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Trader thoughts - the long and short of it

Risk appetite has certainly improved, although I remain unconvinced and feel the risks through the remainder of the week, for asset classes such as equities and credit remain symmetrical and broadly balanced.

Source: Bloomberg

For today, however, we can see US equity indices pushing up over 1%, although volumes are somewhat on the light side (S&P 500 value is 10% below the 30-day average) and this has been a key thematic on most of the positive days in the past month. That said, market breadth has been upbeat and only Nike is the only stock lower in the Dow, while 88% of S&P 500 listed companies are higher on the day. Corporate credit remains unconvinced as well, with the high yield (HY) credit index lower by two basis points, which seems at odds with a 31-handle move higher in the S&P 500.

The lack of any move in HY credit spreads is also a red flag because one could argue it should have performed more favourably given we have seen US crude gain 2.2% on the session. However, if we look at correlations in markets, it does feel that the rally in the barrel from $61.10 (from around 01:15 AEDT) into $62.79 was at the epicentre of the move higher in stocks and US Treasury yields too, where we can see the US 10-year pushing from 2.82% to 2.89% with the move higher in crude. Granted, we were also treated to an above-consensus US services ISM print of 59.5, but the flow into risk had already materialised prior to this data point. The interesting aspect here, as I say, is the lack of any move in credit markets and that suggests to me that when we see a 31-handle gain in equities on subdued volume and no real move in credit then the gain in the S&P 500 is either of a low quality or credit is fully priced.

So crude remains a dominant driver of broad market sentiment and whether this is being driven by a news flow around temporary halts to production in Libyan oil fields or a positive feel to this week’s inventory data, crude is back in vogue. This is also largely helped by the fact the crude futures curve is still in decent ‘backwardation’, which is lowering the incentive to store crude and where we can see the difference between the front-month and August crude futures contracts sitting at a premium of $1.48.

Trade disputes continue to be a key focal point, as has European and UK/Brexit political drama’s. However, despite key Republicans such as Paul Ryan speaking out against trade tariffs, Trump is sticking to his guns and maintaining a defiant message and clearly not backing down. China seems to be at the heart of this stance, although if we look at the reaction in FX markets it’s really Canada which is getting the lion’s share of the treatment from the market, with the CAD which is being taken to the woodshed here. USD/CAD is eyeing the 1.30 handle and currently at the highest levels since mid-2017, while AUD/CAD is also looking quite attractive here, with a huge break-out of the recent consolidation and through parity.

So AUD/CAD is on the radar today, as will be the AUD/USD and the suite of AUD crosses given the event risk seen in Australia today, where the market has seen a number of data points to already feel the balance for tomorrows Q4 GDP is skewed below 0.5% qoq and 2.5% yoy. Today’s net exports as a percentage of GDP is a clincher for the growth read, with the consensus expecting net exports to subtract 60bp from the Q4 GDP read, while we also get retail sales (+0.4%) and the RBA meeting shortly after. One suspects the RBA statement shouldn’t deviate too greatly from the prior statement, and should not be a volatility event and it seems unlikely that rates pricing will alter too greatly either. If we look at the Aussie 30-day bank bills futures, we can see just 3.5bp of hikes priced for August and 11.5bp priced for December and for a reaction in the AUD one suspects this sanguine pricing structure will need to change.

So many are putting weight on the fixed income markets and the ever-increasing yield premium the US 10-year Treasury commands over the Aussie 10-year. However, I would turn the focus to the rates markets and the relative differential between what is priced in Australian interest rates (I‘ve looked at the 90-day bank bill futures) relative to US rates (Eurodollar futures). Specifically, if we look further out the interest rate curve to what is priced from December 2018 to December 2020, we can see Aussie rate expectations have come down far more aggressively than its US peer and while Aussie rate (through this period) still trades at a premium, we can see this advantage has come into 15bp - which is the lowest since December and actually argues that the AUD/USD should be closer to 76c.

A gain is a gain though and after a tough day at the office for Aussie equity traders and investors of late, we can see the ASX 200 eyeing an open closer to 5960 (+65 points), so the bulls will feel a little more optimistic today. Naturally, energy should do well, with materials supported, where we can see BHPs ADR sitting up 0.8%. Aussie financials will put in the bulk of the points though and I would expect the likes of CBA to also open around 0.8% higher. So a constructive open and it will be interesting to see if we see follow-through buying after the full unwind of the index from 10:10 AEDT, or whether traders use this strength to raise cash levels in the portfolio. It could tell a lot about sentiment and whether Asia feels we are in for better days. As is ay, I remain unconvinced, but the market is always right.

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