When thinking about the obvious macro factor that investors should be across in 2020, global bond yields spring to mind, however at Market Matters we’re not about pondering the obvious, we’re about highlighting the non-consensus views which could have a bigger impact on asset prices.
So in this piece, we give an honorary mention to bond yields and our expectation that the nadir on the downside has been and gone, however, we’ll highlight the Australian Dollar as the most influential macro factor for 2020.
The $A is largely driven by interest rate differentials amongst other factors, but it’s the positioning around the $A which makes the local currency a fascinating subject to us at the moment – we believe investors are positioned for a lower for longer $A implying the more aggressive move could happen on the upside.
We have a contrarian bullish opinion on the $A, which if correct will remove the major earnings tailwind that has been helping Australian companies with significant $US earnings. We are bullish the $A, targeting the 80c region.
Australian Dollar ($A) long-term monthly chart
Our view is primarily driven by a bearish outlook for the $US which we believe has reached a major point of inflection after a decade-long rally since the GFC.
As we approach the November 2020 election in the US, the President will likely pull all stops for re-election and applying pressure on the currency in various ways would be very supportive of economic growth.
While the Federal Reserve cut rates in October, Chairman Powell made it very clear that any rate hikes will be conditional upon a marked and sustained uptick in inflation while they will cut again if economic conditions warrant it.
If a trade resolution is successfully negotiated between China and the US which improves global confidence and ultimately global growth at a time when the US is more dovish, then the US currency could well decline sharply.
The $US Index Chart
Historically, it's extremely rare to see Australian 10-year bond yields below their American counterparts but that’s very much the case today, a huge contributing factor to the prolonged bear market for the $A.
If we are correct and Australian bond yields again converge and eventually go above their US equivalent, as has been the norm for the past 50-years, it’s easy to envisage the $A back up around 80c.
Australian & US 10-year Bond Yields Chart
The chart below illustrates over the last few years the clear inverse correlation between the $US and Base Metals, if our opinion is correct on the $US then we believe there’s a strong likelihood that resource stocks will outperform in 2020. We are bullish base metals and resources moving into 2020.
The $US Index & Bloomberg Base Metals Index Chart
So in 2020, currency markets remain the area that could experience a meaningful change to engrained trends.
While engrained trends take time to change when they do the weight of money that needs to change with them is substantial.
We are bearish the $US, bullish the $A, and bullish resource stocks as a consequence.
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Thanks James, what about gold resource stocks like Evolution, Regis, North Star and similar, wouldn't they be negatively affected due to a rising Australian dollar?
Wow! This is not a contrarian call it's a suicide call. The RBA governor said this morning that he's going to stop cutting when our rate reaches 0.25% and that we will not have negative interest rates ... he said the bank would use other means when the rate hit 0.25% ... i.e. QE and the purchase of bonds. The U.S. economy is 'supposedly' weakening but despite the naysayers, their huge companies are continuing to deliver strong quarterly results. Oh, if only our economy was as "weak" as the U.S.'s ... Josh Frydenberg must dream about that scenario.