By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank Ltd.,
US Services ISM blowing upbeat expectations (of 58.2) out of the park with a 8.4-pt jump to 63.7, spelt optimism with a capital “ISM”.
But not just that as this marks a hat trick of blockbuster US data following the outrun in Manufacturing ISM and NFP jobs data as well.
Taken alongside the $2(+1) trillion infrastructure plan, US economic prospects are not just bright but dazzling.
And indeed, as half-full as optimism can get, markets were happy to eat up the stellar economic story without fretting about the inflation genie being unbottled.
So even as equities surged led by Nasdaq’s 1.7% surge (Dow: +1.1%; S&P500: +1.4%) UST yields actually eased back ~2-3bps, with 10Y yields slipping below 1.7% and 2Y at 0.166%.
Whether this was a version of “everything rally” or, UST yields were subdued by softer Oil prices ahead of mid-week FOMC Minutes set to be unequivocally dovish, is debatable.
In other words, what type of “risk on” US economic optimism translated into is unclear.
And FX markets revealed little in broad-based USD pullback (EUR above 1.18, AUD to mid-0.76; USD/SGD down towards 1.34).
A softer USD squares with UST yield slip but assumptions of optimism-fuelled “risk on” drag on USD raises two niggling questions.
First, given USD/JPY slide from high to low 110 begs whether the USD indeed has supplanted JPY as the safe-haven proxy amid US’ vaccine advantages that has only entrenched further.
Second, and more consequentially, whether the USD is operating in the left-half (associated with weaker USD on “risk on”/optimism) or the right-half (corresponding to a stronger USD on optimism) of the USD Smile.
Both aspects have been presented in recent weeks.
Clarity eludes. And optimism alone is not a guarantee of USD bear revival. Watch yields!
RBA’s Reprieve Ahead of Cross-Roads
The RBA is in a fairly comfortable position, able to afford time to assess policy course ahead. But that is not to be mistaken for the absence of policy dilemma/tensions.
Instead it is a coincidence of policy/FX and economic sweet spot that has bought time.
The most fortuitous coincidence of factors that help to buy the RBA time/space are;
i) AGB yields being tamed, albeit at fairly elevated levels further out the curve though the 3Y is well-contained by YCC;
ii) AUD pull back from 0.78-0.79 in mid-March ease back to ~0.76 in April.
And so, the urgent need to ramp up on policy easing is alleviated.W
Whichis to say that the RBA’s;
i) prolonged 0.10% cash rate anchor;
ii) YCC target of 0.10% for 3Y AGBs and;
iii) A$100bn QE being expanded/extended by another A$100 (QE 2); suffice for now.
In fact, one may argue that the RBA’s emerging challenge would be to wean off balance sheet accommodation without creating wobbles in the market.
Especially as risks associated with excessive easing grows in the context of economic recovery that is on by and large track, and housing market activity heating up.
But closer examination reveal a more complex reality as current policy relief may prove temporary with the RBA finding itself at the cross-roads of two way-risks.
Between fading fiscal stimulus/JobsKeeper and rising UST yields requiring policy support on one hand and overheating risks from commodity/asset market boom on the other.G
Granted that the RBA has hit rock-bottom on the cash rate, and it is premature to tinker with bond buying given that QE 2 is just taking off.
But potential for volatility in AUD and yields will require active policy vigilance. Meanwhile, post-RBA AUD may be buoyed.
Source: Mizuho Bank Ltd