Aussie Aussie Aussie Oi Oi Oi

While it is often tempting to suppose that a country's sporting success (or failure) can have a market impact thanks to some sort of knock-on effect to consumer sentiment, there is little evidence to support the notion.  It's true, for example, that the Brazilian real has been pummeled since the Selecao's humiliating exodus from their own World Cup last year...but that ignores the fact that the BRL was pretty stable in the low 2.20's for a couple of months after the loss to the Germans.   Similarly, there has been no notable knock-on rally in the NZD after the All Blacks' defeat of their antipodean neighbours in the Rugby World Cup Final...not has there been any weakness in the Aussie at the time of writing.

Speaking of the Aussie, the RBA meets this evening , and the market reckons (at least judging by the pricing) that there's a decent chance of another easing.  To be sure, inflation remains below the Bank's 2-3% target after last week's disappointing CPI, and commodities are not exactly offering any sort of support to the notion that we're not on the downswing of the supercycle.  As such, markets are looking for nearly 50 bps of easing by next (Northern Hemisphere) summer.

However, there are also reasons to think that the RBA could stand pat.   As noted on Friday, credit growth is now at post-crisis highs, albeit at substantially lower levels than before the GFC.  However, it is not immediately obvious that a return to 20% plus credit growth would an unalloyed positive...or any sort of positive at all.   The secular rise in household debt as a percentage of income is little short of stunning; ironically, the latest reading (132.8%) is just above the peak in US household debt to disposable income of 132.77 registered in Q4 of 2007.


Now, while the high levels of debt suggest that the neutral interest rate is a lot lower than it was before, particularly given the households' exposure to floating or quasi-floating interest rates, by the same token it is also incumbent upon the RBA to dissuade even further levering of household balance sheets when rates are at historical lows.  This is, after all, an economy that has grown for 24 straight years, and a real policy rate of 0.5% is pretty darned low.

The elephant in the room is, of course, house prices, which have become something of a national obsession during the long economic boom.  Housing in major cities has been extraordinarily overvalued relative to incomes for many years; although lack of adequate supply is the real culprit, in recent years Chinese buyers can serve as a useful scapegoat.   Regardless, after a bit of a wobble  at the end of last year housing seems to have responded to prior RBA easing, and y/y gains are now back in double digits close to their post-crisis highs.


One of the arguments in favour of easing calls has been the "need" to lean against recent mortgage rate rises from some of the large domestic banks.   However, if all you knew was that house prices were rising double digits from an already overvalued level, household debt was at record highs, and that real cash rates were in the bottom 10% of their historical range of the last quarter-century, would you expect a rate cut?



Macro Man would not and does not, though obviously there are other factors that play into the decision.   Unemployment is at 12 year highs, though the rate (6.27%) remains one that many other developed countries would like.   If the labor continues to deteriorate, then of course the RBA could move again.  However, Stevens & co. have made it abundantly clear that they're aware that policy works with a lag, and it seems to Macro Man that they'll be willing to give it a bit more time to see if the unemployment rate stabilizes.

Short Aussie has been and remains a popular trade in many circles; not only has the RBA been easing, but of course there is the commodity and China linkage as well.  However, it seems to Macro Man that much of this is fully priced.   He constructed a simple model to value AUD/USD using 4 inputs:

* The daily CBA Commodity price index in USD, which tracks the monthly RBA version extremely closely

* Australia vs US 2 year swap spreads as a proxy for current and expected monetary settings

* Australia's trade balance, lagged to ensure there is no forward looking data in the regression

* The 3 month change in 3 month CNY NDFs as a proxy for China expectations

Using an in-sample period of 2000-2012, the regression has an r-squared of 0.89; the out-of-sample r-squared is still solid at 0.71, which is good given the breakdown in most of the things that had previously supported the AUD.  For most of the last several years, the model has suggested that the AUD should be weaker than it actually was.  More recently, however, the model has viewed the AUD as fairly priced or even cheap.


While Macro Man wouldn't use the model to market-time short-term trades- one lumpy trade figure can generate temporary spikes- as a sense check it does offer some utility.  Specifically, after showing the AUD as fairly consistently overvalued since mid-2012, the subsequent decline has now pushed it into under- or fairly-valued territory since May of this year.   Obviously, this doesn't mean that the currency cannot or will not decline further...but it does suggest that gains from being short over the next year or so are highly unlikely to be as good as they were for the past 18 months.

From Macro Man's perspective, there are easier fish to catch (cough, euro, cough) than the Aussie at the moment.   It's sometimes easy to forget that in trading, unlike in certain sports, they don't add extra (basis) points for degree of difficulty.

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Anonymous
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November 2, 2015 at 10:03 AM ×

German Machine Orders -13% YoY.
Domestic +1%
Foreign -18%

So, measured against orders before QE came in.
QE has had what effect exactly?

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Anonymous
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November 2, 2015 at 10:09 AM ×

It's going to be "interesting" to see how QE works at the top of a cycle as opposed to the bottom.

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Anonymous
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November 2, 2015 at 10:51 AM ×

"QE has had what effect exactly?"

QE has had the effect of making equity & property prices go up. Period. Central banks have one mandate and one mandate only, namely: keep rates at zero (or lower) forever so that governments can run up unlimited debt, and force equity & property prices higher forever to keep the ponzi scheme going. If all savers, middle-classes and the financial system are destroyed, they give zero f*cks.

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Booger
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November 2, 2015 at 12:18 PM ×

Good piece MM. Although for the Rugby and forex comparison, I think you would have to look at aud.nzd, which has actually gone down recently.

I see a lot going for a euro short, but Draghi does seem to have overpromised. One wonders whether he will be able to get consensus on euro QE2 when the data prints are actually improving. Not much dissent so far but one wonders when something might peep out of a Bundesbank official that might pop up the current expectation to see better levels to short the euro.

Aud, if there is a further correction in DX with the rate hike implied probability in Dec swinging to the other extreme in the next month, then there could be a good entry to short AU if the rba does not cut tomorrow.

In terms of room to run, I see euro potentially running to parity and aud visiting GFC lows (0.6), so runway favors aud slightly. Fundamentally, both remain good short long term candidates. Chances are the euro will have another existential crisis in the next few years and after 25 years of continuous expansion, it would be surprising if the Australian economy did not experience one in the next few years.

aud.nzd and aud.cad are interesting crosses at the moment to get away from a dollar directional view.

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abee crombie
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November 2, 2015 at 12:54 PM ×

Great post MM, the quality in the past few months has been top notch. Keep up the good work, it is much appreciated.

Another interesting factoid you might like on Auzzie, when we say that a new generation of Wall Street boys have never seen a rate hike, well what about our mates in Sydney (sorry I dont know the name of their financial center) who havent seen a negative GDP print since Q3-91. Take that Greenspan, that is a real goldilocks economy.

I always find it funny when ppl look at household debt to GDP. Household debt is almost always (in developed markets at least) 80-90% mortgage debt. When you go to get a mortgage they dont ask you for a country's GDP. they ask how much can you put down and how much do you make (similar to GDP). The fact is Austraila's house price / income ratio (P/E) has re-rated due to asian buyers. Though Australia does have a property bubble in Perth, IMO, its much harder to say in Sydney and Melbourne, where the Chinese students like to go. Meanwhile back in the USA I know many ppl that bought recently with FHA and put only 5% down. Which is worse?

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Polemic
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November 2, 2015 at 1:18 PM ×

Though I havent built rather brilliant models such as yours to prove anything, I am with you on the conclusions.

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abee crombie
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November 2, 2015 at 2:08 PM ×

So the German 2 year (shatz) is starting to re-trace some of the Draghi verbiage.

Gold has been down 10/12 days. Guess ppl are re-evaluating that the Fed will never raise rates. Look for silver to crap its pants soon.

EM FX in no mans land. Not following the EUR weaker but if oil goes any lower I would expect it will.

European and Asian equity markets still stuck at 200 day moving avg. Technology Sector touched its old high, now waiting. FB the last of the big new era companies to report on Wed afternoon

Industrials have seen some OK earnings, but poor sales and earnings revisions are near historical lows. ISM today should be big but it will probably just follow Chicago (and thus the stock market). 2016 EPS estimates keep coming down, however analyst expect earnings to pick up in Q4

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washedup
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November 2, 2015 at 2:08 PM ×

The problem with the euro short is that the slide from 1.40 to 1.10, while great for europe is finally having an impact on the US - if its a question of front-running year end flows, secular trades de-jure, and the like, thats one thing (perhaps the most important thing), but fundamentally, there is only so much growth to go around, and europe borrowed 9-12 months worth of this meagre growth from the US via currency weakness in q4/q1 - something has to give to 'accommodate' a euro slide to parity, so either EM currencies will need to exhibit an epic year end rally, or bucky will strengthen a lot and kill whatever remaining growth there is in the US - not sure what implications for risk would be in each case, but one would hazard a guess the latter is just more of the same so it can happen on its own, whereas the former needs millennials to exchange their iPhones for barrels of crude - good luck with that.
All that said, I am not sold on the 'slide to parity' idea for the euro - I think there are too many snipers taking potshots for that one to be a happy and quick journey.

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Anonymous
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November 2, 2015 at 2:38 PM ×

German Bund drops as Draghi cools QE talk.

German Dax rises as Draghi hints at more QE.

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Anonymous
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November 2, 2015 at 4:09 PM ×

GDP = aggregate income

Increasing debt/gdp as a result of increasing mortgage debt indicates that debt is being extended based upon liquidation value of the asset and not the ability of the borrower to organically service the debt. That type of lending is self-reinforcing in both directions.

No, banks don't ask for aggregate income (gdp) when they issue a loan, but the risk in debt/gdp indicates that they aren't asking much about the borrower's income either.

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Anonymous
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November 2, 2015 at 4:53 PM ×

http://www.ft.com/cms/s/0/7a9d5d9a-8155-11e5-a01c-8650859a4767.html#axzz3qLxjqHqY

ECB diaries show meetings with banks before policy decisions

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Anonymous
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November 2, 2015 at 5:30 PM ×

ECB members informed banks of confidential information before major policy changes:

http://news.forexlive.com/!/ecb-officials-met-with-banks-and-asset-managers-before-major-decisions-20151102

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abee crombie
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November 2, 2015 at 7:55 PM ×

RE Anon 4.09. The main point I was trying to express was that Mortgage Debt/GDP doenst consider asset values. I agree its a reflixive process.

Canada's debt to income is much worse than AUZ and everyone there is on a variable interest rate(5 year re-set max) much the same as in Australia.

Thats why neither will raise rates anytime soon, and why I am with Booger shorting the rallies. Bc while Debt/Income matters, its really your payments to income which ppl pay, and rates will stay low to accommodate payments even though both the BoC and RBA realize there is a housing bubble

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Macro Man
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November 2, 2015 at 8:16 PM ×

Actually, abee, Australia's household debt to income is substantially worse than Canada's, and much worse than the US at the peak. Unfortunately, I misread the chart in the post....that is just housing debt as a % of income shown in the chart. The total HH debt to income ratio is 185.9% according to the RBA, much worse than the 167% in Canada.

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Anonymous
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November 2, 2015 at 9:00 PM ×

Anyone still short this central bank equities rally?

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Anonymous
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November 2, 2015 at 10:10 PM ×

FactSet: Q3 2015 earnings decline is -3.8% so far. If S&P500 earnings decline for Q3 it will be the first b-to-b qrtrs of decline since 2009

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Anonymous
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November 2, 2015 at 10:10 PM ×

I'm shorting here. Like a moth to a flame. Should probably know better.

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Cityhunter
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November 2, 2015 at 10:34 PM ×

Anon@10:10pm

Good luck sir! I also think the equity rally does not make sense but don't have the courage to short.

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abee crombie
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November 3, 2015 at 12:38 AM ×

I stand corrected. Thanks mm. Either way the large build up in hh debt in Canada and Australia should give pause to those arm chair hind sight analysts who said it was so obvious when U.S. housing crashed bc of high debt ratios. Clearly there was more at play.

So is any other equity market going to get above its 200 day. To me large cap technology leading here is just a crowded trade and not a sign of strength in the markets. I trimmed my shorts but this feels kind of late in equity market cycle here. Let's see if we get some good follow through from today's gains in eu and Asia.

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Macro Man
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November 3, 2015 at 12:59 AM ×

I view it like this: Debt ratios won't tell you when the housing market will fall (old-fashioned supply-demand and income shocks tell you that), but they say a lot about the vulnerability of the housing sector to significant shocks.

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Anonymous
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November 3, 2015 at 5:15 AM ×

@Cityhunter Calling me sir is inappropriate, but yes I did short a certain us index today. That may be a very provincial position, but macro is just the sum of the parts.

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Nico G
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November 3, 2015 at 7:49 AM ×

just when you though equity markets could not get dumber and more embarrassing..

shorting 2/2 stoxx (yes, im 200 points underwater on the 1/2) and 100% spoos here

happy trading everyone

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