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Trader thoughts - the long and short of it

The market thematic of central bank normalisation of monetary policy took somewhat of a back seat overnight, with tensions between the US and North Korea taking another sour turn.

Source: Bloomberg

I had been arguing that markets were becoming less sensitive to the rhetorical battle between the US and its United Nation allies on the one side, and North Korea on the other. However, North Korea’s foreign minister, Ri Yong Ho, has taken the level of anxiety up a notch. In a news conference, the foreign minister detailed that “Trump’s comments amount to a declaration of war” and “UN members should keep in mind the US declared war”. Reuters went one further with headlines (again quoting the foreign minister) that “we have every right to take countermeasures”.

The reaction has not been huge, but they have taken the wind out of the sails just when risk was looking fairly upbeat as we headed into Europe, despite the uncertainty around the elections. That said, it's hardly panic selling and the moves look measured and contained and really just feels like money managers just squaring up risk in their portfolios. Looking around markets we can see implied volatility in the S&P 500 (“VIX”) up 6% to 10.2, but one tends not to look at the VIX on a percentage basis but by the absolute change. US treasuries have been reasonably well bid across the curve, with the US 10-year treasury lower by four basis points (bp) to 2.22%, with a slight drop in ‘real’ yields, which in turn has seen a strong move higher in gold into $1310 (+1.3%).

The moves in US fixed income were given somewhat of a tailwind by Chicago Federal Reserve member (and well-known dove) Charles Evans, who expressed further concerns about inflation being too low (shock!), but also that the Fed should avoid steps that could be misread that they have a lack of concern of achieving their inflation objective. Read that as a desire to keep the ‘real’ (or inflation-adjusted) fed funds rate below the neutral fed funds rate.

The real event risk kicks in in the session ahead though with Minneapolis Fed president Neel Kashkari speaking in North Dakota at 08:30 aest and then Janet Yellen at 02:45 aest, so this could see the market re-focusing on the mentioned theme of a monetary policy settings and ultimately impacting the rates market and subsequently the USD

European equities have held in firm despite the uncertainty in the German election, although a more pronounced move has been seen in the EUR, with EUR/USD now sitting at $1.1847 and threatening a break of the recent $1.2070 to $1.1830 trading range. While on the subject of the EUR and EUR/GBP should be on the radar too, with the pair ominously poised to break the 15 September low of £0.8774, where a close in the session ahead would bring out a fresh round of momentum selling. Back in equity land, and while the S&P 500 has lost a modest 0.2%, it’s been a weak night for tech stocks, with Facebook (FB) and Apple getting good attention from clients and closing down around 4% and 0.8% respectively.

Tech has shown some vulnerabilities of late given the rise in global bond yields and the impact this has when valuing the companies and discounting their expected future cash flows back to the present day. We can add in concerns around Apple’s product launch and potentially weaker sales in the iPhone 8 and the impact this is having on the supply chain. However, while some will focus on Mark Zuckerberg’s share sale, the real issue seems to be an article in the Washington Post detailing Washington could be looking at FB far more closely going forward.

With modest weakness in the S&P 500, it’s interesting that we are actually calling the ASX 200 to open somewhat higher at 5700. Consider Aussie SPI futures were trading at 5673 at 16:10 aest (the official close of the ASX 200) and they now reside at 5685, so Aussie index futures suggest the platform is set for mild appreciation, although as we saw in yesterday’s tape there is no conviction to hold positioning and the market drifted lower throughout the afternoon. Aside from gold stocks, clearly the sector of the Aussie market that looks set to perform is energy, with both Brent and US crude gaining over 2.5%.

Both look technically sound and have a number of bullish fundamental news developments working for them, ranging from support from OPEC, events unfolding in the Middle East and comments from shale gas CEO’s (such as Continental Resources) who recently suggested output won’t be as great as some had expected.  As mentioned yesterday, we saw a drop of five rigs last week in the weekly US Baker-Hughes rig count (taking the rig count lower for three straight weeks) and that hasn’t gone unnoticed too.

The result is price has broken out to the topside, in what is a continuation of a bullish trend that really started from late August. Brent has been my preferred vehicle to express a view of strong oil demand and a reduction in supply and we can see the bullish structure clearly in the Brent futures curve, which shows strong ‘backwardation’, which in turn portrays a picture of strong near-term demand. A new trading range in US crude looks likely here, with the floor being $50 and this should support ASX energy names in the session ahead and I really like the price action and trend in STO as a stand out here to play higher oil.

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