Trader thoughts - the long and short of it

In the absence of any material event risk to push risk assets higher this week, we are also still seeing signs the market refuses to sell-off with any conviction. The S&P 500 printed a minor double bottom at 2565 on 2 and 9 November, and went on to re-test this level last Wednesday, before the buyers stepped back in and subsequently the benchmark is now just a whisker away from a new all-time high. Technically, a close through 2565 would have taken the index down to key support at 2544, where a close through here would have been the trigger for a broad move lower in risk appetite and would have been the trigger for a decent pick-up in portfolio hedging.

That scenario isn’t in play yet, and we find the lead from US equities (for Asia) as constructive, with the S&P 500 pushing 0.2% higher, with small caps outperforming. We see the Russell 2000 gaining 0.5%. Financials have put in good points into the index, with materials sector up a touch, while energy is flat. We can see implied volatility in the US equity market lower by 7.5%, with the “VIX” sitting at 10.57% and eyeing another move below 10%. Giving the equity rally real backbone has been a fairly robust, five basis point tightening of high yield credit spreads, while in fixed income we have seen modest selling across the curve. Although on an inflation-adjusted basis we have seen five-year ‘real’ yields moving 5bp higher through US trade and this has had a clearly negative impact on gold.

The market hasn’t been overly concerned on the news that Janet Yellen has detailed that she will leave the Federal Reserve altogether after Jerome Powell is sworn in and clearly the market was of the impression this was going to be the case anyhow. It does mean the White House HR team have another post to fill, in what is one of the biggest shake-ups of Fed we have seen. The bigger focus here is who gets the gig as vice-chair, with names like John Taylor, Mohamed El-Erian and Kevin Warsh in the mix.

We can focus on Europe, where the market has not been concerned at all by political developments in Germany and the FDP party’s decision to walk out on coalition talks, with talk that there was a too greater divergence on immigration. Implied volatility in the European equity market has also fallen by some 7%, and there is absolutely no stress the German DAX (closing up 0.5%), where after a modestly shaky start we see the buyers step in, causing the index to rally 1% from the low into the close. New elections do loom large though, with Angela Merkel detailing on German TV that she is ruling out a minority government (although is still open to a grand coalition with the SPD party), and the playbook around the outcome of German politics is one that market participants are trying to fully decipher. It does suggest the Germans are going to play a lesser influence in the Brexit negotiations, which are such a big debate in itself right now. 

EUR/USD has seen modest headwinds and sits down -0.5% on the day at $1.1734, which is naturally having a positive effect on the USD index. Limited moves in German fixed income have curbed the selling in EUR, although we do see US/German yield spreads widening and we have the 2-year yield differential at the widest since 1999, while the 10-year differential is back above 2% (or 200bp). Of course, when you have the ECB buying six times net European government bond issuance and effectively ring-fencing pretty much all political concerns, at a time when Germany is growing at 2.8% and while the Eurozone runs a punchy twin surplus, it’s hard to be too bearish on the EUR.

Staying in G10 FX and we see AUD/USD continues to track a touch lower at $0.7548, with an eye on the RBA’s November meeting minutes at 11:30am AEDT and the governor, Philip Lowe, who speaks in Sydney at 8:05pm AEDT. The key development though and the driver of the pair remains the ever falling yield differential between Australian and US government debt. While most will be focusing on the 10-year bond yield differential, which now sits at 17bp, it is eyeing the year-to-date lows of 14bp. If looking across the fixed income curve, and average the yield of 2-, 5- and 10-year Treasuries, we can see the yield advantage enjoyed by Aussie debt over US Treasuries has fallen 4bp on the session to just 7bp; the lowest premium since 2000. The game is changing for the AUD.

So, aggregating all the news and subsequent market moves we see Aussie SPI futures gaining 23 points at 5984, which takes our ASX 200 opening call to 5975. BHP looks destined for an open some 6c higher, with US crude closing 0.8% lower at $56.09. Bulk commodities look far more promising, with spot iron ore closing +1.4%, while on the Dalian futures exchange iron ore, steel, and coking coals are trading up 1.2%, 1.1%, and 1.8% respectively. Copper is up 0.7%, while gold, as mentioned, has reacted negatively to the move in US fixed income and is tracking -1.2%.

Technically, the ASX 200 has shown a strong desire to defend the 5900 area, but with limited news out this week to really drive one questions if there is the impetus from the bulls to push the index through Friday’s highs of 5991 and back above 6000. If we are going to see follow-through buying after the full unwind of the market (at 10:10am AEDT) then Aussie banks are going to need to see better buying, which is not out of realms of possibilities given the financial sector, along with telco’s, was the strong performer on the S&P 500.