The market has anticipated another rise by the Reserve Bank this year. But instead of being bearish for the economy, the market seems to view it as bullish for the currency. And strictly speaking, that sounds about right to us. Increasing the spread between local interest rates and interest rates in Japan and America virtually guarantees more rivers of cash flowing to the lucky country.
You can throw another factor in too. With the slow-down in the issuance of mortgage-backed bonds in the U.S., a huge destination for global capital flows has been eliminated from the hot-money itinerary. For awhile there, the market for bonds backed by U.S. mortgage lenders Fannie Mae and Freddie Mac was even larger than the market for U.S government bonds. That’s saying something, considering the American government is always rolling over at least US$1 trillion in new short-term debt just to keep the government in Washington open for business.
With the market for mortgage-backed bonds shrunk considerably, and also considerably less attractive in terms of credit quality, risk-averse foreign investors are looking for safe, sturdy, yield. “Well G’day there Australia,” these investors seem to be saying. “Mind if we stay for awhile?”
Local investors probably won’t mind at all. And neither with the ASX/200. Another 20% gain this year from a base of 5,672 would put the index at about 6,804. But since we are a fan of large, round, lucky numbers here at the Old Hat Factory, we’d say the target Melt Up number for the local market is more like 7,000.
Sometime after that…well that’s when you can look for a liquidity black hole. Hot money is fickle. Just when you think you have a serious love affair going, you find it’s been cheating on you with Icelandic bonds. And the next morning your share market—along with others all over the world—loses twenty percentage points in a day.
But that’s the Melt Down stage. Right now, we’re in the Melt Up stage. And despite the seasons changing and the cool air in Melbourne, it’s getting hotter and hotter in the market.
The Daily Reckoning Australia