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Trader thoughts - the long and short of it

The big debate that materialised on Friday and through the weekend has been around who will lead the Federal Reserve when Janet Yellen’s tenure comes to an end in February.

Market data
Source: Bloomberg

The focus really started on Friday with a Wall Street Journal (WSJ) article that first detailed how Kevin Warsh had met with Donald Trump and Treasury secretary Steven Mnuchin. Then later in the session a piece from Politico stoked an already lit fire, by saying the meeting between the three individuals had been ‘very positive’. The WSJ went on to write another article disclosing Jerome Powell had also been interviewed for the Fed chair and we are left with a clear shortlist of four candidates for what is arguably the most important role for markets.

Trump has disclosed that he will disclose who is appointed in the next two to three weeks, but as things stand it will either be Janet Yellen (for a second term), Kevin Warsh, Gary Cohn or Jerome Powell. The fact we saw strong selling in the five- and seven-year part of the fixed income curve after the WSJ and Politico articles were released, suggests the market see’s Kevin Warsh as a genuine front runner now and he has made a strong impression on Trump. One suspects Mr. Warsh is not going to come in and shake things about too drastically, if he does get the gig, but his views on policy are well known to market participants and he is clearly more hawkish than Yellen, although that isn’t hard to be fair.

The speculation around the Fed appointment saw yields rise across the curve, while in the interest rate market we saw the probability implied for a December hike increasing to 76%. We now see two hikes priced in until the end of 2018. This change in rate pricing also came amid fairly poor US data, with personal spending rising 0.1%. If one adjusts for inflation, then we saw ‘real’ spending actually fall 0.1%, while August core PCE also edged up 0.1% or 1.3% YoY. The University of Michigan sentiment survey came in at 95.1 and was also a little uninspiring.

The wash-up of the various news flow was an unchanged USD, while the S&P 500 closed out the quarter up 0.4% on the day at 2519 and printing another all-time high. Tech, healthcare and financials contributed the bulk of the points and the trend higher continues in earnest. This is a market where shorting is super tough work and the path of least resistance seems for higher levels.

There has been absolutely no change in market anxiety levels (the VIX closing at 9.51%), despite the prospect of a new Fed chair, but rightly so the VIX measures implied volatility in the S&P 500 over the coming 30-days, and the market isn’t going to be too concerned for now about Mr. Warsh’s policies, given he hasn’t actually been appointed.

Keep in mind the S&P 500 and Nasdaq are up 12.5% and 20.7% YTD, so don’t rule out the prospect that hedge funds chase this market into year-end, especially with the benchmark for Q3 earnings season set fairly low, with calls for 4.5% and 2.5% ex-energy. Of course, this will only really materialise within the discretionary players of the hedge fund industry. However, to put perspective on this, it’s still an industry with $270 billion in assets under management. It’s not just hedge funds though and as one investment bank put it, this is the fifth year in a row active, mutual fund managers have failed to deliver any significant alpha. So don’t rule out the US equity market moving higher into year-end, purely on the idea of active money managers chasing performance.

SPI futures closed at 5682, which was a change of 22-points from where they stood at 4:10pm AEST – the official close of the ASX 200 cash market. With this in mind, we should see a test of 5700 on the ASX 200 open, although the Labour Day holiday in Sydney will subtract from the level of market participation today. S&P 500, gold, copper and crude futures open now at 9:00am AEST, so this will give us a clearer idea of how the weekend news flow impacts our open. However, judging by the fact AUD/JPY is higher by a mere 14 points and AUD/USD is unchanged at $0.7835, suggests we should not get too carried away by strong manufacturing PMI data out of China on Saturday.

Here we see the index headline print coming in at 52.4 – the highest since April 2012. We can look within the survey and see the new orders and new export orders sub-component working nicely too. We also saw the Caixin manufacturing report (this measures activity in smaller businesses) ticking down 0.6 points to 51, although I suspect the market will place greater interest on the larger National Bureau of Statistics (NBS) manufacturing print.

Keep in mind we also saw the PboC reducing reserve requirements on Saturday, by 50bp to 100bp, to banks with the specific target lending to smaller business. 

Clearly, there will be some focus on Spanish markets too given the scenes in Catalonia and voters looking to place votes in the independence referendum. EUR/USD (currently $1.1792) and the EUR crosses are only very modestly lower, highlighting this is more a humanitarian issue and not one that is going to knock sentiment too greatly in Europe. As we may see some underperformance from Spanish equities, we shouldn’t see too much stress in the bond market and we shouldn’t see significant widening of the Spanish/German bund yield spread.

On the commodity front, and by way of leads to price into Aussie energy and materials stocks, we see that US crude closed 0.2% on Friday. Although, it may find a few sellers in the oil futures open (at 9:00am AEST) given the US Baker-Hughes rig count snapped three weeks of declines, with the rig count increasing by five rigs.

Spot iron ore closed 1.3% lower at $62.05, with iron ore futures lower by 1.5% and recall both China’s equity market and the Dalian futures markets are closed today for National Day, so we lose direction here. If we look at BHP’s ADR we can see this closed up by 8c, suggesting we may see a flat open for the ASX 200 materials sector that is in line with the move we saw in the S&P 500 materials sector. That said, the China manufacturing data should support.

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