Global equity markets may be cheaper again on Monday morning, and some bounce back this week is likely as the market anticipates more global policy easing, but it is hard to be inspired. It feels like a sell the rally market, not a buy the dip. In fact in the eye of the storm this morning, many may think it’s a “just get me out of everything now!” market.
There is a tiredness to global equity markets that hasn’t been seen for a while. Prices of developed markets have been plumped up and lack go-forward and emerging markets are suffering from internal excesses, particularly in China. Commodity prices trends are weak with too much supply adding to fears over falling and too low inflation.
It may be the case that emerging and commodity currencies have to weaken significantly further to help cheapen up their assets and encourage capital flow back to their economies.
The Fed and the UK were on a path to raise rates, but the likelihood is that these plans are put on ice. This will probably help to some extent underpin equity markets.
But it is hard to imagine that it will be enough to see a sustained recovery, at least not until the US economy gathers clearer rising momentum, and this is far from assured.
The Eurozone and Japan may soon find rebounding currencies and falling equities quite unpleasant as they remain far from home base on their inflation objectives. This could eventually force their hand to attempt more monetary easing. This would ultimately end the recovery phase in their currencies.
EUR could find its rebound fleeting, as at least some of the EUR recovery appears to have arisen from improvement in the periphery economies (except Greece) and jump higher in German bund yields since Q1.
A step up in the ECB’s QE stance could be more effective than in Japan where policy makers are largely all in on QE. If Japan feels more compelled to weaken its currency it could go for negative rates or escalate the currency war with unsterilized FX intervention, but these options, especially the later, are harder to reach for and might require significant further strength in JPY first.
I am not advocating selling either EUR or JPY just yet. In fact further strength in both currencies appears more likely as the market absorbs the message that Fed rate hikes are likely to be postponed.
The July FOMC minutes suggested that the timetable for policy tightening in September had been set some time ago and the Fed needed a pretty good reason to delay launch. The strength in the labour market was the most important thing keeping them on track to tighten, and in that respect the evidence was still supportive.
But the risks to launch were all moving in the other direction, and the clouds now brewing over the launch site have grown darker since the Jul policy meeting. The prudent course of action appears now to stand-down. But once the count-down is halted, the market will wonder for how long, and it may seem a more permanent delay, especially with a strong USD against EM currencies and weak commodity price trends. Economic growth momentum is better in the USA than most countries, but it does not appear nearly as robust as it did last year, weighed down by a stronger USD and weaker energy sector.
My strategy at the moment is pursuing weakness in commodity currencies that may need to play catch up to weaker emerging market currencies over recent weeks. NZD is off over 1% today, but it is still only mid-range over the month. AUD is now testing the low side of its range and may be setting a fresh weakening course. I like USD/CAD higher as the most energy sensitive of the three. It has also risen to a new high this morning after a few weeks consolidating.
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