Thin Liquidity Drives Some Big Market Moves

Originally published by AxiTrader

Welcome to my daily Markets Musings – early today as I’m on Sky between 6.15am and 7am.

Feedback always welcome

Greg

Market Summary

Normally the Tuesday after a US holiday is the most difficult of notes to write. That’s doubly the case when it coincides with a holiday in the UK.

But today is not that day given the big falls in oil and the collapse of the new Italian government after the President refused to allow a Euroskeptic economy minister to take office. Instead President Matterella has installed an ex IMF fellow as leader of a technocrat government. Carlo Cotarelli has then decided he will be both Prime Minister and Finance minister. You can imagine how Beppi Grillo and Five Star have taken that. To them it feels like exactly what they stood against.

Anyway Italian, and European, markets didn’t like it. The FTSE MIB in Milan dropped more than 2% and the Italian bond spread to German bunds blew out. Fresh elections seem likely in what could be a genuine existential threat to the EU project – or at least one which offers open hostility should the recent coalition partners prevail.

On forex markets yesterday’s ridiculous bid in the euro gave way to selling almost as soon as European markets opened. EUR/USD is down 0.21% as a result but more than 100 points off the high of 1.1727. Most other currencies are fairly quiet with the Yen back to square at 109.41, and the pound equally unmoved day on day at 1.3309.

Of the commodity bloc the Aussie did worst giving up gains to be down marginally at 0.7541 while the Kiwi managed to catch a bid to 0.6936. USD/CAD is closing in on 1.30 this morning.

On commodity markets their was initial heavy selling on oil futures markets when they opened yesterday. Brent is down 1.47% at $75.32 while WTI is down 2.08% at $66.47. Both are off their lows and have been stable for the past 16 hours. Gold is a little lower at $1297 and copper dipped 0.33% to $3.057 a pound.

It’s anther quiet day here in Australia while we get consumer confidence in Korea and jobs data in Japan. Case Shiller home prices are out in the US.

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

International

• Italy, it’s all about Italy today. The story so far is that the President vetoed a EU skeptic 82 year old from becoming economy minister, which effectively ended the new government. He has, in it’s place, asked a former IMF official to lead a technocrat government. The two coalition parties who were forming government have said they won’t play ball and it seems – as a result – that Italy is now headed to the polls again sometime late this year perhaps next year.

• For the Italian markets this is devastating because of the uncertainty. We can leave the Italy will/won’t be better outside the Euro for another time. But right here and right now traders and investors, indeed companies and citizens – consumers – will be hunkering down as well. We can see it in the blow out of the Italy 10-year spread to the 10-year German bund.

• But it’s not just Italy, there is a vote of no confidence happening later this week in Spain as well which could impact the government there and see fresh elections. It’s a messy time for Europe. And with the monthly asset allocation meeting coming up soon you’d forgive fund managers for lightening their load on Europe, especially Italy and perhaps Span

• Shrek, Toy Story - When my kids were younger we used to watch a lot of those animated movies where the writers were smart enough to have scripted the movies such that the kids AND their parents got a laugh. It was a construction on two levels where the stuff we got was over the heads of the little ones. I raise that this morning as I watch how China is engaging with the US, with Russia, with Iran, and with its neighbours in the South China Sea. All I’ll say is they are playing on two levels. But the important one is the long game. And to that end the improved relations with Russia, in trying to help Iran work through the US sanctions, and the “warning off” of two US naval ships over the weekend suggests while China plays the good guy at the WTO, deals with President Trump over ZTE (HK:0763) and tariffs it is still pursuing its very long term strategic goals. Why does this matter in this daily note? Because it can have impacts on markets. Take Russian Energy Minister Novak’s comment last Friday that Iran’s production will only fall around 10%, not the much larger amount many pundits in the West expect. It’s a sign we need game theory as much as straight geopolitics and economics in working out the fundamentals outcomes of these global machinations. I’ll do my best to keep you updated.

• One thing worth remembering though, China is still developing. Still growing. So I’d expect them to continue to wield an ever increasing impact on global commodities, trade and of course FMCG.

Australia

• Did you hear the one about the central banker who said housing doesn’t matter when setting policy? What was even funnier was that he appeared to have said it with a straight face and in an interview with the Wall Street Journal. That central banker is Ian Harper. He’s an economics professor and Dean of the Melbourne Business School. His LinkedIn (NYSE:LNKD) bio says that “from December 2005 to July 2009, Ian served as inaugural Chairman of the Australian Fair Pay Commission, an independent statutory body whose role was to set and adjust minimum wages in Australia”. So you’d guess he knew a thing or two about the Australian economy, about workers, and about what troubles them.

• But, in the aforementioned interview Harper said (my bolding)“The bank will raise interest rates when it has a basis for doing that — because inflation is starting to pick up. When all that starts to line up, who cares what’s happening to house prices.” Of course Ian, there is no wealth effect in Australia is there? There is no negative impact of falling house prices on consumption in a low wage environment. No, of course not. Can you tell I think this is bunkum? He goes on to say “From my perspective as somebody who has an input into the setting of monetary policy, what matters is what is happening right across the economy”. Yet he wants to abstract house prices from that equation. Because, well, they mustn’t be part of the economy, must they? Of course not Australian’s biggest store of wealth is just an abstract thing, no more than mere shelter. He also notes “it (wages) is all slow. It is steady, but it is all slow”. So all good, wages are low, house prices are falling, but as soon as inflation lifts I’m jacking rates up. Granted he did say the RBA has said rates aren’t going up or down in a hurry and repeated that hamfisted statement from the minutes “Steady as she goes. That is actually the best thing the bank can do for encouraging the confidence and stability that would then feed into higher wages”. Maybe a good start might be the RBA to give more than 2% to the workers at its note printing division.

• Anyway, rant over. But gee whiz.

• Right, back to the markets now and the ASX had a shocker yesterday. Or perhaps local traders were just a little more savvy than some of the folks in our time zone who took stocks, the Aussie dollar, and the euro higher on the back of the Italian President’s decision to effectively deny an elected government its right to choose a minister. And after the moves in Milan, Paris, and Frankfurt last night our traders yesterday look like they may have had the right end of the stick.

• Of course the weakness in resources stocks, and the banks – among so many others was the root cause of the 29 point loss which saw the S&P/ASX 200 close at 6,004. It’s closing in on the 5,977/83 support zone (38.2% retracement of the recent rally and the top of the previous downtrend channel. With the SPI down another 15 overnight, there’s a chance we see it tested today. As for the SPI 5,960 has been and remains the target. But 5,887 has to break first

• Yesterday I suggested the Aussie dollar was a secondary consideration for forex traders and was likely to stay inside it’s 0.7522/0.7605 range. It did that and after initially trading up to a higher of 0.7580 it pulled back to a low of 0.7539 as the Italian turmoil gripped markets from the time European traders put their feet under their desks. Now that Italian voters seemed headed for a euro showdown the Aussie is likely to improve against the single currency so EUR/AUD seems destined to head to 1.5223 perhaps even under 1.50. Against the US dollar the outlook is more uncertain though. Much is baked into the cake for the Aussie dollar. It almost completely missed the lift in metals and mining shares versus the overall MSCI global share index. So now that trend has reversed sharply it shouldn’t weigh too heavily on the Aussie. Short term the range is still holding. But if it breaks then the Aussie is biased back toward 75 cents, then 0.7470/75. In the current atmosphere I’d expected the Aussie to remain offered against the US dollar.

Forex

• It made absolutely no sense to me yesterday that the euro was rallying on the political turmoil in Italy. Maybe the algos didn’t get the nuance that the President’s decision wasn’t likely to be taken lying down by the two coalition partners who are – after all – not populated by your ordinary mainstream political elite. So it was no surprise to me that the euro reversed course and fell around 120 points from 1.1727 to a low of 1.1607 overnight.

• The question of where to next has to be asked. Signs the euro might bounce into the 1.19/20 region are perhaps now void given the next vote – when it comes – appears more EU threatening the French election in 2017 ever was. The big question for euro traders is whether the technocrat government, and the low of 1.16 is enough to turn the outlook a little more positive for a time. The performance of Italian bonds and stocks suggest not. The weekly charts now suggest a move into the 1.1395/1.1450 region.

• For the moment this seems to be mainly confined to the EU and Europe. So it’s the euro which has suffered worst in what is an otherwise reasonably range bond day for developed market currencies. But if we add a fresh EU crisis to rolling EM crisis, then as long as US data remains better than the rest of the globe and on track for the solid growth expected the US dollar will remain strong.

Commodities

• Oil traders game out of the gates in a hurry to hit the sell button yesterday when trade started for the new week. Both WTI and Brent came under heavy pressure in rather thin trade. But after an initial aggressive plunge both benchmarks found their feet and managed a pretty solid rally off the lows. It’s a rally they have been able to hold over the past 16 hours. And it’s a rally which left WTI down 2.08% and Brent off 1.48%.

• Of course, there is much water to flow under the bridge, and likely many comments, prior to the next OPEC meeting. But with the high volume of spec longs still in the market oil remains vulnerable to further price falls. Interesting for the moment at least, it is WTI which has pulled back most. It neither ran as hard as Brent but has come back quicker. No doubt shale and the big lift in rig counts Friday played a part. For the moment though WTI is back at the break out level and holding support.

Have a great day's trading.