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Trader thoughts - the long and short of it

It has been a big night as far as leads go for Asia, and perhaps a little surprising too, as far as the moves go.

Market data
Source: Bloomberg

It’s interesting that the moves in SPI futures haven’t actually been that pronounced. However, given the Aussie index futures were trading at 5686 at 4:10pm AEST (and the close of the ASX 200 cash market). It currently resides at 5668 and we can see the ASX 200 facing headwinds on the open. How the index fares after the full unwind is anyone’s guess, although we saw good buying activity yesterday, so we know there is support at current levels.

That said, these buyers hadn’t expected the reaction we have seen in US markets, with market participants springing back into action after August holidays. We can see a triple threat of negative catalysts promoting some big moves. Firstly, dovish comments from Fed Governor Lael Brainard started the ball rolling. Who, among other comments detailed ‘my own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target.’ We shouldn’t be overly surprised by her stance, she is a well know dove, but the comments come at a sensitive time for markets.

Ms. Brainard’s comments were then complimented by Donald Trump’s tweet. His tweet detailed that ‘I am allowing Japan & South Korea to buy a substantially increased amount of highly sophisticated military equipment from the United States.’ As was the fairly terrible US data points in the form of durable goods report (-6.8%) and factory orders (-3.3%).

One questions if the debt ceiling debate is becoming more a concern too, for credit and equity markets, although it still feels like the Trump tweet was the key talking point. US four-week T-bills now command a higher yield than US two-year government bonds, while the US T-bill maturing 12 October, which is effectively when the US Treasury could exhaust all possible funds, should an extension not be reached, gained a sizeable 5bp to 1.18%. Let’s hope they raise the debt ceiling this week, or it could get quite painful out there.

The culmination of these factors is a further pricing out of a December rate hike, with the Fed funds future pricing in 28% probability of further tightening this year. On this point, we saw ratings agency S&P saying they now don’t see the Fed raising rates until next year. One suspects the investment banks, who largely are still calling for another hike this year, change their calls soon too. The moves in US fixed income have been pronounced, with solid buying across the curve, but there has been a strong move to increase duration and buy into longer maturities, with the US 10-year treasury now at 2.06% and 10 basis points (bp) lower on the session and taking the yield curve (I’ve looked at 2’s vs 10’s) has flattened 5bp to 77bp.

The US five-year ‘real’ (or inflation-adjusted) treasury yield has dropped five basis points, so it’s no surprise that the USD has sold off and gold has rallied into $1344 (+0.5%).

We have seen an 8bp widening of high-yield credit spreads, while implied volatility has increased, with the US volatility index (‘VIX’) pushing into 12.36% (+20%). Interestingly, despite moves in fixed income and falling the greenback, we have seen emerging markets struggle, with the EEM ETF (iShares Emerging Market ETF) lower by 1.3%. US equity markets have moved lower, with the S&P 500 closing -0.8% and the NASDAQ -0.9%, with volumes around 11% above the 30-day average. The moves have most prominently been seen in US financials (S&P financial sector closed -2.2%), however, there have been some pockets of strength, notably energy, with the S&P 500 energy sector closing higher by 0.6%.

It’s no surprise energy has performed well, with US crude closing up 2.8%, helped by a number of US refineries coming back online and promoting the demand side of the supply/demand equation. These moves in crude should help BHP too, with its ADR down 0.2%, and this despite iron ore futures lower by 2.1% (spot iron closed +0.7% at $78.39). Gold stocks should perform admirably today, with the GDX ETF (gold miners ETF) closing up 2.1%.

Aside from the leads from offshore, which of course need to be discounted locally, there is a focus on the AUD and rates market locally. AUD/USD traded into $0.8028 in early US trade, but has come back a touch and is oscillating around the 80 handle. This is largely a story of USD weakness, but we can see a market positioned now for Aussie Q2 GDP (due at 11:30am AEST today) to print 0.9% to 1% QoQ, taking growth on a year-on-year basis towards 2%. Interestingly, we can the fundamental backbone behind the pair’s strength coming from fixed income markets, where the yield premium commanded to hold Aussie 10-year bonds over US treasuries has increased to 61bp, the highest since June 2016.

It will be interesting to see how the GDP print influences the market pricing of future RBA action and whether a GDP print above 1% QoQ (should it come), increase the 6bp of hikes (just over 20%) priced in for the February meeting.  

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