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IG Markets - Morning Thoughts

IG Markets - Morning Thoughts

Volatility picked up in a massive way overnight, as traders reacted by repositioning their portfolios and forex holdings as disappointment set in when no definitive action was announced from the ECB.
The ECB meeting was clearly the event risk of the week. While most (including ourselves) believed that Mario Draghi had built a rod for his own back by building up expectations, on reflection it seems logical that perhaps the markets misinterpreted his original comments that the ECB will do all it can to save the euro.

The initial reaction to the ECB rate decision was to bid up risk assets, but as doubts crept in and markets didn’t hear exactly what they wanted to hear, EUR/USD dropped from 1.2405 to 1.2134, AUD/USD 1.0580 to 1.0463, Dow futures 13030 to 12723 and the SPI fell from 4255 to 4178. These were huge moves by any standard and a clear lesson in positioning. We have had a massive shake out of speculative positioning and the stabilisation at the low levels could certainly be construed in a positive fashion.

We have been left with a Central Bank that has promised a framework for ECB intervention in the bond market, and we should in theory get more colour around this in the next few weeks. The details of this are vague, which is part of the reason for the extreme sell-off, but we do know that it will start buying bonds as and when the EFSF/ESM has been fully ratified and once a sovereign such as Spain or Italy makes a formal request for assistance. This firmly puts the emphasis back on governments to do what is necessary, and the fact that the ECB has suggested it will focus on the short-end of the curve (i.e. buying bonds with maturities of two years or less) backs up this point. This is exactly where individual treasuries have been issuing bonds of late, so it’s in their interest to bring down front-end yields. We also don’t know the exact size of any bond buying or even if it’s unsterilised (expansion of the money supply i.e. QE), so in theory it could be uncapped which would be very positive.

With the Fed likely to do some form of easing in September, the ECB is likely to buy sovereign bonds, although we will inevitably have to see a country like Spain formally request a bailout. With China now making growth its number one priority (as reported today in the Wall Street Journal), surely the conditions are in place for a melt-up in risk assets over the next few months. It was obviously disappointing not to get outright buying of bonds by the Fed and ECB, but it seems they will come and in the case of the ECB, could be unlimited.

Today’s ASX 200 open will be weaker with our call being 4241, down 0.7%, with BHP’s ADR suggesting an open 1.3% softer. It will be interesting to see the reaction of the Asian trading community who have the benefit of going through the information with a clear head, and perhaps not get caught up in the emotion that saw a few traders close out of long positions overnight. We feel or least hope that traders see the positives that are brewing in the macro backdrop and will look to support risk assets on dips going forward.

Clearly tonight’s US payrolls report is the next key event risk and AUD, equity and commodity bulls will be hoping for a number either significantly higher or lower than the 100,000 consensus. A number weaker than 100,000 will surely solidify the Fed’s position on easing and will weaken the USD on QE3 expectations, while a good number will boost risk assets on the premise that the US is not in such a bad shape. Perhaps the jobs print will be watched most closely by President Barack Obama, with some even suggesting the S&P is being supported at present not just by the ‘Bernanke put’, but by the pricing in of a Mitt Romney win this November.

Market Price at 6:30am AEST Change Since Australian Market Close Percentage Change
AUD/USD 1.0461 -0.0021 -0.21%
ASX (cash) 4241 -29 -0.67%
US DOW (cash) 12887 -112 -0.86%
US S&P (cash) 1366.2 -10.6 -0.77%
UK FTSE (cash) 5666 -56 -0.97%
German DAX (cash) 6602 -162 -2.39%
Japan 225 (cash) 8570 -83 -0.96%
Rio Tinto Plc (London) 29.10 -0.95 -3.15%
BHP Billiton Plc (London) 18.58 -0.34 -1.81%
BHP Billiton Ltd. ADR (US) (AUD) 31.60 -0.42 -1.32%
US Light Crude Oil (September) 87.40 -1.48 -1.67%
Gold (spot) 1590.0 -12.1 -0.75%
Aluminium (London) 1836.625 -31 -1.67%
Copper (London) 7290.875 -174 -2.33%
Nickel (London) 15313.5 -340 -2.17%
Zinc (London) 1855.875 -36 -1.88%


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