It has been amazing to watch the Fed fund futures market move from pricing the probability of a hike from a low 20% in early February, to now sit at 90%. If you look at the Bloomberg calculation, it is 79.7% on the CME FedWatch tool. Either way, interest rate traders have said it’s now firmly the base case that they raise. When so many Fed members have shifted into a more hawkish setting and signified a March hike, then the interest rate market participants will not question that.
In US trade tonight we should hear definitive confirmation of a near-term tightening with Fed members, Charles Evans and Jeffery Lacker, as they are due to speak in a panel at 2.15am (AEDT). The generals of the Fed, Stanley Fischer and Janet Yellen, should somewhat seal the deal when they speak at 4.40am (AEDT) and 5.00am (AEDT) respectively. US payrolls could have some influence next Friday, but the trend in job creation has been strong. The probability is that we get a number in-line with the consensus of 180,000 people and wage growth of 2.8%. Then it's good night Vienna, game set and match. The question then, of course, becomes how many more hikes will we get this year?
As previously mentioned, the USD has been the mover on the day and is now the currency du jour. A nice push higher in the 5- to 7-year part of the US fixed income curve has given the USD bull’s new life - we can see 5-year US treasuries looking to test the December highs of 2.12%. It’s probably worth highlighting though the continued flattening of the 2- to 10-year-yield curve, which now sits at 116bp. The bond market seems to be saying that perhaps policy will tighten in the short- to medium- term, but longer-term inflation expectations remain firmly anchored. It’s not a reflection of an argument of a recession, as some will be saying.
Keep an eye on USD/JPY, which is now eyeing a break of the February and March double bottom neckline of ¥114.96, where a break would open up a move into ¥118.00 area. Arguably, the talk of the FX markets has been the sell-off in AUD/USD, and at 1.5% the sell-off is the biggest since 9 November.
I would be focused on how price reacts (in AUD/USD) if the sellers can push the pair into $0.7510, which has been such a pivotal and defining level for so long. The market is clearly net long AUD’s and subsequently hedge funds still have much to liquidate. However, it’s still early days and there are still attractions for holding AUD, namely very low implied volatility, so carry structures still work.
However, the commodity trade has been at the heart of the AUD move, but this in itself is a huge talking point on the trading floors today. Don’t look at spot iron ore, which rallied at 1.2%, it’s all about the dalian futures market. It has been sold fairly aggressively, with iron ore, steel and coking coal futures losing 4.2%, 2.2% and 2.9% respectively. Copper has lost 1.8%, while gold and silver have also been hit fairly hard too.
I quite like the idea of a tactical EUR/AUD long position. I have been bearish towards the pair for some time, but that trade is over for now and I wouldn’t rule out some good old fashioned short covering here. The French elections, of course, pose a significant risk, but the wheels have fallen off Fillon’s campaign and his voter base have seemingly shifted to Macron’s camp, where Macron’s odds of winning have risen to a 54% probability. Le Pen is still in with a shout, but her odds have dropped for 6 days straight and sit at 33%. This has helped the French/German bond yield spread to narrow a few basis points, which now sits at 61 basis points; an EUR positive.
Locally, it promises to be an interesting open for the various equity markets. Japan should outperform, with USD/JPY looking nicely supported and the positive impact that should hold on exporters. The ASX 200 is likely to open at 5755, so despite the moves in commodities, it seems like the selling will be really felt specifically in the materials and energy names (US crude is down 2.2% as well). Financials took most of the points out of the S&P 500 and I see the Australian banks having quite a flat open.
BHP’s ADR is down 1.6% if we use that as a proxy for the mining space. Naturally, expect stocks that are sensitive to a falling AUD to be nicely supported on open.