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Trader thoughts - The long and short of it

We head into Tuesday trade with a distinct risk-off vibe, although the moves in equities are probably best described as a ‘drift’, rather than a ‘spike’ lower.

Market Data
Source: Bloomberg

US economic data has perhaps not met the lofty expectations of the market and some have blamed 16.53 million vehicle sales (consensus 17.3 million) for the slight risk aversion, but this seems a bridge too far. We also saw the ISM manufacturing index coming in as expected at 57.2 (the second highest print since 2014), although the ‘quality’ of this report was high with new orders printing 64.5 and new export orders showing strong external demand at 59. The employment sub-component bodes well for Friday payrolls, or at least the manufacturing contribution, with the sub-index increasing to 58.9.

Data in Europe was also pretty good, if we take a step back, with Eurozone manufacturing maintaining its six-year high. However, there have been good flows into German bunds despite the solid data, with the ten-year bund falling five basis points (bp) to 27bp. We’re looking at short EUR/GBP trades yesterday, but slightly worse-than-forecasted UK manufacturing has seen that idea start off on the wrong footing. Short EUR/JPY was perhaps the better way to play the EUR overnight and the daily chart shows strong buying support kicking in at ¥118.23. Very happy to sell a closing break here for a sharp move into ¥116.40.

US fixed income has also been nicely supported, with strong flows across the curve. The eyes of the FX and fixed income world fall on the US ten-year Treasury, where a break of key support of 2.30% is looking more and more likely. Retail traders can look at the TLT ETF (iShares 20+ Treasury) and see that price here is looking like it wants to move higher (yield lower). The US ten-year ‘real’ yield has dropped three basis points to 36bp and while everyone is focusing on 2.30% on nominal yields, I would also be looking closely at the 30bp level on the inflation-adjusted basis. This was the swing low on 24 February and a break here in inflation-adjusted yield would be hugely positive for gold and presumably the JPY too.

The moves in fixed income have resonated in FX land, with USD/JPY trading through ¥111.00 and eyeing a move into ¥110.00. One suspects this means the Nikkei underperforms today, but as mentioned, equities still seem so calm and US implied equity volatility (I’ve looked at the ‘VIX’) has barely moved.

One element of US policy that has been talked about again is the use of the Federal Reserve’s massive $4.5 trillion balance sheet as a policy tool. We’ve heard a number of Fed members talking about this issue of late. Most prominently New York Fed president Bill Dudley, who I feel has been partially responsible for a move lower in longer-term treasury yields and USD/JPY selling, saying overnight ‘so, if and when we decide to begin to normalize the balance sheet, we might actually decide at the same time to take a little pause in terms of raising short-term interest rates.’

Philadelphia Fed president Patrick Harper also made mention overnight that they could allow maturing fixed income instruments (held on their balance sheet). They’re accumulated through the various rounds of quantitative easing to mature, without rolling over the proceeds into new bonds. There is much one can write about this, but the discussion around the balance sheet is one that is quite prominent now and is certainly prudent for them to be having. Perhaps this is causing some angst in broader market place, because if they get this wrong it could have far ranging ramifications in markets.

Turning to Asia, we see the ASX 200 opening at 5861, with headwinds for the materials and energy sector, given spot iron ore closed -1.2%, copper -1.7% and US crude -0.6%. Gold (+0.3%) is on the radar and reacting positively to the fall in ‘real’ yields, but the conviction in long positions really only kicks in on a break above $1264 (the 27 February high). A closing break of $1264 suggests increasing gold miner’s exposure within the portfolio, with NCM likely to gravitate towards $30 over the medium-term. Aussie banks should open on a flat footing.

The highlight of the day is clearly the Reserve Bank meeting at 2.30pm AEST. Again, this is a fixed income and currency story and equities are unlikely to move too greatly on the statement. Saying that the fact AUD/USD overnight implied volatility is just below 10%, which considering we have a central bank meeting, is super low and suggests traders see absolutely no move today! In fact, the market is pricing in a move no greater than 36 pips in AUD/USD today!

Everything locally is around the housing market, so traders will be viewing any narrative around financial stability. However, judging by positioning in the market and the sizeable net long AUD position held by speculators, most are expecting very neutral and nuanced language. This gives us a few reasons to believe they are even considering altering policy. Perhaps that could change on a weak Q1 inflation read on 26 April, but I would expect headline inflation to push back into the 2-3%, while the domestic banks are doing all the heavy lifting for the RBA.

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