Aussie Stock Set To Open Under Intense Pressure

Originally published by AxiTrader

Market Summary (7.58 am)

Volatility begets volatility and this morning the news is that US stocks are down again and still falling into the close.

The culprit again is the bond market with 10's at 2.82% off a 2.88% high earlier while the 2's at 2.11 and the curve is at 71. But the message from ECB and Fed speakers, not to mention the Bank of England, is that rates will continue to climb because of the strength of the global economy.

That, along with a VIX back at 34 has again impacted on sentiment. And it is this elevated level of volatility, it’s potential stickiness at much higher levels than have become common recently which is the big game changer. I’ll explain that below.

But as I write the S&P 500 is down 2.87, the Dow has dropped 3.81%, and the Nasdaq has lost 3.26%. At 2604 the S&P 500 is just 11 points above this week’s low. A break would be catastrophic.

No surprise Europe also had a bad day with the DAX down 2.6% and the CAC off 1.98%. The FTSE in London fell 1.5%.

Naturally, the corollary of that is a lower SPI as traders bet the ASX will have another poor day. At present, with a loss of around 100 points SPI traders are betting the ASX is going to open under intense pressure. This price action is not encouraging and the falls could be greater. .

On forex markets it has been a bit hairy. US dollar strength was reversed but then gained ground again once stocks disappeared down the rabbit hole in the last hour of trade. Having tested important support near 1.22 the euro is back at 1.2245 while the Aussie had a brief foray above 78 cents around 5.45am but it’s making new lows for the day at 0.7780. It was also a big night for the yen, which has caught a bid on the back of the stock market weakness. It’s gained 0.4% with USD/JPY down at 108.83. The pound too has had a wild rollercoaster ride. From a post-BoE high around 1.4065 GBP/USD is now trading 1.3902. Mark Carney and his colleagues made it clear they see a need to hike. Likely more than they – and the market – previously thought. But Brexit and a market funk hurt the pound.

On commodity markets, gold has traded with overall market sentiment trading a range of $1306-1322 over the past 24 hours and is currently sitting at $1318. Oil's fall continues with both Brent and WTI down more than 2% sitting at $64.13 and $60.29 respectively. Copper is still under pressure but off its lows at $3.09 a pound.

On the day ahead we get home loans data and the RBA’s SoMP here in Australia as well as Chinese inflation data with both PPI and CPI out. UK trade and Canadian employment are also out.

Here's What I Picked Up (with a little more detail and a few charts)

International

• I’ll get to the Bank of England in a sec and why that is a signal to other markets. But first I want to talk about the impact of this move higher in volatility on other assets. What’s important about the uptick in vol, assuming it doesn’t suddenly find sellers happy to drive it back to 8,9, or 10%, is that the uplift must by definition change the asset allocation outputs when it comes to asset allocations.

• Yesterday I tweeted on something Goldman Sachs (NYSE:GS) had said along these lines. I’d picked it up in a Forexlive tweet. The bit I shared says (my bolding) “while we have pushed above previous vol. highs in the current low vol. regime we are not yet ready to call an end of it which could change the balance of risks. Whether volatility settles into a higher regime is critical to asset allocation from here and could still affect allocations from systematic investors”. That is, what increased volatility does is change the potential distribution of returns. That, in turn, increase the chance of the risk of loss, a down month, or a down year. That has to be factored into the models and the result will be less money allocated to risky assets. In this case stocks. So some demand can come out of the market if vol remains elevated. With the real chance that these vol selling - picking up pennies - funds are dead for a while, for a time at least investors, and traders, will be far more circumspect in their levels of aggression.

• The Bank of England was quite hawkish last night. More so than the market thought was possible and while GBP has given back pretty much all of its gains to 1.4065ish back at 1.3914 now it is clear that Mark Carney and his colleagues see a world of strong growth, improving UK growth of 1.8%, and the stickiness of inflation up at these elevated levels. As a result t, e Bank said “were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated at the time of the November Report.” Mark Carney reiterated that saying to get inflation back to target over a “more conventional horizon” the bank needs to raise rates.

• What’s important about this, and comments from the ECB that QE needs to end and further guidance on rates needs to be given, and even on the BoJ’s discussion about rates, is that the unequivocal message is that the global economy is strong and the era of monetary looseness is at an end. Folks that’s the key to everything. It’s why bonds are rising. It’s why stocks are pressured, and its why valuation metrics are being recalibrated. For Carney to be contemplating jacking rates up with what you might still call a tepid growth expectation, consumer retrenchment – which he acknowledged – and the uncertainty surrounding Brexit is amazing really. It speaks to a confidence in the growth outlook globally not seen in central bankers for a very long time.

• Brexit is a mess and the EU is really starting to play hard ball. That, as regular readers know, has been my takeaway for some time now as the ECB subtly but firmly pushed back on Theresa May thinking she had control of the process. Two things have happened overnight which suggest we now have a digital outcome likely for Brexit. Either really hard or the almost non-existent exit a soft Brexit along the lines the EU wants. That’s really important and I’m not sure yet what the outcome would be but I’m leaning 60:40 in favour of the hard outcome. I say that because overnight Brexit secretary David Davis had a pop at the EU for releasing a note which says the bloc can restrict access to the single market during the transition phase. Davis said, “I do not think it was in good faith to publish a document with frankly discourteous language and actually implying that they could arbitrarily terminate, in effect, the implementation period. That’s not what the aim of this exercise is, it’s not in good faith, we think it was unwise to publish that,” he told Sky. Seriously when is the UK government going to realise the EU is actually a scared of Britain outside the bloc and does not want them leave but if they do will make their life as hard as possible. So when I also read that May is going to tell cabinet today that they should seek a “bold Brexit deal” I think there is much gnashing of teeth to come on the Western side of the channel. It’s one of the reasons I have a lifestyle short in the pound.

• I could write forever this morning, there is so much to talk about but time has me. So here are some highlights.

• The Winklevoss Twins are talking their books and saying us old folks, especially the really old folk like Buffett, just don’t get it.
• The NZ central bank, like Governor Lowe, delivered a perfectly pitched upbeat but not too upbeat outlook with an emphasis on no rate rises soon kind of statement yesterday.
• Chinese trade yesterday looked okay to me. Yes the balance was lower but the growth in exports and imports speaks both to a strong domestic economy and a strong global economy. But there was also some focus on pull-forward given the Lunar New Year is coming up this month.
• BoJ Kuroda and Suzuki seemed to have different hymn books. The governor reiterated his message that accommodation is here to say while Suzuki intermated the chance of a change.
• Bundesbanker, and uber hawk, Jens Weidmann said both QE should end but also that the ECB will be watching the exchange rate. That’s important for the path and timing of rates. QE should definately8 already be a thing of the past I reckon.
• Neel Kashkari said again overnight that rates shouldn’t rise. Seems he’d prefer to have to deal with the issue of trying to put the fire out rather than stop it starting. But Dallas Fed Pres. Robert Kaplan said he’s now leaning toward 3 rate hikes. And Patrick Harker, he of the celebrating Philly Fed, said he is open to a March hike.
• On the topic of Fed hikes, SocGen is now saying thee Fed is behind the curve. This folks is important. I agree. The tax plan, the budget that’s likely to get passed in the next day or so, both are incredibly stimulatory. This is where policy divergence has emerged again and its helping the US dollar.

Australia

• RBA governor Lowe spoke last night in what was both an upbeat but cautious look at the Australian economy. You can read the speech here. It’s a decent speech and worth a read. But what I wanted to highlight from it was what he said about the flexibility a floating Aussie dollar – exchange rate in his terms – gives the RBA. Lowe highlighted that as a result “we did not lower our interest rates to the extraordinarily low levels seen elsewhere after the financial crisis,” which now means “just as we did not move in lock-step on the way down, we don't need to do so in the other direction”. That’s one of the least aggressive, but clear, jawboning efforts I’ve ever seen from a central banker.

• And then, to make the point rates are on hold for a while, Lowe said “our circumstances are a little different. We are still some way from what could be considered full employment and our central scenario for inflation is for it to remain below the midpoint of the medium-term target range for the next couple of years”. Of course as credibility would demand he was honest enough to also say the next move in rates in Australia is likely “up, not down”. But that will be predicated on the re-emergence of both wages growth and inflation.

• That’s the key as I highlighted earlier this week. The growth estimate for the economy is certainly strong enough to raise rates. But why do that when we are nowhere near full employment, wages are growing meekly, and inflation is still relatively quiet. It was a perfectly pitched speech – I encourage you to hit the link above and have a read.

• Turning to stocks now and the less than confident bounce I highlighted yesterday morning was the story of trade yesterday even though the ASX200 fought back to finish up 14 at 5,891. Moves like this week, particularly when the local market had already been struggling, really dent confidence of the marginal buyer which in turn undermines sentiment and thus support.

• The bad news as trader get their feet under their desks this morning is that the tentativeness of yesterday could turn to outright bearishness today. That’s certainly the case if SPI traders are right, and if US markets close in this minus 1-1.5% region. Looking at the chart the “hardly a confidence bounce” of yesterday has turned to outright ugliness as the SPI falls back into that 3 month range of last year. My sense is we will head for a test of the other side of this range at some point under 5,600. EDIT – It’s fallen further and is now at 5681 as I get ready to hit publish.

• Just quickly on the Aussie. It wasn’t unduly impacted by Governor Lowe’s message that rates are on hold for a while. Certainly the 0.5% loss is a little more than the kiwi, and has underperformed the pound and the euro. But the message he conveyed will become more important in time as folks recalibrate the pace of US rate hikes and as Aussie bonds inevitably continue their recent trend into negative territory against US rates. MY target of 0.7740 remains intact for the Aussie and if that breaks it is a full round trip to where this all began around 75 cents.

Forex

• China was important yesterday. The reversal in the yuan was the very thing I was looking for to confirm the trend toward US dollar strength might truly have begun. Don’t get me wrong the fact euro held above 1.22 last night and that the US Dollar Index is still below 91 gives me pause.

• But the yuan has mapped out a perfect technical pattern to the low, roughly hit the level of the 2015 devaluation and is biased back to 6.41 at least in CNH terms. Here’s the chart.

• The pound has had a shocker. Technically it looks terrible now after rallying to 1.4065 and then flipping all the way back to 1.39. 1.3835 is the key. A break could see another 200 points off pretty quickly.

Commodities

• Just quickly, as I’ve run out of time. Oil looks biased lower and my target of $61.50 in Brent seems more likely now that the last line of support for the recent upmove gave way with the break of $65 overnight. Of course there is a clear narrative change in oil markets given the builds in inventories even with the refinery runs. But this is also about the return to strength of the US dollar with which oils moves have been highly correlated over the past 6 weeks. And it’s also about positioning. Everyone is on one side of the boat. The bullish side and a rebalancing is necessary.

Have a great day's trading.