The Bull

Sunday 01

February, 2015 3:03 PM

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Afternoon Thoughts

Afternoon Thoughts

It?s a good day to be an equity bull.

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By Expert Panel 30.01.2015

Chris Weston, Research Analyst, IG

It’s a good day to be an equity bull.

European and US markets look set for a renewed tilt at recent or all-time highs, while the Nikkei has found good buying and looks set to test the top of its recent range at 18,000. Even the Greek market has seen a modest rebound and, while there have been articles about Greece having no choice but to leave the monetary union, there is also an argument that the current program of structural reform will be maintained.

ASX 200 looking strong

Locally in Australia the ASX 200 is a pillar of strength and is on track for a weekly gain of 2%, building on last week’s 3.8% rally. The bulls are dominant and, after a 6.6% gain from the 16 January low, has the August highs and 5700 on the index in their sights.

The swaps market is now pricing a 65% chance of a rate cut next week, although this is no certainty and, to be fair, traders are cueing off one article by a journalist who hasn’t had the same inroads to the Reserve Bank of Australia (RBA) for many years. Caution is therefore required and I think the playbook is not as black or white as the RBA simply leaving rates at 2.5% and the AUD subsequently rallying.

There is every chance we will see rates unchanged, but the RBA changing the last paragraph in their statement, removing the key phrase ‘on present indications, the most prudent course is likely to be a period of stability in interest rates’ to something more dovish like there is ‘some scope to ease’. This, in turn, will give a clear signal they will be cutting in March.

In this case, we could see AUD/USD all over the place and after an initial pop we could see the currency undergo a vicious reversal. As mentioned yesterday, it is understandable why implied options volatility is so high.

There is an argument that the RBA will be keen to leave the cash rate as it is to give it firepower in case of a major offshore economic development further down the line. However, if we do see rates on hold, then the full focus of the market will turn to Friday’s Statement on Monetary Policy. Recall one of the inputs the central bank uses for its June 2015 inflation forecasts of 1.5% to 2.5% is Brent Crude, which they previously forecast at $86. Given front month Brent is trading 43% below their prior estimate, it will be interesting to see if they tweak the forecasts.

Still, judging by price action in the market, there is a real belief the RBA are going to join New Zealand, Europe, Denmark, Switzerland and Canada in easing policy. The fact the buying in the ASX 200 is fairly broad-based is interesting, but that could also be a function of the Chinese Vice finance minister saying China will keep strong and sustainable growth between 2016 and 2020.

Keep in mind that we get Chinese manufacturing PMI numbers over the coming week, so there is risk of gapping on Monday. Market consensus is that we see manufacturing expand at a slightly faster rate at 50.2.

Positive signs in Europe

With Asian markets generally supported, we should see a positive open in Europe. We all know European markets have performed strongly as traders priced in the idea of liquidity making its way into the equity market.

Still, I think there are some signs of ‘green shoots’ in Europe. Firstly, if the European Central Bank focused on core inflation as opposed to headline inflation, they probably wouldn’t have announced its recent QE program in the first place. Headline inflation is released today and expected to fall another 30 basis points to -0.5%. Core inflation, however, should stay unchanged at 0.7%.

We have seen signs in the ECB’s Q4 bank lending survey that banks are starting to lend more, with new loans to business hitting the highest level in over three years. Yesterday’s M3 money supply continued to improve and is now running at a 3.6% annualised rate. Perhaps things aren’t so bad and it’s possible we will see inflationary signs later this year, with ECB economist Peter Praet saying yesterday that the turning point in inflation ‘may be around be around Q3’.

A basic ‘fair value’ model of EUR/USD (using a number of variables, including two-year swap rates) suggests EUR/USD could find better buying in the short term and perhaps the heavy selling is over for now. Near-term resistance is seen at the December downtrend at $1.1450 and a break here would see the pair target the 38.2% retracement of the December sell-off at $1.1659.

I’ll be watching the US employment cost index (expected to grow at an annualised pace of 2.4%), as this is a data point that the Fed watches closely. Further improvement could see the market once again focus on when or if the Fed will hike.

Ahead of the European open we are calling the FTSE 6829 +19, DAX 10795 +58, CAC 4665 +34, IBEX 10572 +65 and MIB 20720 +127

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