Rising Bond Rates Drive Global Markets Into Risk Off Territory

Originally published by AxiTrader

Quick Recap

Ugliness abounded overnight with rates higher, stocks lower and oil collapsed under the weight of new forecasts that demand is likely to fall again. Gold can’t can’t a bid which reinforces to me that it’s the increase in long bond rates which is hurting the yellow metal.

On forex markets the US dollar was stronger and the Australian, Kiwi and Canadian dollars were pole-axed in what's a general risk off night hurting them and the commodities on which measures of value rest.

What You Need To Know

Here’s what I picked up

International

• Volatility clusters. We know that from Benoit Mandelbrot’s work and we know it from the observed market price action of the GFC and many market funks since. So after a tidy bounce in US stocks yesterday they’ve given back the gains, and a little more, overnight.

• At the close in New York the Dow Jones Industrial Average is down 258 points, 1.4%, the Nasdaq 100 is off 57 points for a 1.1% dip, and the S&P 500 has lost 32 points and is off 1.5% at 2127. Does the S&P need to test the trendline from the low this year at 2087? My inner chartist says YES.

• This move is not about the Fed. It is about global investors sensing a shift in the efficacy of monetary policy. It started with the BoJ’s policy error in January which saw USD/JPY defy logic and selloff sharply as the Yen surged. That move planted a seed in the minds of global investors, commentators, and central bankers themselves. As that seed germinated and grew we’ve seen an ever-increasing number of highly respected investors and market watchers questioning he efficacy of unconventional policies.

• In questioning policies they are also implicitly saying that negative yields on bonds can’t last. Which is really what’s driving the reappraisal in markets. Mario Draghi and the ECB are being blamed as a catalyst for this move after not offering further stimulus last week but the reality is that investors global, bond ones in particular who have been buying negative rates in the hope that someone else buys the bond off them more negative, know that strategy is flawed. So as I noted yesterday with bond rates increasing and USDJPY still under pressure there is more to this move than just fear of the Fed.

• To that end, a Bank of America (NYSE:BAC) survey of investors, released overnight, showed money managers raising cash holdings to 5.5%, their highest level in nearly 15 years, with a record number of respondents saying that stocks and bonds were “over-valued”.

• So we are on the cusp of a potentially huge global asset reallocation move – and reckoning – that could carry bonds substantially higher and stocks much lower. Many say it’s just another “taper tantrum” and rates will settle and rally again. Perhaps. But even if I accept that – which I’m not sure I do – where will rates run to first. That’s the relevant question at the moment.

ELSEWHERE

• No surprises here in the current environment but the BoE was offered 3 time more bonds than it wanted in its QE operations overnight. Likewise, the US Treasury’s auction of 30-year debt wasn’t as well bid as expected. BONDS folks, bonds. US 10’s finished at 1.73% up 7 points, Bunds rose 4 points to 0.8%, UK 10 year gilts were also up 4 to 0.82%, and 10 year JGB’s are still holding just under 0% at -0.018%

• Speaking of which Billionaire hedge fund founder Paul Singer said investors should sell out of bonds.

• And John Taylor, famous for the Taylor rule of cash rate setting, not only said the Fed is behind the curve but also that negative rates do more harm than good.

• On a positive note US household income is rising and surged for the first time since 2007. It was up 5.2% in 2015 to $56, 516. That’s good news but the US census bureau reported that even though that number is 7.3% above the post-recession low it’s still 2.4% below the inflation-adjusted high in 1999.

• And Citi says folks aren’t taking the chances of Trump presidency seriously enough. I couldn’t agree more. While I put the odds slightly higher than Citi’s 35% the point they make that because this is just one roll of the dice means it could happen is the key one. Whatever you think of Donald Trump’s politics when well known investors like Mark Cuban, a noted Clinton supported it must be said, are saying the market will tank on a Trump victory traders need to perhaps factor in what other traders will do if Trump does surprise conventional wisdom.

• FWIW – I still think the Fed should go next week.

Australia

• The price action in the US and Europe was poor last night. But the action on the ASX has been nothing short of appalling over the past week. Behaviourally the lack of ability of the local stock market to regain 5600, then 5500, then 5400 and now 5300 fairly screams a deterioration of the underlying sentiment toward valuation on the Australian stock market.

• Yesterday’s high in the S&P/ASX 200 of 5276 was a little shy of where futures traded thought the market should open after the US bounce but the fact that the market gave up the ghost and closed on its lows with heavy selling in the banks and miners, amongst everything else, showed buyers have stepped back while the knife falls. Indeed the close of the Commonwealth Bank Of Australia. (AX:CBA) at $69.50 on the 25th anniversary of its listing was the lowest level since July 2013 and opens up the potential for another big fall.

• Looking at the day ahead it’s unlikely anyone is going to be brave enough to catch that falling knife on the ASX 200 today. After the physical market failed to hold back inside its previous uptrend (5250) yesterday the SPI 200 futures have now also broken the 2016 uptrend with the 26 point fall overnight. There is, perhaps, some support around 5100 but if volatility clusters and US stocks go off the index (and the SPI) are going under 5000 again. Here’s the SPI chart showing the overnight break.

• Looking at stocks specifically miners were under pressure overnight, financials too. So it’s hard to see where the bright spots might be today. Certainly the CBA is unlikely to be one of them given it has closed at its lowest level in 3 years and outside the bottom of what previously might have been considered a potentially bullish setup. This is a weekly outlook so no ‘official’ signal yet but it’s looking like a move toward $63, maybe even $59 on a medium term time frame could be on the cards.

Forex

• The US dollar was stronger across the board overnight as the air of uncertainty, and rising bond rates supported it once again. That saw the US dollar a little stronger against the Euro which is at 1.1210, the Yen which reversed yesterday’s 0.8% gain with a reversal of the same amount overnight. It sits at 102.65 – still incredibly strong in Yen terms all things considered. Here’s the DXY chart from my Reuters Eikon.

• Risk off saw the commodity bloc hammered overnight.

• The Australian dollar is another 1.4% lower at 0.7458 as the confluence of selling across oil, iron ore, and commodity markets more generally, the CRB index is down 1.3%, saw the buyers step back from the accumulation zone near 75 cents. That makes perfect sense. No one wants to catch a falling knife and the range break of the August low material changes the near-term outlook for the Australian dollar – pointing it lower as traders find the next level of support where the buyers are happy to accumulate once more.

• Arguably this 0.7450/60 should offer some support as should the 200 day moving average at 0.7390/95 – but buyers are likely to be a little cautious while markets more broadly are in a funk.

• Elsewhere the USD/NZD is down 1.46% and even though there is some fundamental attraction traders have shown for the Kiwi recently as dairy prices have improved and the economy looks okay the buyers will be a little concerned about where this overall global market funk could head. So like the Aussie Kiwi traders will be a little more cautious for the moment.

• The GBP/USD was off 1.1% to 1.3188. That’s a big move (maybe its not commodity bloc but commonwealth bloc selling) and reports are blaming the inflation data for August which showed a deceleration in yoy growth to just 0.6% from 0.7% expected. Feels like a bit of a stretch but it fits with the price action recently.

Commodities

• Crude Oil has lost 2.9% overnight after the IEA forecast of demand said there had been a sharp slowdown in demand. That comes just a day after OPEC said it’s competitors are likely to pump more oil for the rest of this year and 2017.

• Taken together the two pieces of news suggest that the continued message from OPEC over the past 6 months that the market was moving toward balance should be rolled back as the imbalance, and glut, persist. The question of what this means for a deal at the end of the month is an open one. Would a deal even make a difference. Equally now that we’ve seen news the Saudi’s have taken back the mantle, from the US, as the world’s biggest producer can they credibly stitch up a deal?

• Prices look like they want to test lower - $43.50 as a start and then perhaps even back below $40.

• Gold is lower under the weight of the US dollar and, I think, the resurgence in yields back above 0%. It’s an interesting level of weakness given the uptick in uncertainty and reinforces my hypothesis that gold’s rally has been in some part a function of the move in global sovereign yield curves below zero.

• Copper is relatively okay all things considered at $2.09 but Iron ore futures were down a little again.

Today's key data and events (all times AEDT)

• Australia - Westpac Consumer Confidence (Sep) (10.30am); RBA Assist Gov Debelle Speech (7.50pm)
• New Zealand - Current Account (QoQ) (Q2), Current Account - GDP Ratio (Q2) (8.45am)
• China - Nil
• Japan - Industrial Production (MoM) (Jul), Industrial Production (YoY) (Jul), Capacity Utilization (Jul) (2.30pm)
• Germany - Nil
• EU - Industrial Production w.d.a. (YoY) (Jul), Industrial Production s.a. (MoM) (Jul) (7pm)
• UK - Claimant Count Change (Aug), Claimant Count Rate (Aug), ILO Unemployment Rate (3M) (Jul), Average Earnings including Bonus (3Mo/Yr) (Jul), Average Earnings excluding Bonus (3Mo/Yr) (Jul) (6.30pm)
• Canada - Nil
• US - MBA Mortgage Applications (Sep 9) (9pm); Import Price Index (YoY) (Aug), Export Price Index (MoM) (Aug), Import Price Index (MoM) (Aug), Export Price Index (YoY) (Aug) 910.30pm); EIA Crude Oil Stocks change (Sep 9) (12.30am); 30-Year Bond Auction (12.30am)

Have a great day's trading

Greg McKenna

Chief Market Strategist AxiTrader