With the market front-running the idea that we’re seeing signs of an upcoming plateau in the case count in certain countries. And, feeling somewhat assured (complacent?) that the economic shocks are mostly discounted, liquidity has come to the forefront and drive risk. The question of whether you chase or is this just a massive bull trap is the question everyone is asking.We can look at money supply (M2), holdings of assets on a central bank’s balance sheet or even excess cash/liquidity and see this ramping up as a result of the recent central bank measures. Much attention often falls on the level of excess reserves created in the US or Europe but look at excess cash here in Oz – it has gone wild and at a$84b, will only go one-way in the next few weeks; higher.
It’s no disguise that the RBA is content, we heard this in the tone in yesterday’s monthly meeting statement, especially with the interbank cash rate (the rate at which banks source overnight secured funds) trading below the cash rate and into 18bp and likely gravitating towards 10bp – the rate the central bank pay certain financial institutions to hold excess capital on the banks’ balance sheet.
So, liquidity has dominated. It has certainly caused a rampant wave of short-covering, but we’re also hearing a number of major financial institutions saying that now is the time to look at risk (equities and credit) selectively. Perhaps, but many remain unconvinced – that said, I guess we’ve had an unconvinced market since 2009, and it’s never really felt right buying risk, which is why we always ‘climb the wall of worry’.
What’s interesting is there has been a solid lift in inflation expectations, and that has largely outpaced any upside (through selling) in nominal bond yields. If I look at US 5-year breakevens (a bond instrument for expressing inflation expectations over a five-year timeframe) we can see they have lifted from 11bp to now sit at 87bp. That said, they have come off their highs today of 95bp today and if they roll over, I am guessing it would be a headwind for risk assets (such as equities and high beta FX – AUD, MXN, ZAR)
Are following stocks or vice versa – chicken and egg…?
(S&P500 vs 5yr inflation expectations – red)
The same can be said for the AUDUSD, which has been the star performer on the session pushing into 0.6208 and threatening to print a higher high, with a break of the 31 March high of 0.6214. For this to happen it seems we need stocks and inflation expectations to keep heading higher. If stocks rollover, so will the Aussie it seems.
Part of the rally in the AUD into 62c can be explained by the RBA statement, although, it is somewhat puzzling. The line that — should conditions improve, “smaller and less frequent purchases” will be seen clearly resonated. This, of course, is in relation to their asset purchase program, which has been the reason for the massive increase in excess cash in the system. However, the fact they formally detailed they would look to taper the QE program caused a reasonable reaction, not just in the AUD, but we saw a strong underperformance from Aussie 10-yr bonds, with the 2s v 10s curve closing +14bp at 66bp. The ASX 200 fell 1% but recovered into close.
(AUDUSD – white v US 5yr inflation expectations)
So, not a great reaction from a market that has already seen the pace of bond purchases in decline and where the pace of purchases easily covers any additional bond issuance needed from the government (or the AOFM – Australian Office of Financial Management). Either way, it shows how sensitive we are to liquidity, again.
It leads me today’s set-up and specifically that of the US500. This chart is so defining for other markets, and sentiment more broadly. Throw in oil, which I also consider being a huge driver of sentiment, and we have an interesting session ahead of us. A gravestone doji like this will always trigger alarm bells, but it’s what happens after that is so important. If this kicks lower it could trigger a wave of selling through Asia, as those participants that haven’t bought for a 12-18-month view take some off the table. A re-test of the range low at 2467 would be interesting. A renewed bid would obviously negate the candle and it would encourage a chase of the market.
(Daily chart of US500)
What trumps liquidity? Obviously, stats that show perhaps the plateau happens later and the shutdown will play out through August. A big drop in crude would see the bears take notice and certainly you’d see that resonate in petro-FX with NOK giving back some of its recent gains. The CAD would be the better short though.
I am not a bottom-up equity guy, but I do think next week’s US corporate reporting season will be must-watch viewing even for macro heads like myself. The market is pricing FY EPS at $151.59 (Bloomberg consensus), which represents a 12% decline in the last few weeks. There are calls from some houses though that estimates should be closer to $110, which would mark a 36% fall in earnings. The question then becomes what multiple the market wants to pay for those earnings and in weak growth, high volatility may be lower than 17.5x seen at present even if real yields are incredibly low.
*There will be no Daily Fix until Monday
All the best,Chris