Equities continued trading north yesterday as recent developments revived hopes with regards to new stimulus measures by major economies, helping investors to overcome the recession fears triggered by the US Treasury yield inversion last week. In Australia, the minutes of the latest RBA meeting confirmed that policymakers remain willing to ease further if needed, and also revealed a discussion over unconventional measures.
The dollar traded higher against most of the other G10 currencies on Monday and during the Asian morning Wednesday. It lost ground only against NOK, while it was found virtually unchanged versus NZD. The main losers were CAD, GBP and JPY in that order, while the currencies which underperformed the least were AUD and EUR.
Although the performance in the FX sphere does not paint a clear picture with regards to investors’ morale, the equity world suggests that Monday was a risk-on day, with all major indices closing their sessions in the green. Asian markets were more mixed today, with China’s Shanghai Composite sliding 0.11%, and Japan’s Nikkei 225 ending its trading 0.55% up.
It seems that investors have been overcoming the recession fears triggered last week after the spread between the 2- and 10-year US treasury yields turned negative, as a cocktail of recent developments revived hopes with regards to fresh and decent stimulus measures my major economies in order to avert a downturn. Following remarks by ECB member Olli Rehn last week with regards to an “impactful policy package”, reports hit the wires over the weekend noting that Germany could increase spending by EUR 50bn in case of a recession.
On top of that, on Saturday, China announced interest rate reforms, that could result in lower borrowing costs for businesses. Indeed, during the Asian morning today, the first 1- and 5-year loan prime rates (which are calculated using the lowest 1- and 5-year rates 18 lenders offer to their best clients) were announced at 4.25% and 4.85%, below the 4.35% and 4.90% respective benchmark lending rates. The LPR would be announced on the 20th of every month and would be the lending benchmark for banks when setting rates for loans to households and businesses.
Having said all that, as we get closer to Fed Chief Powell’s speech at Jackson Hole, we would prefer to take a somewhat more cautious approach with regards to further gains in equity indices. At their latest meeting, Fed policymakers decided to cut rates by 25bps, with Powell saying that this was not the beginning of a long series of rate cuts, rather a mid-cycle adjustment to policy. That said, this was just a day before Trump’s decision to threaten China with fresh tariffs, with the new round of trade tensions prompting investors to add to their already elevated bets with regards to further easing by the Fed. According to the Fed fund futures, they are fully pricing in another cut in September, and a third one in October, while there is an approximately a 5% chance for a “double cut” at the September gathering. Thus, even if Powell appears more dovish than he did at the press conference following the last meeting, his remarks have to well satisfy market expectations in order for the equities to extend their recovery. Anything hinting at less easing than what investors are currently pricing in could have the opposite effect.
After getting held again at its short-term tentative upside support line drawn from the low of June 3rd, the Dow Jones Industrial Average moved higher, getting closer to its key resistance area near the 26420 barrier. But in order to examine further upside in the near term, we would need to see a break above that barrier first. From the shorter-time perspective, although it seems that the current path could be set towards the 26420 level, there is a chance to see a small correction back down before another leg of buying. As long as the index is trading below the 26420 level, we will stay cautiously bullish.
A move a bit lower could send the index to the 26000 area, or even slightly below it, to the 25946, marked by the low of August 18th. The price could also meet the 20 SMA of the Bollinger bands around there, which may provide some additional support. If so, the buyers could jump in again and send DJIA to the 26245 hurdle, which is yesterday’s high, a break of which might clear the path to the aforementioned 26420 barrier, marked near the highs of August 9th and 13th. This is where the index could also test the 200 EMA on the 4-hour chart.
On the other hand, if the correction down will be a larger one and the price falls below the 25805 zone, which is the intraday swing low of August 16th, this is where we will abandon our somewhat bullish view. This may lead DJIA to the next possible support area between the 25650 and 25690 levels. The index might stall there, or even rebound a bit. But if the buyers are not capable of lifting the price back above the 25805 barrier, the sellers could take advantage of the higher price and push it back down. Such a move may bypass the above-mentioned support area and target the 25325 obstacle, marked by the intraday swing low of August 15th. Around there DJIA could also touch the aforementioned upside support line.
Staying in the central bank world, during the Asian morning today, we also got the minutes from the latest RBA policy meeting. The message was the same as the one we got from the meeting statement, namely, that members remain willing to continue easing monetary policy if needed. What appeared interesting to us is that members reviewed the experience of other advanced economies with unconventional easing measures, such as negative rates and buying government bonds, and noted that a package of measures tended to be more effective than measures implemented in isolation.
As for our view, we stick to our guns that the “if needed” part suggests that policymakers may not be in a rush to cut rates when they meet in September and rather wait for the October gathering. Indeed, this appears to be more or less the market’s view as well. According to the ASX 30-day interbank cash rate futures implied yield curve, there is now only a 12% chance for a September move, while the probability for cutting in October stands at 65%. A 25bps reduction is more than fully priced in for November. In other words, investors expect the RBA to cut rates in October or November. It would be also important to see whether the discussion of unconventional measures will take a spot in upcoming meeting statements.
The Aussie reacted very little to the minutes’ release and actually traded higher in the aftermath, perhaps due to the increased risk appetite. With investors already expecting more action by the RBA in the next months, the Aussie could now stay somewhat more sensitive to changes in the broader market sentiment for now. However, in our view, there is a paradox here. If the improvement in risk appetite is due to hopes of fresh stimulus by major economies, including Australia, will the Aussie continue gaining? In our view, this may depend on which would be the counterpart. For example, increased speculation over a significant stimulus package by the ECB in September, combined with expectations of a sidelined RBA at its next gathering, may allow EUR/AUD to trade lower for a while more. The Aussie could also outperform the safe-havens JPY and CHF, which tend to come under selling interest when market sentiment improves.
In the beginning of August, EUR/AUD spiked higher, reaching the area near the 1.6785 level, from which the pair reversed and is now drifting lower. We notice that on the 4-hour chart, EUR/AUD is forming somewhat of a falling wedge formation. These, of course tend to eventually break to the upside, but until we see a clear break through the upper side of it, we will continue targeting lower levels, while moving inside of that pattern.
A further push lower, below the 1.6330 hurdle, could send the rate to the lower side of that wedge, which if holds, could force the pair to rebound somewhat. EUR/AUD could move sideways for a bit, but if remains below the 1.6330 barrier, this may be a signal for the sellers to step in again and drive the rate to the 1.6256 obstacle, a break of which might lead the pair to the 1.6211 level, marked by the inside swing high of July 31st.
On the upside, if we eventually get a break through the upper side of the falling wedge formation, this may be a good sign for more bulls to join in and lift the rate to the 1.6490 hurdle, marked by the intraday swing high of August 15th. Initially, EUR/AUD might stall around there, but if the bulls are still feeling strong, a break of that hurdle may lead the rate all the way to the 1.6595 level, marked by the high of August 14th.
From the UK, we get the CBI industrial trends orders for August, with the index expected to have risen, but to have stayed into the negative territory. Specifically, it is expected to have risen to -25 from -34. Later, from the US, we get the API (American Petroleum Institute) weekly report on crude oil inventories, but as it is always the case, no forecast is available.
On the political front, Italy’s far-right League said that it will present a no-confidence motion against PM Conte as the relationship with its current coalition partner, the FiveStar movement, has become increasingly tense recently. If Conte steps down, President Mattarella will conduct consultations with all the parties in an attempt to form a new government. If that’s not possible, the Parliament would have to be dissolved and new elections would be called.
As for tonight, during the Asian morning Wednesday, Fed Board Governor Randal Quarles will speak. Following the escalating tensions between the US and China just after the latest FOMC meeting, we may get some early hints with regards the Fed’s future plans, ahead of the Jackson Hole economic symposium.
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