All the overnight action was in the currency markets. The Fed’s decision to delay interest rates rises is having a major impact on the flow of global capital. The Aussie dollar had a massive session, finishing at 78.95 US cents.
As I explained last week, traders got caught out by the Fed’s ultra-mega dovishness. They had positioned for the start of US interest rate ‘normalisation’…then the Fed wavered. As a result, the US dollar is now in correction mode as these bets are unwound.
The Aussie dollar, commodity currencies and commodities more generally are all beneficiaries of this current unwind. The question is, how long will it run?
To try and answer it, you need to understand what drives these short term movements. It’s not really fundamentals. It’s speculators punting on the futures markets that really drive the short term price action.
When these futures markets get out of balance, that’s when you see rapid price moves. Leading into the Fed decision last week, a majority of traders positioned themselves for the wrong outcome. When that became apparent, it was panic time.
To get out of a futures trade, you have to sell it and buy something else. So if you’re ‘long’ the US dollar (betting on it going up) and short the Australia dollar (betting on it going down) and then need to get out, you need to sell the greenback and buy the Aussie…quickly.
It’s the same with other currencies and commodities. The commitment of traders report (which is a weekly snapshot of trader positioning in the futures markets) was out on Friday. It showed how extreme the positioning was in the commodities markets in the lead up to last week’s Fed announcement.
Here’s some analysis on the commodities complex from Saxobank:
‘Hedge funds cut their bullish exposure for a fourth week running during the week ending March 17, in the run-up to the FOMC meeting. The net-long position, collapsed by 60% to a multi-year low of just 132,000 lots. At the peak of the financial crisis back in 2008 following the collapse of Lehman, the exposure to commodities sank to 250,000.
‘A rising USD, at least until last Tuesday, combined with ample and rising supply of many key commodities, has triggered this unprecedented exodus out of raw materials, with 19 out of the 24 major commodities tracked in this report were net sold, with10 of these reaching the least bullish level in more than one year.
‘Gold net-long collapsed to just 35,121 lots after a 46% reduction. This reduced the bullish exposure to the lowest since December 2013 as longs were cut and short positions were added at a quite aggressive pace. By last Wednesday, the day of the FOMC statement, the positionings were skewed towards pricing in bearish news. As they failed to materialise with Janet Yellen joining an ever increasing group of central bank doves the foundation for a recovery was established.’
The first paragraph gives you an idea of just how negative sentiment is towards commodity markets right now. At the worst point in the financial crisis, traders were ‘long’ 250,000 commodity futures contracts. Last week, that number was just 132,000.
Specifically, gold wasn’t at all popular with traders ahead of the Fed meeting. It seems everyone was expecting the worse. This type of positioning always sets the stage for a rally.
But commodities need to do much more before you can get comfortable that the worst is over for the sector. The chart below puts the recent move into perspective. It’s saying that right now, the best that you can expect is that this is a bear market rally.
The chart shows the Reuters/Jefferies CRB Commodities index. After making a new low last week, the index has put in a little rebound. The first target is the 50-day moving average (blue line).
As you can see, the blue line capped the last mini-rally in February. The index hasn’t been able to keep its head above this line since early 2014.
While this could be the bottom for commodities, it’s far too early to make the call. The trend is down, and you’ll need to see another few months of constructive price action before anything changes.
You could say the same for the Aussie dollar…the trend remains down. This latest rally, if it continues, will of course give Glenn Stevens and the RBA room to cut interest rates further, either in April or May.
That’s despite the fact that lower interest rates are doing nothing for the economy apart from inflating house prices beyond all contact with economic fundamentals.
If the RBA was really independent, it should just come out and say that interest rates have done their job for the moment. It should say that what’s required now is action on other fronts…and until it sees that action, interest rates won’t fall further because the risks to long term financial stability are too great.
But the RBA is independent in name only. It’s conflicted and self-interested and puts the short term ahead of the long term, which is exactly what its independence is meant to guard against.
What do I mean about action on other fronts? Well, tax policy for a start. Everyone knows that the biggest effect of low interest rates is on property, and that’s because the tax system actively encourages capital to flow into property.
Lowering rates from current levels will simply exacerbate these flows and do nothing for the longer term health of the economy. Will the government act though?
Next week sees the release of the long-awaited tax White Paper, which should give the government impetus to make some productivity enhancing changes to the tax system. But you can bet they will ignore them.
Venture capitalist Mark Carnegie thinks they will too. From today’s afr.com:
‘The federal government is less than a week from releasing its much-touted tax white paper but prominent investor Mark Carnegie says there’s no point: it should instead return to the Hawke-Keating era of decision-making and boldly implement the changes identified by reviews already.
‘Increasing the rate of the goods and services tax, plugging loopholes that help the rich to dodge tax and picking up ignored Henry tax review recommendations – chiefly land tax – are among the changes Mr Carnegie said were well-known reform musts.
‘"This is an issue of political will and execution," the outspoken, high-profile Sydneysider told The Australian Financial Review.
‘"We’ve got collective action problems, not a paucity of ideas. Everybody agrees on what needs to get done.’
Except the politicians. Carnegie points out that most of the work on tax reform happened five years ago with the release of the Henry Review. Apart from the altered then botched mining tax, both parties have roundly ignored the recommendations in that review.
Can we expect anything different when the White Paper comes out? Sadly, no. An election will likely take place next year. You won’t see anything useful in terms of policy changes until 2017 at the earliest…and even then it might just be more tinkering around the edges.
Sometimes, you just don’t get genuine change until you get a genuine crisis. Right now, it feels like the majority of Australia thinks everything is just fine.
Along with inept leadership and a difficult Senate, this isn’t the combination that usually leads to ground breaking structural change.
for Markets and Money
PS: If you want to have a punt on this being the bottom of the commodities market, you can check out Diggers and Drillers latest speculative picks here.