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Trader thoughts - the long and short of it

Geopolitics was the dominant theme last week and clearly enough reason for investors to increase cash allocations and look to for portfolio protection.

Market data
Source: Bloomberg

However, it seems we have seen tensions over North Korea ease off a touch over the weekend, which could offer some relief to the concern from financial market participants. There is still a ‘buy the dips’ mentality running through financial markets, assisted by global growth in a good spot. Global corporate earnings have been strong and liquidity (from developed market central banks) is significant, making their way into financial markets. So with this in mind, it should be a key week, with a focus on the S&P 500, which printed a bearish outside key week reversal. This suggests a test of the 2405/07 support, if the bears truly have wrestled some sort of control here.

In terms of weekend news flow, we have heard from Central Intelligence Agency Director Mike Pompeo and Nation Secretary Advisor H.R McMaster, who both talked down the prospect of conflict, in a similar vein that Rex Tillerson did earlier in the week. That being said, keep in mind that tomorrow is ‘Liberation Day’ in North Korea and once again, we may see this being used to show the might of Kim Jong-un and his arsenal. We also know the US and South Korea will be conducting joint military exercises on the 21 August , so we are not out of the woods yet and the situation in North Korea will remain front and centre.

Given the close proximity, Korean markets have been given a focus from market participants and seen as a guide to sentiment here. Last week the KOSPI lost 3.2% (although is still +14.5% for the year), while the KRW was the second worst performing currency in emerging markets, just behind the BRL. It won’t surprise then, to see the perception of risk of Korea and the cost to insure against bond default increased 11 basis points (bp) over the week to 68bp and the highest since February 2016, although this level is hardly thematic of a genuine concern that a conflict is imminent. Asian markets may take their cues from Korean markets today.

Aside from the weekend news, which has focused on geo-politics and Donald Trump’s handling of the shocking scenes in Charlottesville. If we take a step back to Friday’s US trading session we can see signs of calmer heads prevailing.

The US volatility index (‘VIX’) closed down 3.3% at 15.5%, while the VVIX index (which is implied volatility of the VIX) closed 5.8% lower, so these measures of implied volatility will remain closely followed this week. The S&P 500 closed largely unchanged, which has seen SPI futures follow suit in appreciation, closing -3 points. S&P 500 volumes have been light (15% below the 30-day average), amid neutral breadth (51% of stocks closed lower). Tech put in the points, while financials, materials and energy closed mostly lower.

US core CPI was the central focus on the data front, and another soggy read at 1.7% and 0.1% month-on-month has created a decent re-pricing of Federal Reserve expectations, which in turn caused the US dollar index to close down 0.4%. One can also focus on Dallas Fed member Robert Kaplan, who is seen as holding a middle ground of the Fed stance on policy. He detailed that he wants to see ‘more evidence of inflation hitting target’ and that he is ‘willing to be patient now’.

Either way, we have seen the interest rate markets now pricing in just seven basis points (or a 28% chance) of hikes this year, while only one hike is priced in through to the end of 2018. We have seen a bull steeping of the curve, with short -term yields outperforming here, with two-year US treasuries closing -3bp to 1.294%.

Gold has found buyers on this dynamic and it’s clearly a big week for the gold bulls, with price needing to break $1296.15 to avoid a triple-top. If price can clear $1296.15, then this will be a strong bullish development, and bring out a whole realm of technical and momentum-focused traders.

So the focus, as I mentioned, is on semantics and how this feeds into the Aussie market open. However, we have futures markets opening at 8:00am AEST and it will be interesting to see if we see any change in oil, VIX, gold and S&P 500 futures here. The lack of any real move in FX markets on the Monday open suggests little change should be seen in futures markets though.

Full-year corporate earnings will be in play in Australia, with ANN, BEN and NCM getting the limelight. With around 15% of the index having reported thus far, we still have some heavy lifting to do to inspire the bulls, with 48% of companies having beaten on earnings and 44% on sales. We also have the headwind of some clear profit taking in the bulk commodities, with spot iron ore -1.9%, while iron ore and steel futures closed -2.5% and 1.8% respectively. Oil closed up 0.5% at $48.82, which is a stabilising factor, although we still see the likes of BHP opening today unchanged.

On the data side, it’s all about China today, with retail sales (consensus at 10.8%), fixed asset investment (+8.6%) and industrial production (+7.1%) due at midday. Whether this impacts the AUD in any great degree is debatable, unless of course we see a strong miss/beat on the data flow. The upside in AUD/USD has been capped at $0.7911 (on Thursday and Friday), so a break above here would be positive. If you flip the chart to a four-hour, you can see the bulls are warming up here, which again can be seen by another sizeable increase in the markets holdings of AUD futures. These are the highest since 2013.

Expect iron ore futures to be closely watched as well though, given Friday’s news flow and the calls from CISA to ensure stable operations of the steel industry. Basically, retail traders in China have taken this to mean the highs have been seen.

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