IG Markets Afternoon Thoughts

IG Markets Afternoon Thoughts

After pretty lacklustre US trade, Asian participants felt compelled to sit on their hands, simply waiting for more clarity on how the US debt debate plays out.

Looking around the region, the Nikkei is down 0.5%, almost certainly getting a double blow by the strength of the JPY. The Hang Seng is down 0.1%, whilst the Shanghai Composite is up an anaemic 0.2%. A news report released earlier suggested that China may raise rates at least once this year, although it seemingly has had little bearing on trade.

In Australia, the ASX 200 has traded in a relatively narrow range for most of the day, as again domestic traders questioned exactly how a downgrade to US debt would change the dynamics of different asset classes. The chances of a full default are very small, almost zero, with the worst-case scenario (on Credit Suisse’s estimations) being a 5% fall in US GDP and a pullback, perhaps to the tune of 30% in equities. The loss of confidence globally is not worth thinking about, so it simply won’t happen; the two warring US parties know this and therefore it will be sorted out. However, a downgrade to US debt is very real, and last night’s survey of economist by Reuters showed that 56% of them actually see this happening in the next three months. This is keeping investors cautious in the short term, and even though equities are cheap, if the worst-case scenario was to play out the earnings environment for global companies would deteriorate massively. The perfect situation would be a compromise from both Republicans and Democrats which would see at least three to four trillion dollars being cut from the deficit over ten years and the debt limit being extended until after the November 2012 elections. Anything less and the ratings agencies could cause more global chaos.

Until we get clarity on the situation, gold, silver and Swiss francs remain the places to be, and traders will buy any dips as they look to hedge out portfolio exposure.

The key level to watch on the ASX is 4600, the downtrend resistance from April. The index has respected and pulled back from this figure around six times, so this has clear validity. Until we see a sustained close above this level, the index remains in a short-term downtrend with traders looking to sell into strength.

Certainly the highlight of the day was the Australian 2Q11 CPI figure, which came out before midday. The RBA had suggested it would be putting credence on this figure, so forex, equity and fixed income traders around the country paid close attention too. The fact that CPI came in above consensus at 0.9% saw AUD/USD make a new all-time high of 1.1063, although profit taking pushed the pair lower as we get closer to the London open. The AUD actually pushed up against all G10 currencies, notably against the SEK, where AUD/SEK has gained 0.9% today. We don’t think this really gives the RBA the ammunition to put up rates in the short term At the very least this provides reassurance to traders that the next moves is not down, even though there are many out there who would dearly love to see that happen. The credit market has reacted and are now pricing in a 20 basis-point cut over the next 12 months, with a 40 basis-point cut expected prior to the release.

The AUD/USD is getting quite crowded from a positioning perspective, although we believe the fundamentals are strong for the pair right now. With central banks diversifying into AUDs, it is unlikely we are going to see everyone run to the exit at once. The next stop appears to be 1.12, and traders will be paying even more attention than ever to narrative from CEOs at the upcoming earnings reports on potential downgrades to future earnings due to the high AUD.

ENDS

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