Australian dollar poleaxed as Fed hawks take flight

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Forex markets have comprehensively puked their recent funk into a period of volatility and the Australian dollar is covered in stink. DXY is re-entering its bull market and EUR is getting murdered:

The Australian dollar has destroyed the neckline of its head-and-shoulders top against DXY. Its equally weak versus JPY. EUR is falling almost as fast:

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Ominously, it is far weaker than its EM commodity basket:

CFTC contracts moved 9k short:

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Gold is vomit as real interest ratee bottom and DXY soars, as expected. Oil will also struggle against this tide:

Base metals bust:

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Big miners bust:

EM stocks looking a little shaky again:

But junk is still serene so no need to be overly bearish:

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Then again, the US bond market is howling policy error as the curve caves in:

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Which is not pleasing stocks. Value is a goner. Growth fell but did better:

The major event of the evening was Fed governor James Bullard:

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Now, you should be aware that the FOMC operates very differently to the RBA. Its governors are much more independent and open with their divergent views so this is not “The Fed” speaking, it is James Bullard. When RBA governors speak they very rarely break with the consensus script.

So, that means that the Fed is still dovish in total so there is no cause for panic. That said, tapering is clearly on the agenda, and the process towards tightening has begun. So there is some momentum that way.

The two points come to head in what happens next in the global economy. In my view, the Fed dissidents have moved at precisely the wrong moment. The US fiscal impulse is about to crash. The inventory super-cycle is about to ease. China has already tightened credit hard and will keep doing until the commodity bubble fully bursts. That has started.

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Within a matter of months, maybe even weeks, we will see global PMIs begin to fall away as new orders top out and fall fast. The early gyrations we are seeing today on the Fed pivot may morph very quickly from an inflation unwind to an outirght growth scare as corporate profit growth also peaks.

I said on Friday that my base case of a 50% probability is that the inflation unwind will be benign for equities as value rotates back to growth and falling input costs boost margins even as the commodity bubble bursts and Australian dollar sinks.

But, I had a risk case of 30% probability that US and China slow more than Europe speeds up just as Fed policy error plus runaway DXY smashes inflation, high yield debt, equities and crushes the Australian dollar.

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If the Fed is going to keep up the hawkish jawboning then that risk case rises to 40%.

What is equally crucial to note, however, is that the full FOMC has not yet committed this policy error. If markets do tank in anticipation of it as growth and inflation fall away, then it will be very easy for the Fed’s dissident hawks to backtrack and tapering to disappear.

I do not see the US labour market anywhere tight enough over H2 to prevent this if need be.

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In short, buy the dip is still in operation for equities which may prevent any sell-off from gaining much momentum from Fed taper talk. Or not!

Anyways, enough game theory. The Australian dollar is still biased down until we discover the pace of Fed tightening, not to mention how quickly the commodity bubble is going to fully pop as China slows.

About the author
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 founding 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.