May 7, 2015

Markets Today: What a tangled web

We are likely in for an interesting debate ahead: Central banks lower policy accommodation to astonishing levels and then suggest that markets might be a touch expensive.

We are likely in for an interesting debate ahead: Central banks lower policy accommodation to astonishing levels and then suggest that markets might be a touch expensive. Funny that. The warning from the Fed’s Janet Yellen was heeded overnight, with US equities lower and bond yields higher across the board. The oil up, USD down process continues, with the EUR benefitting most from the carry trade unwind.

The Fed’s Janet Yellen was responding to a panel question when she (not for the first time) noted that equity market valuations might be “quite high.” She then went on to note that bond yields were also “very low” and that there might be “dangers there.” She warns that we might see a sharp jump in yields when the Fed raises interest rates.

The distortions in markets which arise from extremes in policy accommodation have been pondered for some time now but we are likely getting to the pointy end of the debate. How to extricate yourself from such policies without causing a rapid re-pricing in markets is the question. We don’t want a ‘taper tantrum” but neither can we see rates on hold forever – which can create overvaluation in assets. It’s a tangled web.

Markets are testing out the possible implication and we continue to see bond yields rise sharply. One of the additional explanations for last night’s move is the stabilisation of oil prices which raise inflation expectations. And in the currency world, the narrower yield differential to the US, and higher volatility, means an unwinding of short EUR trades. The EUR has recovered the ground it lost from February. This was helped by some modestly positive news from Greece and better services PMI data.

On the downside, for US risk assets, was the poor ADP employment data. This series really isn’t that credible an estimate for US payrolls anymore (the last few month’s misses have been around 70k), so they shouldn’t have been a strong factor in market moves overnight.

Interestingly, the Fed’s Lockhart noted that a possible interest rate hike was still “reasonable” in September. So while the data remains mixed as we move on from the Q1 weather distortion, the first baby steps towards normalisation are still in play. That will keep volatility supported. This does create risks for high beta assets, such as the AUD and EM. That is not being factored in at present – EM FX outperformed the USD overnight: revert back to Yellen.

Coming Up

Amid the general market volatility, today we get the monthly Australian labour market data. Expectations can be taken with the usual pinch of salt, with forecasts ranging from -20k to +20k (NAB is flat). With the RBA having provided little guidance to the policy path ahead, the data and the unemployment rate in particular, is going to have more of an influence on markets. We know that volatility rises on less market guidance. Given this, and no matter your thoughts on the data, the employment report remains a key event on the FX and domestic asset calendar.

The day is likely to then be relatively quiet as the UK finally gets to vote. Now elections garner lots of interest in markets with speculation over possible partnerships (recent years have seen a rise in coalition governments), and policy; but rarely do they have a lasting effect on market. This one may be different given the inherent uncertainties involved. The polls are neck and neck and the possible partners an interesting mix. Even if the status quo gets up, there may be a referendum on the UK remaining part of the EU. All of this is fodder for market uncertainty and risk aversion. The UK polls close at 10pm (LDN) and the exit polls are likely to be a few hours later. But, given the complexity of the race the results are unlikely to be known until at least well into Friday.


On global stock markets, the S&P 500 was -0.70%. Bond markets saw US 10-years +4.52bp to 2.23%. On commodity markets, Brent crude oil +0.07% to $67.57, gold-0.2% to $1,191, iron ore+3.7% to $60.89. AUD is at 0.7975 and the range was 0.7919 to 0.8031. (For more market prices, please see p.2 of the pdf).

•           US ADP +169kA, 200E, 175P rev from 198.

•           EU services PMI 54.1A, 53.7E, 53.7P

•           UK services PMI 59.5A, 58.5E, 58.9P

For full analysis, download report:

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