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Trader thoughts - the long and short of it

Markets have swooned this past session; but the true to character, US equities would not feel the pressure for too long. Other regions would hold onto their losses a little more readily.

Market data
Source: Bloomberg

Asian and European shares generally closed firmly in the red while carry trade in the FX market was also under pressure. What makes the contrast between US markets and their global counterparts particularly remarkable is that much of the shock value in the slide originates in the United States. Heading to Davos, a concerted effort to warn that protectionism was back on the menu serves to create another bout of ever-escalating shots to earn growth at others’ expense. For now, the benefit may swing to the US; but these sort of reactionary efforts rarely stop at one volley. 

Wall Street: While US indices opened the day to a significant slide, the losses would ease as the session progressed. With the New York close on Wednesday, the S&P 500 will have gone 110 trading days without a 1% or larger decline – matching the longest period of extreme complacency since June 1985. That may not be as impressive a historical figure as the record series that the same index has notched since its last 5% retreat from highs, but the extremely low boundary to break that run makes this bout of extreme quiet simply extraordinary. As quiet prevails, investors grow increasingly complacent, volume thins and exposure increases, hedging efforts typically diminish as it is seen as an unnecessary cost. These are conditions ripe for catastrophe.

US Protectionism Hits Dollar and Equities: Protectionism often gains traction within countries when there is the belief that mediocre growth – or outright economic contraction – are the result of unfair relationships with trade partners. Though GDP for the US and the rest of the world is not breaking records, it is far from stagnant. Furthermore, the level of capital market benchmarks are breezily notching records at regular intervals. That is what makes the recent swing back into the protectionism camp from the United States so remarkable. President Trump started off the week announcing Chiense tariffs on on solar cell and washing machine. Commerce Secretary Wilbur Ross would take up the same battle cry by suggesting more trade adjustments would come for the relationship with the world’s second largest economy. It was Treasury Secretary Steve Mnuchin, however, that truly dealt the Dollar a deft blow through this past session. The finance minister at Davos spoke to the benefits of a weaker Dollar for the US economy. Whether or not that was meant to voice support for the currency’s slide and the developments that ushered it there, FX traders felt it reason enough to drive the Greenback to its lowest level in three years. Protectionism rarely benefits a single country – or its assets for long – as retaliation is generally inevitable.

ECB Rate Decision: Top event risk for the coming session – and arguably the most loaded even this entire week – is the European Central Bank’s (ECB) rate decision. In the past few weeks, we had seen a strong speculative reaction to the mere perception of modest policy shift from the two most dovish central banks in the world: the ECB and Bank of Japan. Yet, we saw the Japanese authority earlier this week downplay the technical adjustment they made to their regular QE purchases which in turn curbed speculators anticipation. Now it is the ECB’s turn to confirm or deny the interpretation made from the minutes of the last meeting. That transcript stoked speculation that the policy group would soon make a course correction on forward guidance which in turn would be interpreted as intention to make more measurable efforts to tighen policy – definitively end QE in September and/or hike rates in 2018. Given the Euro is already trading at three year highs versus the Dollar, it is ready to accept good news – and in a stretched position if it registers disappointment.

Pound Earns Its Own Rally: It is difficult to separate strength from individual currencies from the weakness of the US Dollar. When we look to EUR/USD, do we see strength in the former or weakness in the latter? Looking across various Euro-based pairs, we see very little of the enthusiasm that the benchmark cross reports. In fact, an equally-weighted index of the most liquid Euro-based majors is virtually unmoved. That puts the responsibility for the dramatic move at the feet of a tumbling Dollar. It is true that GBP/USD is also being geared by the Greenback’s crash, but the 1.5% rally to post-Brexit highs isn’t just the doing of a cratered US currency. Looking at an equally-weighted Sterling index, we see broad strength. What was the making of this charge? The December labour report certainly contributed to the enthusiasm. While jobless claims rose 8,600, the employment change over three months rose a remarkable 102,000 while the ILO unemployment rate stood at 4.3% and weekly earnings excluding bonus ticked up to 2.4 percent.

ASX200: Considering the state of the European indices this past session, the ASX did well to escape a deeper contraction Wendnesday. The question is whether the relief effort late in the New York session will translate readily into Australian shares. The index itself is not very far above 6,000 – a level that represents support from the past two weeks but also lines up with a three-month rising trendline support for chart watchers. A rebound in protectionism in the world will not bode well for exporters or the relationship to China.

Commodities:  Commodities were firmly higher through the past session. Looking at various commodity indices, we would see breakout moves from already significant highs. That translated well down into individual assets. With some varying degree of remarkable performance in natural gas and heating oil, US-based crude oil (WTI) charged through $65 this past session to trade at fresh three year highs. That puts a dramatic end to a head-and-shoulders pattern that had formed recently. In metals, gold stood out for a break above $1,345. More important than the 16-month high it went on to hit, this was a clearance of a four-and-a-half year trendline resistance. The slide from the Dollar certainly had a lot to do with ath performance.

Australian Dollar: On a close basis, AUD/USD is at levels last seen since May 2015. Yet, when we account for intraday price action, we are still dealing with last year's highs in the 0.8100 vacnity. With pairs like EUR/USD, GBP/USD and USD/JPY taking clear advantage of the Greenback’s pain, it would be fitting for the Aussie Dollar to do the same. Yet, is this single pair’s performance going to readily spread to the rest of its crosses? Looking across other pairs, it doesn’t look to be the case. Protectionism does not support currencies whose appeal is strong supported by trade – especially in the absence of competitive yield.

Market Update:

SPI futures moved 17.7 or 0.29% to 6054.66.

AUD/USD moved 0.0072 to 0.8072.

On Wallstreet: Dow Jones 0.03%, S&P 500 -0.01%, Nasdaq -0.53%.

In New York: BHP 1.58%, Rio 1.19%.

In Europe: Stoxx 50: -0.79%, FTSE 100: -1.14%, CAC 40: -0.72%, DAX 30: -1.07%.

Spot Gold moved 1.36% to US$1359.46 an ounce.

Brent Crude moved 0.24% to US$70.13 a barrel.

US Crude Oil moved 1.29% to US$65.3 a barrel.

Iron Ore moved 0.48% to CNY524 a tonne.

LME Allumnium moved -0.87% to US$2229.5 a tonne.

LME Copper moved -2.05% to US$6923 a tonne.

10-Year Bond Yield: US 2.64%, Germany 0.59%, Australia 2.83%.

By John Kicklighter, Chief Strategist, DailyFX

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