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Trader thoughts - the long and short of it

On first blush, one could say that we are due for a positive open for the ASX 200 and Hang Seng, with flat moves expected in Japan.

Market data
Source: Bloomberg

However, with plenty going on through the weekend, we really need to see how futures react on open, as they discount all the news flow. This is somewhat harder to predict, but the fact USD/JPY is trading 20 pips lower in interbank trade, suggests modest weakness to S&P 500 and SPI futures.

With Aussie SPI futures sitting up 29 points from 4:10pm AEDT until the Friday night close, which in effect gives us an opening call for the ASX 200 of 6030. One suspects this could be closer to 6020, once SPI futures re-open for the new week at 9:50am AEDT. Any early weakness in S&P 500 futures should be supported though, in my opinion, and markets should gravitate back to the flat line by the European open.

While markets had largely anticipated the US government shutdown, price action showed a lack of concern to hold equity into the weekend, with the S&P 500 managing to close up 0.4% at 2810 and at session (and all-time) highs. Hardly a market terribly worried about an impending shutdown and the reality is that we can see the last three government shutdowns (in 1995, 1996, and 2013) actually showing positive returns in the S&P 500 through the period. We can see that many of the market sentiment gauges (such as the put/call ratio) are showing extreme readings. As Morgan Stanley highlighted, pricing in the S&P 500 options market currently suggests a 15% chance of a 2% pullback in the S&P 500 over the next 30-days, a fate so rare it ranks in the fifth percentile since 2001. All is calm, all is well.

The shutdown has played out with Congress failing to come up with the necessary agreement and subsequently holding back on allocating funds to spend on discretionary spend, such as entitlements and government outlays. Clearly this is a story that has been a talking point among traders and media over the weekend. However, in reality, the shutdown should impact Q1 GDP to a small extent, obviously depending on how long it drags on for and the associated costs involved. By way of a guide, for every week the government is shutdown we should see a drag on Q1 GDP of between 0.2ppt and 0.4 ppt (QoQ annualised). Although, this depends on the economists model, and much of this loss of growth will work its way back in the form of payback into the Q2 GDP reads.  

The real risk to markets comes in the form of the debt ceiling debate and that isn’t really a theme until late February. From this point, markets will take their cues from US T-bills and those maturities covering periods when the US Treasury is due to exhaust funds to pay it coupons and maturing debts. One suspects that issue is a low probability, but a government shutdown goes a small step to believing it could materialise. The political headlines are rolling in as I type and traders need to separate what is noise from the facts, but from what we can currently see, Majority Leader Mitch McConnell and Democratic leader Chuck Schumer are to “have a conversation” about the shutdown today. Therefore, hopefully progress can be made here and certainly Trump would like a resolution as he heads off to Davos for discussions focusing on trade.

The other interesting piece of weekend news is that we have signs of a political breakthrough in German, with the SPD party signaling they are willing to negotiate their position with Angela Merkel’s CDU party to form a ‘grand coalition’. The EUR clearly likes this news, but it is going to take something to push EUR/USD through the $1.2250 to $1.2300 level and one would expect the market to sensitive to holding EUR longs into this week’s key event risk. That being Thursdays ECB meeting, which takes on more relevance, given the likes of ECB members Nowotny, Constâncio and Villeroy have all expressed concerns about the EUR’s appreciation. This coming at a time when economists are warming to a view that the ECB will fully cut its bond-buying program in September and hike the deposit rate in March 2019, although to be fair this is already priced into markets.

One to watch, but the moves in EUR in early trade suggests upside risks to the DAX on open, where a closing break of 13,500 (the November and all-time highs) would get a fair amount of attention from traders.

So plenty to occupy trader’s mindset on open, as there will be throughout this week, with tomorrows Bank of Japan meeting also a potential landmine, where the risks are the central bank push back on growing market expectations of a change to its yield curve control program later this year. JPY bulls could feasibly see better levels this week to sell USD/JPY. Of course, US earnings will continue to roll in, starting with market darling Netflix tonight, but judging by the moves in the S&P 500 of late one suspects the consensus is expecting something closer to 15% EPS growth (yoy) for the full reporting period, up from 11% a couple of weeks ago. On the data side, we get US Q4 GDP and a raft of key German economic releases, however, the data doesn’t start to really heat up in Australia until we get Q4 CPI next Wednesday.

In markets, the focus remains on the US Treasury market and specifically if the US 10-year can build on its current move into 2.64% and push into 2.75%. This is a level many feel the Bank of Japan are looking at and it's not far off year-end consensus levels. Inflation expectations are also moving higher and this needs to be paid attention too as well, if for no other reason that the Fed focus on this metric. However, whether it transcends into actual inflation is yet to be seen, but the risk premium built into the yield should fall from here, pushing the 10-year higher. Keep an eye on the XLF ETF (US financial sector ETF) as this has been on the radar for a while and is trending higher beautifully. AUD/USD looks vulnerable about 80c, especially if US rates head further higher as traders start to re-focus on those countries with very high household debt and of course that paints the AUD in a far less bullish light.

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