We have to focus on developments in the USD, as this is such a key talking point right now in markets.
With the EUR contribution over 50% to the USD index, there was some influence from the disappointing core inflation numbers seen in Europe, with the data printing 0.9% versus the 1% the consensus was looking for. Interest rate markets only very modestly reacted with the difference between euribor December 2019 and 2018 contracts falling a tad to 32.5bp. There is no doubt this inflation print would have disappointed the EUR bulls though, who really wanted a somewhat hotter number to push EUR/USD through the September highs of $1.2092 and into ‘blue sky’ territory, but most expect inflation to start to pick-up into the second half. Let’s also not forget the world is as long EUR as we have ever seen. One just has to look at the weekly CFTC positioning report to see speculative holdings of EUR sits at an all-time high of 128,000 contracts and up 35,000 contracts last week alone. I am still happy to hold a long bias, with a view to add in the case of a close above $1.2092, but a close through $1.1990 alters that view and there are a few factors working in favour of the USD here.
As we have seen across the global capital markets, low inflation is an equity traders dream, except for those perhaps overweight European financials. We have seen the DAX and other European market respond in kind. The techincals suggest staying long the German DAX here and building conviction on a break of the 19 December high. From here we should see new all-time highs come into play.
In the US, the calendar was rich with event risk on Friday, with disappointing data points seen in the non-farm payrolls (148,000 vs 190,000 eyed), November trade data (highlighting a deficit of $50.5 billion) and services ISM (55.9 vs 57.6 eyed), although factory orders were slightly ahead at 1.3%. The wash-up was some slight revisions lower to Q4 GDP expectations, although the GDP run-rate still maintains a 3 handle. Financial markets were somewhat unsure, and the initial reaction to most of the data was to buy Treasuries and sell USD’s. However, as the session wore on this stance reversed and we saw EUR/USD faded throughout trade, resulting in a close 0.1% higher in the US dollar index, and US 10-year Treasury closing up 2bp at 2.47% and eyeing a break this week of the key 2.5% area. The S&P 500 was a beacon of strength throughout and closed up 0.7% at 2743, on volumes in-line with the 30-day average, with good buying in tech, materials and healthcare. This flow in the US helped push Aussie SPI futures to a 0.3% (or 13 points) close higher, taking our ASX 200 opening call into 6140.
This is a big week of event risk though and while risk appetite is elevated, there are landmines that could alter that sentiment somewhat this week. However, I would stop shy at saying we will see any real pick-up in implied volatility. The USD is once again key and specifically one questions can we see EUR/USD find buyers into this pullback of sorts. AUD/USD has moved progressively higher again on Friday and finds itself faced with a test of the 79c level, and although the pair faces local data in the form of building approvals, job vacancies, retail sales and also inflation and trade data from China, the US side of the equation will likely be far more influential.
Here we see in the latter stages of the week US PPP (Friday at 12:30am AEDT– 2.5% eyed) and then the elephant in the room being core CPI (Saturday 12:30am AEDT – 1.7% eyed). This consumer inflation report will be key and traders will be watching to see if bond yields can rise here, as a break in the US 10-year above 2.5% would be interesting. However, more importantly inflation expectations have also been rising of late and this is keeping ‘real’ yields from moving higher, which is again supporting the equity markets.
Another focus is the emerging market trade, which is working beautifully of late and this seems to be supporting the AUD. Positioning is also supportive of the AUD, where the weekly CFTC positioning report highlighted the biggest net short position held by speculators against the AUD (as of Tuesday) since February 2016. Keep an eye on the EEM ETF (MSCI Emerging market ETF), which is trending like a dream and sitting at highest levels since 2011.
US Q4 earnings will also be a big catalyst for the US equity market, with a number of banks in play in the later stages of the week. So again put the XLF ETF (US financial sector ETF) on the radar as this has been a great way to play the space and is also breaking out of a consolidation zone and arguing for further upside. The market goes into this quarter of US corporate earnings expecting around 10% earnings growth, with all sectors bar telco’s expected to report growth. That said, the Trump tax reform makes things a little more challenging as companies will have being forward charges related to the repatriation of overseas cash and earnings, as well as taking one-time charges on deferred taxes. Therefore analysts are likely going to focus on sales and operating numbers. One to watch and this reporting season could be a catalyst, but it does promise to be somewhat messier than prior quarters, not to mention sentiment towards US equities is already sky high.
So as mentioned, the ASX 200 should build on last week’s 0.9% gain and we should see Aussie banks put in the points on open, with CBA likely to open some 0.3% to 0.4% higher. BHP looks likely to open on a flat footing, with little to inspire from spot iron ore (+0.3%) or Dalian bulk commodity futures. Copper closed lower by 1.3% and US crude closed Friday down 0.9%, and this is a natural headwind to the energy space. This has so far been the standout in the ASX 200 in the short period seen in 2018. Gold has performed admirably in 2018 and gold stocks have responded in kind, but could see more cautious behaviour on open.
Japan also looks to support, with the Nikkei 225 following through its recent bullish break and USD/JPY above 113 should help the bid here. News flow over the weekend has been mostly of a political nature, with Donald Trump’s ‘stable genius’ comments getting much attention, as did released transcripts from in-coming Fed chair Jerome Powell (dated 2012) actively detailing that the Fed’s activities were designed to prevent losses in financial markets and encourage risk taking. So a bit to focus on, but that said, if we look at the limited moves in G10 FX in early trade it suggests the futures open should also be fairly sanguine.