Complex Equation Unfolds
Despite limited moves in Asia Market yesterday, one could cut the tension on APAC trading desks with a knife as dealers were busy rethinking strategies within this complex Central calculus.
As expected, yesterday’s Brainard bounce in Bond and Equity sentiment was short lived as both markets sold off again overnight, but adding to the equity market woes was a new IEA forecast that indicates the oil supply bulge would last longer than previously expected, given weak global demand.
The lack of near-term easing stance by the G-3 central bankers is weighing on risk sentiment. The markets are finally coming to the realization that the central banks are now at a point of diminishing returns from QE. We are witnessing the fallout in some asset markets that are extremely vulnerable to a potential pullback of the exceptional QE measures from both Europe and Japan.
The Central Bank easy-money policies and its unprecedented bond-buying program have pushed investors into risky assets and have helped jolt asset prices higher, but it is an entirely different ballgame when Central Banks start reducing these measures and we may only be witnessing the tip of the iceberg at this point. The renewed equity weakness and steeping yield curves is a pretty toxic mix for a market accustomed to summer complacency.
As the G-3 Central Bank “Game of Thrones” theme unfolds, I think that forex markets will continue to be driven short term by equity and bond market movements amidst the broader risk aversion play. We are in for a bumpy ride through next week’s FOMC.
Yesterday’s timid Australian Dollar bounce, post dovish Brainard, was the first sign of the shifting dynamic in risk assets where traders are moving from a buying the dip, to sell the rally mentality. With equity markets looking shaky overnight, traders pounced on the risk currencies at the slightest hint of risk aversion, which saw the Aussie dollar plumb to .7445.
In the commodity markets, despite stronger-than-expected Chinese data, Iron ore was off over 3% on overhang supply concerns after the China Notation Bureau of Statistics revealed steel output rose by 3 % year on year.
Oil markets are also weighing on Commodity currencies as the IEA cuts global oil demand forecasts; it puts the whole notion of OPEC production freezes in the meaningless file.
The plot thickens as the USDJPY jumped higher following US 30y Treasury auction which went off poorly, pointing to higher US yields as the 10y yield topped at 1.72%. The pair then caught tailwinds from repurposed BOJ easing speculation after the Nikkei reported that the BOJ was exploring delving deeper into negative rates.
Once again, we are experiencing deja vu as the market clambers for top side exposure to USDJPY for fear that the Bank of Japan might surprise this time around. While the Nikkei story offers little more than recirculated conjecture, the one area the BOJ could surprise is through an expansion in foreign asset purchases, the measure suggested late last month by Koichi Hamada to weaken the Yen.
We saw the double-edged sword effect of the mainland’s economic news, as despite all the activity metrics for August coming in better than expected, the equity markets fell as the data diminished the likelihood for additional PBOC stimulus.
USDCNH is trading above 6.69 on the backdrop of a stronger US dollar, this despite the oppressive CNH short-term funding rates. USD is king in the current risk aversion environment
Besides factoring for the mainland holidays, liquidity has been weak as everyone is waiting for more guidance in the Fed funds rate path; conditions will probably remain as such through to next week’s FOMC.
The Ringgit is getting little joy from oil prices after the IEA cut its global demand forecasts and warned that supply would outpace demand in 2017. The Ringgit looks precariously perched as G-3 central banks temper the liquidity taps, with oil prices reeling and concerns resurface as to a global economic slowdown. It has been a very rough 24 hours for Emerging Markets.