Peak growth, peak inflation, peak equity returns come into play

With 10yr Treasuries -5bp into 1.17%, while US equity markets were down smalls, under the hood we see a clear rotation into defensive sectors and out of cyclicals. Value sectors has been stung and largely as a result of falling bond yields – which, as have stimulated in prior reports, are starting to flash amber – a close through 1.17% in 10s and the momentum crowd take yields lower and we start really talking 1% on the benchmark – equities may see a higher volatility world here, and we can already see the VIX index closing at 19.46%, a gain of 1.22 vols on the day – 20% is in the sights.

The US ISM manufacturing report was the catalyst and it was a good number at 59.5, but could this be opportunity for traders? This has been in fitting with other global PMIs, and an economic slowdown is being priced at a time when the Fed are debating the idea of reducing the pace of QE, and other central banks in both EM and DM are in the process of preparing for hikes.

Bond markets and commodity markets

These are well worth watching for the growth argument and equity markets may go from a period of repositioning into defensive, to one further on where broad equity gets hit. Until mega-cap tech gives in on a volatility spike, then we’re unlikely we get a 5-10% correction and traders will lean into longs around the 50-day MA (US500).

FX markets have actually behaved quite well and there's been very limited volatility. Granted, the petrocurrencies (CAD and MEX) are lower, but the selling has been very measured. The big risk today is the RBA meeting and so devising a simple playbook (guesstimate) we see three clear outcomes:

1. Increase the pace of QE from $5b to $6b – this would genuinely enforce credibility to the RBA’s flexible mindset and get the bank of the front foot - AUDUSD should fall into 0.7320/10
2. Leave the original schedule for tapering the QE run-rate to $4b unchanged – there are reasons to think they could do this, notably as increasing QE would have limited economic benefit and most see an economic snapback in Q4 anyhow. What it does do is destroy any notion of RBA flexibility, and given the likely growth contraction in Q3, what more do the RBA need to see? - AUDUSD into 0.7400/10
3. Push back on the original September QE taper plan and maintain a monthly pace of $5b – the consensus position, so it is somewhat priced - AUDUSD into 0.7385/90

On options 1 and 2, it would not shock to see a sudden and swift move in the AUD, with traders fading the move – so do watch exposures over the meeting. The AUS200 could be interesting and should the RBA leave the original schedule in place, it would not surprise to see the AUS200 tail off into the close. A pushback on tapering in September should cause too much of a reaction. Trade the opportunity with Pepperstone.