Below trend growth to continue
Tangerine Dream, the German electronic music group, provided the soundtrack for Risky Business, the 1983 Romantic Comedy starring Tom Cruise and Rebecca de Mornay. The group have produced over 100 albums since forming in 1967.
There’s German efficiency for you, and which is a big part of the story vis-à-vis the largely Euro-led weakness in the US dollar in the last week or so and which gathered momentum on Friday. It came alongside a resurgence in risk sentiment, exemplified by the VIX trading back below 10 (it closed at 9.36 on Friday having been as high as 14.5 at mid-month. Ignore the intra-day print of 8.56 – a record low – that looks to be dirty data).
On Friday, the German IFO business survey surged to a new record high of 117.5 from 116.8 (well above the 116.7 expected) hot on the heels of Thursday’s Manufacturing PMI which also printed a record high of 62.5 up sharply from 60.6 in October. Thanks to the largesse of the ECB’s one-size-must-fit all monetary policy, its country’s 10 year bond yield is trading at 0.36% and its 5-year bond at -0.33%. That’s a story we think will have to change next year, but not this.
The strong German data, alongside evidence that Angela Merkel’s CDU and the SPD were inclined towards forming another grand-coalition government, meant that the EUR led the 0.47% drop in the DXY dollar index on Friday, albeit most of the gain came well after this news flow had hit the screens. As well as strength in the Euro and EUR-linked currencies (SEK, CHF), the British pound also fared well with optimism towards progress on Brexit negotiations ahead of the December EU Summit remaining evident. The EU has set a 4th Dec. deadline for progress on the divorce bill and the even thornier subject of the post-Brexit status of the Irish border.
AUD and NZD remained the laggards Friday, both down intra-day, while the JPY ended Friday as the weakest G10 currency thanks to higher US yields across the maturity spectrum. Emerging market FX indices took a small hit late Friday from the fall in the Rand on S&P downgrading South Africa’s credit standing to junk. Weak GDP growth and related deterioration in public finances was the pretext. Moody’s has held its (lowest) investment grade rating but shifted the outlook to negative. USD/ZAR jumped from 13.9 to 14.2.
This is relevant to Australia insofar as the AUD has been tracking closely with the likes of JPM’s global EM FX index in recent weeks (down from mid-September through mid-November, but up since) while ignoring the strong showing by Asian EM currencies. The index took a small hit on Friday post the SA news, but still ended 0.3% higher on the week. Weakness in EM FX will need to broaden out again to come back and bite the Aussie. While the USD is back on the skids, this isn’t likely to happen.
US Treasury yields by and large held the gains witnessed during the APAC time zone, averaging 2bps and so the curve not doing much. On the week though, the curve flattening theme remained very much in evidence, 10s lower and 2s higher, the latter notwithstanding the impact of the Yellen comments and FOMC minutes, both revealing concerns that the factors that have supressed inflation this year may be more than transitory. The spread between 10 year Aussie and equivalent US government bond yields compressed by a further 7bps last week.
In commodities everything was up bar gold (-$5) with oil benefiting further on optimistic noises regarding chances of OPEC and non-OPC producers (dubbed OPEC 2.0) agreeing to preserve current production cuts through 2018. They meet on Thursday.
Iron ore can do no wrong at the moment, up another 30 cents to $67.94 and +8.5% on the week, but with limited impact on the AUD compared to other drivers (remember almost none of the incremental revenue from higher iron ore prices will flow back to Australia). That said, commodity prices are now back offering a tailwind for the AUD alongside the recovery in developed markets and global EM risk sentiment as well as the softer big dollar trend.
Ahead of Q3 GDP next week and the RBA meeting the week after, most local interest this week will centre on Thursday’s Capex for signs of business investment improvement and enhanced expectations.
Internationally, markets will be looking for Fed rate clues from Chair-elect Powell and Yellen, Yellen delivering her final semi-annual testimony and Powell speaking at his Senate confirmation hearing (Tuesday and Wednesday respectively). There’ll be understandable focus on Wednesday’s US PCE deflator and Friday’s ISM manufacturing report. The OPEC meeting starting Thursday will be important while on Thursday and Friday we’ll get both the official and Caixin China PMI prints for November.
At least until we get into the meat of the week’s event risks, AUD/USD can probably build on last week’s 0.7% gain; the 50 week moving average near 0.7650 is one technical draw-card.
On global stock markets, the S&P 500 was +0.21%. Bond markets saw US 10-years +2.31bp to 2.34%. In commodities, Brent crude oil +0.49% to $63.86, gold-0.4% to $1,287, iron ore +0.4% to $67.94, steam coal +1.0% to $96.55, met. coal +0.1% to $190.50. AUD is at 0.7623 and the range since Friday 5pm Sydney time is 0.7607 to 0.7632.
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