Originally published by Commonwealth Bank of Australia
There are a few large elephants, in a few small rooms. Some we dare to discuss, some we dare to dismiss. But these menacing beasts, may be reflections of black swans. Something only the great Salvador Dali could conjure on canvass. There are 3 potential black swans reflecting elephants:
1. The largest, most unpredictable elephant resides in the G20 boardroom. An elephant rising in popularity around the globe, and well protected. Populist protectionism threatens global trade. Open borders may become brick walls. And brick walls threaten economies most open to trade (Antipodeans). Trade wars will stifle growth and inflate costs. Geopolitical risks have risen. And elevated risks kill confidence. We struggle to invest without confidence. It’s all about confidence…
2. The often ignored elephant in the Fed’s boardroom, has grown in stature, from US$900bn to US$4.25trn. The Fed’s elephant is surprising nimble for its size. Its trunk can lengthen and shorten (duration) at will, in a process known as operation twist. It can starve itself (a bit) or gorge at will. It was born to flatten curves. This elephant does not work for peanuts. This elephant demands term premium.
3. The Aussie elephant engulfing the RBA boardroom, stands tall on bricks and mortar. The great Aussie housing elephant is much loved, ridden by the wealthiest, and force fed the finest salted cashews (negatively geared tax incentives). The ivory tusks on the great beast are mesmerizing in their beauty. The smell of the previous (mining) beast that once dominated the RBA board room remains. The foreign funded elephant strapped to the LNG and ore mines had worried officials for 10 years. The transition from one elephant to another means officials will become more (macro) prudent. And perhaps we’ll get prudent by the postcode. At least these ‘other’ measures will enable the RBA to remain actively inactive.
The IMF have upgraded global growth forecasts, noting: “after six years of disappointing growth, the world economy is gaining momentum”. Although the IMF warn that rising protectionism hampers economic expansion and could fuel a trade war. The risks we face are ever evolving. And the liquidity is ever evaporating. We run through market pricing in the US, Australia and New Zealand, and assess the risks against the rewards. We have been forced to take profit on some old paid positions and stop out of new ones. Our short duration bias remains, despite taking a battering… And we still expect steeper curves.
We add a few bets, make a few resets, and face a few regrets.
Table 1 plots current market pricing for the US Fed, RBA, RBNZ, ECB and BoE. Recent price action in short‑end rates has been brutal. And there are some good opportunities now. Thoughts of rate hikes have evaporated in the US. Thoughts of near‑term cuts have strengthened in Australia. And pricing of 2018 rate hikes from the RBA have all but vanished. We don’t know what the Kiwis are thinking. But a hike by March 2018 without a new Governor seems pretty punchy. There’s a hedge if ever we’ve seen one. Pricing for the ECB seems fair to us. And pricing for the BoE is still an effective hedge into Brexit.
So let’s pay the Fed, play the RBA, and fake the RBNZ. We have a hedge at the BoE, so let’s leave the ECB.
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