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Trader thoughts - the long and short of it

Welcome Back! After a week off to celebrate the Golden Week holiday, China is back, and markets are welcoming the return to normalcy regarding volume.

Market data
Source: Bloomberg

This is especially true in metals, which have focused on China’s efforts to manage the economy and the environment, which has provided confusion around the demand for base metals. Before the holiday commenced, metals led by Iron Ore were retracing much of their mid-year gains and the concerns looks to have returned as well while selling pressure is feared to be a common theme for the base and precious metals at the start of Q4.

Wall Street: A key driver of US equities in Treasuries was offline Monday due to a local holiday in the US. The higher yields have failed to produce the concern that would lead to selling equities from lower margin. Instead, higher yields have been seen as a vote of confidence that the Federal Reserve has been right in their assessment of the economy that favors moving forward with rate hikes. On Monday, US shares were higher again as they remain in record-breaking territory. The amazing thing about the current rally higher in global equities is the inability for concerning stories to stick. If there’s one thing that has caused bears to question their own sanity, it is likely that every “sure-fire” development to take down the record-induced rally only leads to stronger buying and new highs when the concerning headline subsides.

Some of the current concerns that continue to catch air-time, but have failed to bring stocks lower is the global credit bubble that sees too much issuance with too little regard to serviceability on the global scale, political concerns from South Africa to the UK/EU Brexit negotiations, trade renegotiations with NAFTA, and of course the succession of the Federal Reserve chair with little belief that able-minded Yellen will be considered and either Jerome Powell or Kevin Warsh will be tapped to see the continuation of the balance sheet runoff and reference rate normalization to the terminal rate.

NFPs Miss, But Weather Discounts Concern: A rare drop in US Non-Farm Payrolls was not enough to bring down the expectation of a December Fed rate hike. After the news release on Friday, the expectations rose to an 88% probability of a rate hike for the December FOMC meeting. Despite falling 33k,  the hurricanes that took over headlines in Florida and Texas were the reason that traders failed to consider the US economy was hitting a soft patch, and rather the focus shifted to the household survey, which was less affected by the storms and showed rising confidence.

A key highlight of the employment report was that unemployment rate fell as labor force participation picked up alongside wage growth. The combination was enough to keep the US dollar supported, and US 10-Year yields are pushing closer to 2.4%, which has been resistance for the US yields to overcome. Naturally, the unusually weak September Jobs report will turn focus to next month’s report to provide further clarity for job trends and wage growth as the storms effect’s fade away.

Chinese FX Reserves Show Consistent Gains: A key way that doubters of the Chinese economy bolstered their argument in the second half of 2015 and early 2016 was through the falling FX reserves. The argument went that to stop capital outflows from weakening the yuan further, the PBOC was running through their reserves at a rapid pace. That tide has turned. On Monday, the PBOC showed their foreign-exchange reserves posted the eighth-straight monthly rise in September.

Utilizing the earlier logic, this would support evidence that pressures caused by cash outflows have eased alongside a stronger yuan. The PBOC holds the world’s largest FX stockpile, and it grew by US$ 17B to a total of US$ 3.109T. The current eight-month rising trend is the longest since mid-2014 that lead to the current peak of holdings at US$4T.

The stable FX reserve position in China helps to show the prior trend of declines has definitively reversed. The reversal is further supported by local growth, lack of concerning capital outflows, and a stronger yuan, which altogether is expected to insulate China from the likely tightening of the US Federal Reserve as they look to raise rates rather consistently if the data holds up through 2019.

NZ Elections Provide AUD/NZD: A political premium is being added to the Kiwi as the rate to a majority for New Zealand’s 120-seat parliament is amazingly close. The close race has led to a decline in the NZD against AUD and other currencies. The close race provides little clarity for investors, which is adding to the risk premium addition for NZD. Over the weekend, the election gave the opposing Labour Party and the Greens two addition seats which put their collective total to 54, compared to 56 seats for the ruling National Party. Thursday could see volatility as the kingmaker New Zealand First Party is expected to decide by then after both partied began coalition. Currently, the forward market through forward interest rate differentials is providing little clarity for NZD bulls but is likely encouraging the bears.

Australia Dollar: Aussie traded flat against the US Dollar, which was muted due to thin holiday trading on Monday. Tuesday and Thursday will provide the balance of economic data prints for the week with a focus on consumer confidence to help guide clarification on economic sentiments. A stronger reading could help AUD regain some of the lost ground as AUD/USD is trading near 2-month lows as the market woke up to the prospects of Fed hikes continuing unabated in September. A further slip of consumer confidence would align with the recent trend of weaker ‘hard’ data on economic activity, which could keep AUD struggling. The strong positive correlation to Iron ore also looks to be a liability to the Aussie as the Chinese winter curbs is expected to provide a headwind to any bounces in the base metal. Friday’s commitment of Traders report from the CFTC in the US saw a cutback of long positions, but large speculators net bullish positioning remains aggressive at 96% of the 52-week range. An unwind in this aggregate position could also lead to further AUD weakness that traders should watch.

ASX: The ASX closed higher by 0.5% through Monday’s active session after catching excitement from Chinese shares resuming trading and doing so with buying pressure after a week’s holiday. The leading sectors in the ASX were banking, healthcare, and consumer-related sectors. The highest breadth of gains was seen in IT with 88% of shares were up on the session with the largest contributor to Monday’s gains being consumer discretionary. Looking forward, the mining sector will remain in focus as China’s winter steel curbs over the November-to-March heating season will likely hurt demand and increase season weakness per a report from the Department of Industry, Innovation, and Science in their quarterly report published Friday.

 

Commodities: Activity in the commodity sector returned to life as Chinese investors came back after Golden Week holiday. However, the concern now facing commodities and China is the renewed focus on steel-output cuts in China over the winter hurting demand and the potential for new supplies being brought online from the world’s top miners. The concern is best visualized through Iron Ore, which has recently traded toward July lows on the most-active SGX AsiaClear contract. In other commodity news, focus turned toward recently volatile WTI Crude Oil, which continues to oscillate around $US 50. Recent comments by OPEC Secretary-General Mohammed Barkindo said that to succeed in re-balancing an oversupplied market, Oil producers will likely need to take “some extraordinary measures,” to restore stability on a sustainable basis in the oil market. So far, the production cuts appear to be working as there has been a marked decline in crude inventories and a better balance in the oil market and OPEC ministers and non-OPEC members like Russia who have participated in the curbs remain confident that their actions will bear fruit.
 

Market Watch:

SPI futures up +28 points or 0.5% to 5739

AUD +0.02% to 77.68 US cents (Overnight range: 0.7748 - 0.7782)

On Wall St: Dow +0.05%, S&P 500 -0.03%, Nasdaq +0.1%

In New York, BHP +0.15% Rio +-1.57%

In Europe: Stoxx 50 +0.2%, FTSE -0.2%, CAC +0.11%, DAX +0.15%

Spot gold ­+0.3% to $US1281.20 an ounce

Brent crude +0.1% to $US55.65 barrel

US oil +0.3% to $US49.46 barrel

Chinese markets reopened after Golden Week

Iron Ore delivered to Qingdao China – 62% Ferrous Content +0.7%, 62.67

LME aluminum -1.15% to $US2146 a tonne

LME copper -0.7% to $US6654 a tonne

US Fixed Income Closed for Holiday

10-year bond yield: US 2.359%, Germany 0.44%, Australia 2.82%

 

By John Kicklighter, Chief Strategist, IG Chicago and Tyler Yell, Trading Instructor & Currency Analyst, IG Addison

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