Originally published by Pepperstone
It’s all Australian dollar selling today, although we’ve seen good interest to be long the ASX 200 (AUS200) as well. RBA governor Lowe caught traders off guard, and his comments (at 12:30 aedt) saw the floor give way, with Aussie 3-year bond yields falling a sizeable 8 basis points, causing AUDUSD to drop off 80 pips or so into 0.7159, with AUDJPY having the big move on the day, with a 1.2% sell-off
(AUDUSD 5 minute chart)
Dr Lowe has given his view that the bank has moved to a formal neutral policy setting, which should be seen in writing in this Friday’s SoMP. Granted, the governor hasn’t moved to an explicit easing bias and said that he doesn’t see a strong case for a near-term rate cut. That’s fine, but the market doesn’t expect a near-term rate cut either, but, they do see a move by 2020, and they see the risk of a cut by December at 54%.
The ASX 200 has attracted buyers from the unwind of the auction and found another leg higher on Lowe’s (NYSE:LOW) comments, with a touch of rotation out of financials and into industrial and material names. The message seems fairly clear - avoid the banks and stocks which are a solid proxy of the domestic economy, and now we have clarity of the regulatory environment, the investment case to own the banks is premised on your view on how the Aussie economy looks in six-, 12- and 24-months.
If you take the view that we are headed towards a recession-type environment, and bad and doubtful debts are to rise, then it leads in strongly into the key question. That being, whether the bank's dividends sustainable? At this juncture, analysts feel dividends are sustainable, with the consensus calling for CBA (if we take this bank as an example) to pay a $4.32 dividend this year, $4.37 in 2020 and $4.43 in 2021. The moment traders see cashflow under threat, and a real risk to dividends then watch short interest ramp up.
CBA's (AX:CBA) 1H19 earnings numbers today were uninspiring, especially after the recent rally. Granted, the stock trades on 14.3x 12-month earnings, and an undemanding P/BV, so there was some cushion from valuation, but cash earnings were around 0.5% below the street, while revenues were soft. Asset quality was fine (at 15bp of total loans), but again, this is a story about asset quality in the future should the economic momentum continue in its current fashion. The fact their capital ratios were better than what was expected should provide an additional buffer should a real downturn play out. Expenses were handled well and again this will play a role in delivering the $5.40 EPS for FY2019.
Economic divergence If we look at the Citigroup (NYSE:C) Economic Surprise Indices, which looks at economic data relative to expectations:
• Orange – Australia
• White – US
• Blue – Europe
• Grey - UK
It feels as though we are seeing signs of economic divergence again, with data in the US generally improving through January. Ok, so if we look at survey’s, such as the month NFIB small business survey we can see it's not all rosy, but on the whole, we can see an increasing divergence in market sensitive data points, such as the manufacturing PMI series. European data has been consistently weak, with Italy now in a technical recession, while Aussie data has started to roll over relative to forecasts. This is a trend we need to watch because if US data starts to stabilise and other economic data points show further vulnerabilities, we should almost see a re-run of 2018 when the USD strengthened and global capital made its way into US assets.
Equity bulls in control for now
Nothing has really changed from the note I put out yesterday and the S&P 500, Nasdaq and Dow continue to grind higher. I have focused on 2815 as the near-term target (in the S&P 500), and tactically it feels as though the price will meet a wall of supply into here. So much discussion has taken hold on the floors around liquidity dynamics, with much focus placed on moves in the global M2 money supply. As we can see in the Bloomberg chart, the global M2 money supply has had a solid move higher for some months now, and this may have supported global equity markets (the yellow line is the MSCI world index).
Regular readers of The Daily Fix will have seen the below chart before, and its one that I focus on closely. Here, we can see the influence changes in US excess reserves held with Fed banks (the green line) have on the USD index (USDX on MT5). Take a view on excess reserves, take a view on the USD.
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One interesting correlation that has broken down recently, for reasons more specific to supply, with Vale declaring force majeure on certain contracts, is iron ore futures (orange) vs EURUSD three-month volatility. Correlation vs causation, but I feel EURUSD volatility is just too cheap and ready to head higher.
To put this in perspective, the implied move over the coming three months is 288-pips, which considering the time premium involved is just too low. Something doesn’t sit right with this, especially with the 7 March ECB meeting potentially being a vol event in itself. The daily chart of EURUSD shows the pair commanding a 1.13 or 1.14-handle (at one stage on an intra-day basis) for a joint record 58 trading sessions, and it feels as though once it pulls away from one of these levels, then a strong trend should be formed. I see risks of a move into $1.1330 and the low Bollinger band.
I am also watching GBPUSD here, as we see implied volatility creep up and traders are paying up for put vols over calls. Tomorrow, Theresa May meets Juncker and Tusk to discuss the Irish backstop, which will end the way it always does….with no signs of a resolution and we head ever closer to the critical deadlines. Cable is holding the September downtrend, but momentum is headed lower, and a break of trend support should be respected. GBP bulls need price to bounce here, or the risk of a move into 1.2930 is likely.
