An Antipodean Focus
Pepperstone | Feb 07, 2019 15:34
Originally published by Pepperstone
There are literally two games in town right now, that being long ASX 200 and short the Australian dollar. This seems to be a re-run of what I said yesterday, but it feels like we’ve had a bit more time to digest the changes.
The AUD was taken to the woodshed yesterday, with sell-off against the greenback was a 3.15 z-score move. Statistically rare, it shows the fall was as punchy as we have seen since June 2016 and woe beholds anyone short AUDUSD volatility. That said, there has been a reluctance to build on the falls today, and the range has been a tight 17-pips.
Interest rates pricing has moved again through Asia, with a 55% chance of a cut now priced by December (from the RBA), and Governor Lowe’s (NYSE:LOW) acknowledgement that there could be a case in the future for hikes and now for cuts. We know this is as textbook neutral they will go, but the market issaying that if the trends continue then, the RBA will cut rates and that is the story we hear from rates.
The AUD is following rates, but the front-end of the Aussie fixed income curve is finding good buyers, and since November the Aussie 3-year bond yield has fallen from 2.14% to 1.63%. This is a strong move by any standards, with the yield advantage commanded to hold US Treasuries over Aussie debt moving ever higher and subtracting valuation support from AUDUSD.
h2 (white - US-AU 2-Year bond yield spread, yellow – AUDUSD)/h2One question I asked in recent reports was whether we would see the AUD move away from its cheap proxy of emerging markets, and focus more prominently on domestic factors. With the move to follow yield spreads more closely again (and away from the Hang Seng), we can see the AUD is looking inwards now, and that makes perfect sense given the Lowe’s firm wait-and-see approach.
The RBA, in precisely the same light as the Fed, is watching upcoming data, so we, as traders should too. Looking through the calendar, the first port of call is tomorrow’s Statement on Monetary Policy. However, from here it’s hard to make a case for a cut until at least the May meeting, but even that will require a poor wage data (20th February), a Q4 GDP QoQ print closer to 0.4% (6 March) and further negative trends in credit, house prices, business and consumer confidence.
h2 What would a rate cut actually achieve?/h2
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Personally speaking, and I know people are reading this who I would class as greater property experts than I, I can’t see what a 25bp, or even 50bp cut, would do to lift the economy for a sustained period.
Fine, if it's needed, the RBA has to be seen to be acting, and using the one blunt policy tool readily at their disposal. I also accept lower borrowing rates would provide some additional capital for households, and that would be welcomed from a semantics point of view. But, unless people are prepared to pay higher prices for housing and take out increased levels of credit risk again, then house prices are not going to go much higher on a cut. I can’t see it doing much for inflation expectations either, but if Australia moves to an almost ZIRP (Zero Interest Rate Policy) world, it will remove any yield support for the AUD, bringing it closer to a funding currency status.
I am not saying that will happen, but this is the message I am hearing from the rates market and should a 50bp cut fail to stabilise proceedings, then will the focus turn to the notion that the RBA could use its balance sheet to greater effect, expanding base money and buying Residential Mortgage Backed Securities (RMBS), and other assets through what is commonly known as QE. I’d say the Aussie economy would be in a terrible state if the market was having a strong debate about QE and it would be a bleak picture indeed. I would also look at the moral argument, as many feel QE just further widens the wealth divide.
Yield is the key issue at hand, and the fact Aussie 3-year bonds are finding further buyers through Asia today is key. Not only do falling bond yields enhances the dividend yield in the ASX 200, which is one of the highest in developed equity markets. But, the expected future cash flows of Aussie-listed corporates have become just a bit more compelling from a relative perspective. Of course, a falling AUD has positive and negative ramifications for different stocks, but the tailwinds for the market have been in place, and the ASX 200 has pushed in 6100.
/h2
If I look at a simple model of the ASX 200 internals, which can be a useful way of assessing the level of euphoria in the market, we can see clear signs this rally is at a mature stage, but we don’t have a full suite of red flags. Here, we see the numbers of companies (in order):
• With an RSI > 70 = 19%
• At a 4-week high = 43.5%
• Price > 50-day MA = 83%
• Price > 20-day MA = 77%
This needs to reflect today's 1.2% rally, especially when 76% of stocks are higher
I guess we’ll keep an eye on the S&P 500, as there are signs the low volume rally is finding exhaustion here. A close below the 5-day EMA and horizontal support (at 2675) would make me turn a touch more cautious on DM equities.
As mentioned yesterday, the risk of EURUSD of moving into the lower Bollinger Band at 1.1330 has increased, and I feel this could come into play by the weekend. GBPUSD will get some focus tonight, where momentum currently favours further downside, with the meeting between Juncker, Tusk and May likely to be a punchy affair. Although, one that would be incredibly unexpected if anything tangible on the Irish backstop came to light. The USDCAD daily chart looks interesting too, and I would be trading this from the long side, although the preference is a for a daily session close through the rising trend at 1.3217.
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