The Daily Fix

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Politics and geo-politics dominate the market narrative in Asia, with a further escalating war of words and actions between the US and China, which has seen Google enter the fold, suspending some business activity with Huawei, with a number of US chipmakers cutting off supplies as well. The fact China have recalled two giant panda’s from San Diego Zoo shows the increased level of tit-for-tat unfolding.

We have also seen the US narrative towards Iran beef up, notably, Trump’s tweet detailing that “if Iran wants to fight, that will be the official end of Iran”. Oil is having a move today, with WTI crude up 1.3% and eyeing a re-test of the failed breakout area of $64.70.

We can add in elections in India, with Prime Minister Modi getting a second term, which should sit favourably for Indian markets and we are seeing USDINR gaining 1.2% on the re-open. In the UK, the political news flow has ramped up again, and traders are being forced to refocus on the Brexit saga, with Theresa May promising a “new and improved” Brexit deal. GBP implied volatility is elevated, and as long as traders feel any further votes will fail to pass through the Commons, and this week’s EU parliamentary elections will result in Nigel Farage’s Brexit Party confirming they are a serious challenger in the UK’s political landscape, then GBP should continue to be the ugly child of G10 FX. Certainly, the vultures are circling Teresa May’s political career and its Boris Johnson that is the clear favourite at this stage.

It’s unclear if the EU elections will pose any serious threat to the EUR this week, although there is a renewed focus on Italy and the yield spread between Italian and German bunds back as a volatility driver. With Italian deputy PM Salvini detailing that Italy could look past the EU’s fiscal shackles, the yield differential is our benchmark of political risk. For now, though, the main event will be upcoming Eurozone data, with German IFO and PMI data due through the week.

All the talk is on the Aussie political landscape

It’s the Aussie political picture that is all the talk locally, with Scott Morrison securing a majority in the lower house. Naturally, all the focus has turned to the inaccuracy of the polls for consistently providing market participants high expectations of a Labor victory, and it just makes us think how we will price assets around binary events in the future. When so many of the recent political case studies providing absolutely zero confidence polls are a useful guide to help accurately price risk, we understand we can’t avoid polls, but we know we can’t rely on them either and have to consider alternatives going forward.

The wash-up is we have the LNP commanding a majority in the lower house, and as such we’ve seen a quick repricing here, notably in the equity market with the ASX 200 pushing to 6477 and the highest levels since February 2007, on volumes some 30% above the average. This has taken the ASX 200 12-month price-to-earnings ratio to just shy of 16x (the highest since early 2018), with the risk premia partially coming out of the market.

As you’d imagine, the financial sector has led the charge contributing a massive 101-index points, with private health names having some sizeable moves as traders’ re-price the potential for margin expansion. Property has worked well too, as has consumer discretionary, while the index could have been higher, but for mining and industrial names finding buyers hard to come by, and considering the index gains, breadth hasn’t been great.

We’ve seen a reasonable sell-off in the front of the Aussie bond curve, with 3yr Treasury yields gaining five basis points at 1.237%, and 4bp for 10s. In rates, we’ve seen selling in the June cash rate futures contract, which is at the centre of the debate we’re all having – that being, will the RBA cut rates in the June meeting or will they hold off? With the election giving us the certainty that the status quo will be maintained we’ve seen the implied probability of a cut on 4 June fall to 72% (from 80%). This feels fair, and not to be alarmist, the unemployment rate is actually trending higher now and is sufficient for the RBA to question the logic of waiting – if they are going to go, why wait, seems to be the message the rates market is portraying.

We’ve seen positioning in AUD futures, specifically, those held by asset managers, blowing out to -43k contracts, while leveraged accounts (hedge funds) have increased their net short position to -11k contracts. We can also see AUDUSD 1-Month risk reversals trading to -1.1575x, and this shows a strong skew from options traders to buy out-of-the-money ‘put’ volatility over ‘calls’. The market is short AUD and sentiment is cooked and rightly so.

So, with these dynamics in mind we could argue the AUDUSD should be a touch higher, but with RBA governor Lowe due to speak at a lunch tomorrow at 12:15aest, potentially pre-guiding the world to a cut, its hard to be long the AUD with any real conviction and I’d say most of the flow we have seen today is purely short covering. Of course, if we don’t get a clear indication tomorrow from governor Lowe then the implied probability of a cut will fall below 50%, the AUDUSD will rally into the 0.7000/50 zone, and the ASX 200 will be sold. It is an event risk we should be aware of.

It’s interesting that after stronger open, AUDUSD has reverted to tracking USDCNH, albeit inversely. The fact the PBoC has called for a ‘steady currency’, has promoted selling of USDCNH and in turn supporting AUDUSD.

I am still holding AUDJPY shorts, but with price now above the 5-day EMA it suggests waiting for confirmation of a close above the average before exiting, and I have placed a hard stop loss above 76.37. It would not surprise if we saw sellers coming in through European trade, so I am happy to hold for now. In the battle of political currencies, EURAUD and GBPAUD dominate here, and I am looking at EURAUD as price unfolds. A rally off 1.6122 could suggest a move into 1.6350, which is a huge level for the pair.

Published by Chris Weston, Head of Research, Pepperstone

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