Start of a new week – end of another month today, however tomorrow marks the start of a big month for both equities and currencies.
Being May the old adage ‘sell in May and go away’ will be rolled out as it is every year. Fundamentally valuations are ‘tight’ in equities and bonds however the central question here is: if one sells out – where to from here with my investment capital? Watch the push-pull in May it will be strong likely to the conservative side.
Looking at the data for the week and it really starts tomorrow but the crux of the week is: central banks, US inflation and US employment.
Lets start by highlighting something rather important, this chart from Westpac off Bloomberg show the 2-year up trend in the AUDUSD has broken down
The possible retracement from the high to low over this period has the AUDUSD heading to 73.23c at the 61.8% level.
Considering the carry trade now has a spread difference of -20 basis points in the Aussie-US ten year and the level of perceived ‘risk’ in markets is picking up the AUD is facing headwinds.
The pair’s decline makes sense and (in my view anyway) will likely see further declines over the coming month as the spread in the 10yrs widens on Fed hikes.
This brings me to the central banks of the week
The Fed (FOMC)
May is a ‘non-testimony’ month therefore both the market and economists are forecasting no change to the target rate.
But this isn’t the key to the release the statement is. Any signs of inferred meaning of a more hawkish board would move the market’s opinion on the forecasted hike trajectory path.
Therefore, what will catch the markets attention if mentioned?
• The impact of the recent tax cuts and infrastructure spending on economic growth; is the US economy facing now ‘heating’ issues monetary policy needs to tackle?
• Jobs growth: are we at ‘full employment? The continued acceleration and slack in the job market suggest the US is at ‘full employment’. This week’s non-farm payrolls are after this week’s meeting so will not be included however signs are for another strong print in the average hourly earnings however unemployment and underemployment are at or nearing pre-GFC levels.
• Inflation, inflation, inflation: US core inflation is poised to pass the Fed’s second mandate of 2% inflation. The PCE inflation read for March is released tonight – the print has seen upside pressure due to wages increases over the past four months.
The Board is acutely aware that ‘runaway’ inflation will cause an acceleration of their ‘normalisation’ of the Fed funds rate. When the like of Lael Brainard and Neel Kashkari are turning hawkish due to ‘accelerated’ inflation the risk of 3 more rate rise in the State is building.
Of all the G10 currency central banks the RBA is the most neutral and most constrained by data – one could argue it’s the most ‘stable’
Even the most hawkish economists have had to move forecast of rate rises right out – three economists had a 25-basis point rate rise pencilled in for tomorrow in January, not anymore.
Making the month to watch November as it’s the only month left in 2018 where more than one economists forecasting a rate rise in 2018. (I can’t see a single move before Christmas, economic momentum is fragile and inflation is below trend.)
The interbank and the swaps markets have less than a 50% chance of a rate movement in the next 12 months and there is hedging build into these markets suggesting the markets’ probability for hikes could be even less.
All this feed back to the earlier chart – the AUDUSD is facing a central bank differential that should see upside pressure on the denominator through to December.