Originally published by Commonwealth Bank of Australia
War rhetoric heated up last week as Trump declared North Korea "will be met with fire and fury and frankly power. The likes of which the world has never seen before". Risk appetite turned for the bomb shelter. After reaching a record 2490, the S&P 500 dropped 2% to end the week. Treasury yields fell, with the 10‑year ending down 10bp at 2.18%.
The RBA are comfortably neutral. Speeches and testimonies, and now minutes, all point to an extended period of nothing but waiting for inflation to lift. So get comfortable, as an RBA rate rise is not something we’re likely to see for at least a year. The Aussie curve is appropriately priced, but should steepen into year‑end.
The RBNZ consumed the headlines on Thursday. The unchanged decision was accompanied by a neutral bias. Markets had moved to incorporate the risk of a dovish tilt. But they expect the huge fiscal impulse in the pipeline to offset recent data weakness. The New Zealand dollar was given a nudge, with mention of intervention, though this is NOT on the cards.
Escalation in “nuclear” war threats and rhetoric consumed markets. North Korea threatened a pre-emptive strike on the US military base in Guam (again). The US are building justification for military action, though it’s most likely aiming to force Kim Jong Un to the negotiating table. Actions speak louder than words. But words are getting heated, fueled with fire and fury.
Turnbull joined in the chorus, referring to the ANZUS treaty; “Australia will come to the aid of the United States… The United States has no stronger ally than Australia.” And Turnbull made the key point: “While every nation should be united in bringing this rogue regime to its senses, we note especially the importance of China's role as North Korea's major economic partner, China has unique leverage. And we welcome, in particular, China's support for these strong and much more harsh sanctions imposed by the Security Council. The regime must come to its senses and stop its illegal provocations.”
The US CIA director was out stating there’s “no imminent” threat, and “There’s no intelligence indicating we’re on the cusp of a nuclear war.” Pompeo’s comments may calm us down for a day or so.
The local highlight of the week will be the flattening Phillips curve. We get Aussie wages on Wednesday, and the outlook remains weak (just 1.9%). But the Aussie employment report Thursday is likely to show another solid gain. Commonwealth Bank Of Australia (AX:CBA) and the consensus look for a 20k rise, even after the three recent stellar results. The National Australia Bank (AX:NAB) survey is healthy, and points to another lagged gain in the ABS data after the misleading turn south back in Q1. Sample rotations are always a risk for volatility around trend. But we think the jobs news will be good. But the policy stance will be unresponsive.
The RBA governor endorsed a protracted tightening bias on Friday. Lowe said: “The current market pricing implies a greater probability of a rate rise than a rate reduction, I think they are reasonable assumptions and I don't want to dissuade them.” A comment of common sense and optimism. The market is adequately priced in our opinion, with a full rate hike pencilled for December 2018.
The problem of course is the lack of spill over to wages and household incomes. The WPI on Wednesday is expected to show wages growth stuck at 1.9% y/y, with the private sector remaining a touch below that. It’s hardly the stuff of any change in the inflation trend.
Indeed, households continue to present a clear risk to the outlook. For while the jobs and GDP story has improved of late, the chart at right highlights the clear constraint for consumer spending. Rising mortgage interest rates (which RBA Assistant Governor Kent today estimated to be worth about 10bp) compound that pressure to some degree, as does the desire to pay down debt rather than withdrawing equity from mortgages and spending as might have occurred in years gone by. With the Australian dollar on an upward path, keeping inflation contained, the most likely course is that the cash rate remains stuck at 1.5% for a long time yet.
Against that backdrop, our view remains that a 3‑year yield at or above 2% is a good buy, when we get there. As detailed last week, our preferred option for now is to buy against Treasuries as opposed to on an outright basis. That 3yr Aus‑US bond spread went nowhere last week, as both markets eked out small gains amid Trump’s rhetoric and another soft US inflation report. But, with just 1½ Fed hikes priced over the next two years, we still think this is the way to play the situation.
Across the Tasman, the RBNZ heavyweights made some ripples in currency markets. The decision to leave the OCR unchanged was no surprise, nor was the decision to leave the OCR track unchanged. At least that’s what we thought.
But in the days leading up to the statement, the market positioned for something more dovish. Following the unchanged MPS, the little kiwi lurched higher. So McDermott came out in the afternoon to nudge it back into (its) place. Talk of intervention wasn’t discussed, but made the headlines anyway. You’ve got to love (hate) creative journalism. The fake news captured the FX markets, and the kiwi fell. Neither McDermott nor Wheeler actually mentioned intervention as a tool currently being discussed. They simply (cleverly) made reference to a tool which is always available. A “step in the direction” was made to sound like something imminent, rather than the first step in a four day camel trek – before intervention would be actively considered.
The main point from the MPS was fiscal policy, not monetary. The main upgrade since the May MPS was the budget stimulus. Despite the downside surprises of late, the large fiscal impulse in train, has nullified the impact on OCR trajectory.
It will take a lot for the RBNZ to change track in November. Markets will again move in anticipation of change for the sake of change. That’s where we come in, to counter change in favour of stability. Receive when the market over pays, or pay when the market over receives. All the while, we’ll keep 1.75% as the base… A series of implied rate hikes persist with natural curvature, and Kiwi rates continue to offer some juice for receivers. For now we simply hold what we have (received positions from better levels). The levels are not attractive, currently, for new positions. But the carry is still good enough for old. So it’s a time to hold, wait, and see.
We are currently received May’18 OIS from 2.03% (entered 19th April), currently 1.84%. There’s still 10bps of juice here to play for. We are also received kiwi 2y3y swap versus US 2y3y swap from 98bps (entered 14th June), currently 93bps. The compression trade is in its infancy, and we target a move to +50bps (initially).
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