IG Markets Afternoon thoughts 6/5/11

Across Asia, regional markets are all lower following the big sell off in commodities prices overnight and the weak equities lead from New York. This sent traders to the sidelines ahead of tonight’s key US jobs report. The Kospi and Nikkei 225 are the worst performers, down 1.9% and 1.6% respectively. Elsewhere, the Hang Seng is lower by 0.6% and the Shanghai Composite is down 0.2%.

In Australia, the ASX 200 is currently 02% weaker at 4746, well off its earlier session lows of 4713. On the back of heavy overnight losses across US markets, the local market opened down sharply but may now be benefitting from its recent underperformance with oversold names staging somewhat of a recovery. The biggest gains for the day are coming from the healthcare and financial sectors, while the materials and energy sectors are unsurprisingly under heavy selling pressure after the entire commodity complex was smashed overnight.

The financial sector is one of the best performers. National Australia Bank is the standout as it continues to benefit from yesterday’s stronger than expected first half result. The market was surprised by the result, with no fewer than three brokers upgrading the stock to buy. This has definitely resulted in some switching, with Westpac likely the main funding stock.

The technical support levels around the 4700 – 4725 levels have been proven once again today; the market traded to an early low of 4713 before the buyers moved in to support the market.

The main concern this week for markets has been the rout in commodities prices, which all started in the precious metals complex. The CME raising silver futures margins no fewer than four times has seen the metal plunge near 30% in four days, the biggest such fall in 28 years. The selling spread to other commodities, reaching fever pitch overnight as the US dollar staged a sharp short-covering rally.

There has been a lot of froth in US dollar denominated commodities prices recently; since the S&P credit outlook downgrade, the US dollar has fallen out of bed, sharply boosting the prices of commodities. However, the lessons and fears from the GFC are still front and centre of traders’ minds. A lot of participants are ‘dancing a lot closer to the exit door’ these days and are willing to hit the sell button a lot quicker than pre-GFC days. This is the main reason pullbacks seem to be more volatile these days.

It is hard to keep pace with the moves we are seeing in the AUDUSD at present; overnight we saw a dramatic bout of profit taking as commodity prices were sold off hard whereas today traders look to have squared and reversed short positions after hawkish comments from the RBA helped a solid bounce from the lows.

Whilst the RBA maintained its view that households remain cautious and the housing market subdued, the fact they see 4Q CPI at 3.25%, effectively an upgrade from 3% in February with GDP above trend at 4.25% in Q411 was positive for the local currency. They also anticipate the unemployment rate at 4.25% in 2013 which will only add to wage pressures. Comments that ‘higher rates will be needed at some point’ also helped support the bullish cause.

It was not just the AUDUSD that rallied; the AUD pushed higher against all G10 currencies as interest rate expectations increased and were bought forward. Not surprisingly, the credit markets reacted, pricing in 37 basis points of tightening over the next 12 months and bringing forward the timing of rate hike expectations; there is a 38% chance of a hike in June, up from 14% prior to today’s minutes.

We still believe that the RBA are not in a huge rush to raise rates in the short term and given the fiscal restraints likely in the upcoming budget, it could be counterproductive to run a ‘too restrictive’ policy. However, a hike later in the year is certainly not out of the question.

Tonight’s nonfarm payrolls report will no doubt generate further volatility. A number north of 200,000 private sector jobs should ignite a risk rally, pushing the AUDUSD convincingly above 1.07.

ENDS

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