May 8, 2015

Markets Today: Snapping the elastic band

If you pull an elastic band hard enough, it will snap back and might hurt. It seems we are getting that in yields, but we know that the band runs out of energy at some point.

If you pull an elastic band hard enough, it will snap back and might hurt. It seems we are getting that in yields, but we know that the band runs out of energy at some point. We might have seen that last bit of energy last night. Yields are flat, US equities are a little higher. The USD was stronger.

While German bunds look relatively unchanged on the night, a look at the run up over the week and the intraday moves overnight are astonishing. There has been an extreme reaction to the almost zero yield (0.454%) earlier in the month. There has been a reassessment of the risks and half a percent for a 10 year bond was thought to have been too low; the longs have been rapidly unwound and yields have snapped back up. Last night there was a (perhaps) last hurrah – a rapid rise in yield and then a reversal later in the day. There was no specific news.

That suggests that the extreme move higher might have run out of steam. It is thought that perhaps this yield move is driven by a stabilisation in oil prices, some better European data and rising term premium. Add to this the electronic platforms were halted, given the volumes and sharp price moves, and it all adds to volatility.

If we get to extremes in price of assets, it doesn’t take much to get reversals, particularly at economic turning points. What then matters is if you believe the reversals are warranted or sustainable. In the case of bunds, it depends if you believe the ECB will need to ease more or not, or if there is a recovery or not. What we can say is that there remains a lot of uncertainties ahead and these moves are unlikely to remain in a straight line.

At present, it is the bond market which is driving the news and other markets’ direction. The reversal at the end of the day saw the USD recover some gains from the past week. But the moves were relatively small. This saw the EUR lower and the AUD underperformed the rest of the G10.

Yesterday, while Australia’s labour market data headline came in a little worse than expected (-2.9kA, +4E) the previous month was revised higher (+48.1kA, 37.7P). The unemployment rate ticked up to 6.2% as expected.

Coming Up

As we noted yesterday, this morning we are likely to get a succession of headlines regarding the UK election outcome. The newsflow is likely to have more of an influence on currency volatility (obviously more so in GBP and EUR) but general sentiment may weigh somewhat on the local currency.

More interesting (for local markets) is likely to be the RBA’s statement on monetary policy (SoMP). With Tuesday’s easing coming without much guidance, and subsequent pricing out of future interest rate easing, all eyes will be on the SoMP to see if a bias is indicated. The risks for a move in markets are skewed to some easing being re-priced.

China’s trade data has historically been very important for local markets and we should have passed the lunar new year distortions. There is an expectation that the decline in domestic demand (via imports) has stabilised and that exports have started to pick up. That would be good news for Australia. Although, the volume of our exports being sent to China hasn’t been the big worry- the price has been. News on that front in recent days has been good, with iron ore back to $60.

But with all that going on, the US’s monthly non-farm payrolls release remains king. After some poor US data, much hinges on an improvement in April. Estimates range from +175k to +327k; with a median of 230k. last night’s jobless claims were encouraging; with the four week moving average at a 15 year low.

The recent rapid rise in bond yields has been large, far greater than warranted by the economic data or newsflow. In this, the FX markets have followed, but to a smaller and less consistent extent. As such, the greater risks lie to the bond market for a weaker payrolls outcome (yields lower) and to the FX markets on a stronger than expected employment outcome. On a stronger than expected outcome (the lower probability outcome), the USD should be afforded some additional catch-up.


On global stock markets, the S&P 500 was +0.40%. Bond markets saw US 10-years -6.31bp to 2.18%. On commodity markets, Brent crude oil -3.42% to $65.45, gold-0.6% to $1,183, iron ore -0.9% to $60.36. AUD is at 0.7906 and the range was 0.789 to 0.8005. (For more market prices, please see p.2 of the pdf).

•           US jobless claims 265kA, 262P

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