoJ beyond programmes already in place. In 2020, we’re on our own.

The improvement will be modest compared with past recoveries, and will be a mini-cycle recovery in the context of a late-cycle expansion, but it means that a recession next year would be avoided. Importantly, this recovery will also be uneven, with the greatest acceleration in corners of emerging markets against flat-lining growth in the US.

For markets, the benefits of better growth need to be balanced by what’s already priced in. Relative to past mid-cycle slowdowns, for example, US equity markets are significantly more expensive, US credit spreads are tighter and volatility is lower. In contrast, global equity valuations are in line with their average during past inflections of mid-cycle growth.

These valuations are one reason why we’re entering 2020 neutral on equities overall, given forecasts that call for mid-single-digit upside in global stocks. But our preference for non-US over US equities is greater than before, with our net ex-US versus US equity weight moving from +2% to +5%.

With this shift, we’re closing the underweight we’ve held on global equities since early July. At that time, we thought weaker growth would pressure valuations. Instead, despite a continued slowdown, the MSCI ACWI Global Equity Index has gained about 3%. With our economists now calling for a better outlook, we think it makes sense to bring our overall weight closer to neutral.

But another important theme is that varied market valuations overlap with the varied recovery that our economists expect. Growth should pick up in 2020, but unevenly. Getting the sequence right will be important.

First to recover, in our view, will be economies that saw the steepest declines in 2019 and were dampened by the slowdown in trade. Any stabilisation in trade will make a big difference here, while weaker current conditions will make incremental improvement easier to achieve.

This applies to both growth and earnings. To cite one example of the divergence we expect, we think that companies in Korea and Brazil could look early-cycle next year, with earnings growth north of 15%. US companies, in contrast, will see little or no earnings growth in 2020, on our estimates.

We think that sequencing the cycle should boost EM currencies and weaken USD. We think it will keep US yields range-bound near 2% while yields in the UK and Germany rise. We expect it to lift US high yield spreads modestly while spreads in Europe remain range-bound, as EM fixed income outperforms corporate credit. And in commodities, we don’t think the pick-up in growth will be enough to overcome the excess supply we see across a whole host of markets. We like copper, one pocket where we think supply is tight, while we’re more cautious on oil and other metals.

What are we watching? An unusual aspect of our 2020 story is its sensitivity to a single factor – trade. Our economic forecasts assume no further escalation in US-China tariffs. This is obviously an uncertain, evolving situation, and events could change in the hours between when I finish this note and it hits your inbox. An escalation in trade tensions would push out the 1Q20 growth recovery that our economists forecast and re-introduce the risk of non-linearity kicking in. Markets could face immediate pressure, given how high we believe expectations have risen that progress is imminent.

I remain quite unsure that DXY is going to fall. US outperformance on growth and inflation is intact. Europe cannot recover until China does and there is little in prospect for the stimulus needed there. Hong Kong is collapsing. That all puts a natural ceiling on how far this rally can get.

As markets pile into the hope, while geopolitics looms over everything, we are in a situation of equally elevated reward and risk. So we retain solid balances of bonds while exposing ourselves to the rally as much as we dare with high cash balances. The equaities rally is already very advanced, indeed has over-priced any recovery in earnings (even if it could get more so). As Goldman’s sentiment indicator exposes, markets haven’t been this over-extnded since 2008!

Yeh, that’s worth a very nervous giggle. That the AUD has only managed to zig an inch away from a post-GFC low during such excitement gives you some notion of how on the nose it is.

If things turn for the worse then it will sink.

David Llewellyn-Smith
Latest posts by David Llewellyn-Smith (see all)

Comments are hidden for Membership Subscribers only.