Confidence on Wall Street wanes; markets prepare for RBA

Wall Street continues its sell-off

Market participants are starting to behave a little panicky. The short-term downtrend continued in Wall Street equities to begin the week; and naturally, so do the short-term uptrend in government bonds. Oftentimes its hard to see the proverbial trees through the forest in financial markets. And this stands out as potentially one of those instances. Largely, this is because if one looks at the price-action currently, almost all outward appearances suggest traders are preparing for a marked-global economic slow-down. How rational this impulse happens to be, it remains to be seen. Nevertheless, its hard to argue it isn’t happening, and worth entertaining as a possibility.

Markets getting noisier

It could be so there’s more noise than substance in the recent run lower in global stocks. Perhaps this something of the flipside of what we got in the first four-months of the year when markets were silent, stable and generally optimistic. After all, most in the know would acknowledge there was a lot of momentum-chasing driving the market to begin the year. The current dynamic could simply be the reverse of that: another example of irrational behaviour in markets. Whatever the fundamentals happen to behind this sell-off, for market participants, it pays to stand to attention, because fear is beginning to feed upon itself.

Fed to cut aggressively, according to traders

Arguably, the most telling feature of market-action presently is what is being implied about US growth, and the necessary policy approach from the US Federal Reserve. Traders are pricing in an over 80% chance the US Federal Reserve will cut interest rates in in July. Such a move would be an extraordinary pivot from the Fed, away from what is currently an avowed “patient” and neutral policy stance. At its core, markets are betting that the escalation of the trade-war, as well as the new trade-spat with the US and Mexico, is going to create a major economic slowdown – if not a recession.

Stock-off, bonds-up, gold-up

Again, using the “R-word” must come with the caveat that market-dynamics right now could be completely off-course. Irrespective, it pays to at least heed the warning, and follow what the prices are saying. Fundamentally, traders seem to be betting that higher trader barriers will have a material impact on US corporate earnings. Government bonds – the US 10 Year note rallied 5 basis points last night – have been bought-up, in anticipation of slower growth and lower interest rates. And interestingly, the tumble in US Treasury yields has sent the USD plunging, boosting the EUR, gold prices, and even our AUD.

The devil in the detail

And this is where the nuance can be applied: European equities actually performed rather well overnight, even despite being mired in the last global-stock pull back. At that, the Chinese economic data that was considered the major risk event yesterday, Caixin Manufacturing PMI figures, though doing little to help Chinese equities, printed better than expected, and eased concerns about the Middle Kingdom’s growth. The conversation, considering this, could possibly be turning into one centred around a US economic slowdown, primarily: amid trade-disputes and late-cycle behaviour, US ISM Manufacturing PMI numbers greatly disappointed last night, portending malaise (and stock markets weakness) in the US economy.

RBA centre of attention

That one is a nascent narrative and will take time to unfold. Matters closer to home will take priority today, with the RBA almost unanimously tipped to cut interest rates at its meeting this afternoon. Interest rate futures have priced in 25 basis points of cuts from the RBA today – and are currently following that assumption with a further cut in September, and another “half-a-cut” by December. A dovish RBA, therefore, is already priced in, so the general attitude is that today’s meeting is almost a formality: a reduction in interest rates from the RBA merely affirms what the market already believes.

What traders are watching

Given this is so, there’s two broad scenarios that can come from this situation. The first: the RBA doesn’t cut, and markets go temporarily bonkers pricing-out at least the 25 basis-points of cuts in the market. Stocks would dive, bond yields would spike, and the AUD would rally. The seemingly more likely outcome is that the RBA does cut, and all attention turns to the accompanying policy statement. This is where nuance comes into it. From here, it will all be about the RBA’s language, and determining when, if at all, the next rate cut will be, and what that all means for market prices.