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Trader thoughts - the long and short of it

We head into the new week with some key event risk to work through and if the outcome is risk friendly, which I suspect it will be, then we will continue viewing what has been seen as the goldilocks backdrop for further risk taking in financial markets.

Market data
Source: Bloomberg

The lead we have for today’s open is certainly constructive. For the first time in a while, we are seeing a stronger belief that we may actually get fiscal stimulus in the US and not just accommodative monetary policy that has cornered investors into credit and equities.

The fact the Senate has passed a budget resolution for 2018 has been taken well by markets and we should see (given various amendments) this being passed through House. There is little doubt that the market has been enthused by something being actually passed and while there is still much water that needs to pass under the bridge, the idea of fiscal stimulus when the economy may need it in 2018 is a strong positive.

We have also been treated to a plethora of headlines on Friday, regarding the likely appointment of the next chair of the Federal Reserve. From what we have seen, it now seems to boil down to three candidates, which could be revealed this week.

These being Jerome Powell, John Taylor and Janet Yellen. Judging by headlines on Friday from Fox Business that “Trump says bringing Taylor, Powell to the Fed together an option” and there is an increased view that Jerome Powell will lead the central bank, with Taylor as the vice chair. The market likes this combination, although the bulls would obviously prefer a Yellen/Powell combination, but the fact we have struggled to see any signs of stress on any of the headlines (around the potential candidates) suggests traders don’t see the appointment as being too much of a game-changer. After all, it’s one vote within the broader collective…right?

The news flow saw the S&P 500 gain for a sixth day, putting on 0.5%. This has also had the added tailwind that after 18% of the index has reported Q3 earnings, a sizeable 81% have beaten on earnings and 75% on sales, with aggregate EPS growth at 8.5%. Moves in fixed income have also been punchy, with the US 10-year treasury putting on seven basis points (bp) to 2.38% and more technically minded traders will be eyeing a daily close above 2.40% this week.

We have seen a slight steepening of the 2’s vs 10’s treasury yield curve, which has been taken well by the US financial equities (the S&P 500 financial sector gained 1.2%), while we can also see inflation-adjusted (or ‘real’) yields moving higher, with the 10-year ‘real’ treasury yield moving to the highest level since June at 51bp. These factors, have naturally been taken well by the USD, with the USD index gaining 0.5%, notably against the CAD, NZD and JPY.

Credit spreads have narrowed again and we can see the US high-yield CDS (credit-default swaps) index testing the years lows. Implied volatility is non-existent and one suspects this could be in play through this week, with 40% of the S&P 500 due to report, in what is the liveliest week for earnings. Friday’s release of US Q3 GDP print also holds upside risks to the 2.5% consensus call.

Still, amid this scenario it’s hard to feel that nominal or ‘real’ bond yields will move up too quickly from here, as inflation is still not indicative of a strong move higher. Again, it’s hard to be anything but long global equities in this environment, despite narrative that so many macro discretionary funds are literally all in this move.

USD/JPY will be interesting to watch this week, if this positive feel continues. The weekend Japanese election has gone as expected, with Shinzo Abe and LDP/Komeito coalition retaining the two thirds super majority, thus keeping the status quo in play. USD/JPY has gained 0.3% to ¥113.87 in early trade and is building on the moves seen in the pair on Friday. Look for further gains in the Nikkei 225 on open, which again should support S&P 500 futures and underpin the ASX 200 to an extent.

EUR/USD, is also on the must-watch list, given one of the key highlights of the week is Thursday’s ECB meeting (at 10:45pm AEDT), where the playbook around the various outcomes is diverse. I sit in the camp that the ECB announce it is set to lower the pace of asset purchases to E30 billion (starting in January), but extend the program for nine months.

However, the risks (in my opinion) are skewed to the dovish side and they may only cut by E20 billion, which given EUR/USD is somewhat ‘expensive’ relative to the US/German yield differentials, puts downside risks this week in EUR/USD.

Aggregating all the known news, it’s hard to see much weakness in S&P 500 or US crude futures when they come online at 9:00am AEDT, especially with the Baker-Hughes oil rig count falling by a further seven rigs. The fact Aussie SPI futures closed up five points on Friday night sees us calling the ASX 200 to unwind at 5918, with banks likely to support again locally, ahead of full-year earnings start on Thursday.

If the Aussie index can sustain the gains it would see the ASX 200 close up for a ninth straight day and we haven’t seen this sort of run since December 2015, so it tells you just how powerful the recent break of 20-week consolidation channel was.

The gains last week were broad-based and while financials have put in the bulk of the points, the outperformance was actually generated in utilities and staples, so it would be really positive to see some rotation into areas that may have lagged.

A lower AUD/USD is also a consideration, especially with the market eyeing Wednesday's Q3 CPI print in earnest. Whereby a quarterly print of 0.8% on headline and 0.5% on trimmed mean print would cement a move below 78c.

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