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Trader thoughts - the long and short of it

The US economy has capped off what has been a strong round of global manufacturing data, with animal spirits roaring ahead.

Market data
Source: Bloomberg

A reading of 59.7 in the US manufacturing index is consistent with Q4 GDP above 4%, although it’s more likely closer to 3%-3.5%.

Digging into the report, we can see the new orders sub-index printing 69.4 (up from 64.4 in November) and growing at an incredible clip, with this being the strongest read in new orders since 2004. We can look at the new orders-to-inventory ratio and see this again fairly inspiring. Perhaps a small blemish in the report was the employment sub-index that fell to 57.0 (from 59.7). However, employment in the manufacturing space is still growing. Outside of the ISM manufacturing read we saw US December construction spending, with this gauge increasing at an above consensus of 0.8% in December (month-on-month). Again, this should put support the Q4 GDP read, when released in late January.

The net effect of this data was a 30-pip upside move in USD/JPY into ¥112.50, backed by a modest sell-off in the US bond market, although traders were quick to sell into the USD move ahead of the December FOMC minutes. We saw a nice bid running through the US equity markets and this was given extra legs with European equity markets taking part in the feel-good factor, with the German DAX gaining 0.8% and reclaiming the 13,000 level. A focus on the S&P 500 and we saw the index trading to a new high of 2713 by 4:50am AEDT, before dropping back a touch into 2707. The buyers have supported into 2707 and with 30 minutes left (at the time of writing) the index is threatening a break of 2713 again, but where ultimately the leads for Asia remain constructive.

Decent upside moves have been seen in the materials, energy, tech and financial space, with defensive sectors underperforming once again. The world is a happy place right now and investors still want growth, but that may change and there is a growing view that value stocks, specifically in the US equity market, should outperform this year.

In the back end of the session the Federal Reserve released in December meeting minutes and the net effect has been a slight bid in the USD and some selling across the fixed income curve. Of course, this has resonated in commodity land, where gold is traded into $1307, before the buyers have stepped back in and again the words ‘gold’ and ‘resilience’ can be put together. Copper lost a bit of ground too, although it is supported by the stronger economic growth thematic which is playing through financial markets.

US crude has found buyers easy to come by, showing no interest in USD moves and currently sits up 2.1%, so it’s no surprise that energy stocks are outperforming. The minutes themselves are subjective and can be interpreted as dovish or hawkish, but the subdued moves in the front-end of the US bond suggest the market took them as less dovish than what they could have been, but nothing has really changed. Here, the pace of rate hikes is expected to remain gradual, with the committee still firmly in agreement that inflation developments need to be monitored closely, where a "few" participants that see inflation skewed to the downside and a "few" skewed to the upside.

There was a more intense debate around the flatter yield curve, something Fed president James Bullard has been outspoken about of late and as we heard, was one of the key considerations why Minneapolis Fed President Neel Kashkari dissented against rate hikes in December. So one to watch, especially as the US Treasury 2’s vs 10’s curve is eyeing a break of 50bp. This could garner increased attention, although, as the bulk of the Fed agreed, “the current degree of flatness of the yield curve was not unusual by historical standards” and the equity and credit markets are not in any way concerned about moves in the Treasury curve.

We can also see the Fed funds future pricing in a greater degree of certainty around a March hike, with interest rate markets pushing up from a 70% chance of a hike in the March, to now stand at 81%. There should also be focus on the longer-term neutral Fed fund rate, where the market's pricing is still far below the Fed’s own estimate of 2.75%.

We have seen signs of covering of USD shorts and this has led to some modest downside in select commodities, but our ASX 200 call at this stage sits up at 6098 (+0.5%). It suggests that the bulls are back in town, dominating proceedings in the local market. BHP’s ADR suggests the miner should open closer to $30.45 (+0.8%), so BHP should put a few points into the index alone. CBA’s ADR is also fairly upbeat and sitting up 0.7%, so with the strong moves expected in energy, the question needed to be asked is whether we can not only close above 6100, but can the uptrend seen in the index re-establish itself?

We should also pay attention not just to the Nikkei 225, where the index looks like it wants to smash through 23,050. This has been a ceiling on the market since early November and where a closing break could start the ball rolling on a fairly powerful move higher. However, I also feel we should focus on USD/CNY, as the correlations of late between CNY strength and AUD/USD, and commodity moves has been strong. A weaker CNY, or a stronger USD/CNY could become a headwind, even for the ASX 200 materials sector.

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