Trader thoughts - the long and short of it

Despite cries from certain circles on social media about an impending recession, it seems global growth is seemingly accelerating and the prospect of any recession occurring in 2018 is very low indeed. China started the ball rolling with its service and manufacturing data, both in its larger industries (as measured by the National Bureau of Statistics) and also the Caixan print, which surveys the smaller end of town - both measures were good enough keep sentiment elevated. We have seen manufacturing PMI’s continue to highlight that Europe is in a good spot, and the need for negative interest rates and €30 billion a month in asset purchases is diminishing. Despite the Euro area final manufacturing read coming in at 60.6 – a record high, we haven’t seen any moves in the interest rate markets, with the difference between the Euribor December 2019 and 2018 futures contracts remaining at 35 basis points. This is a great gauge for pricing around future ECB expectations - it's a 'must watch' gauge this year in my opinion.

Despite the lack of move in European interest rate expectations, we did see a reasonable sell-off in German and peripheral European bond markets. This created a tailwind for EUR/USD, pushing into a session high of $1.2081. We have also seen nice flows into long GBP/USD positions too, with the pair hitting $1.3600 and eyeing a break of the September 2017 highs, despite UK manufacturing PMIs that are a touch under expectations at 56.3.

It has been a USD move though and we can see USD/JPY under pressure too, with price testing the 112 handle. Some are attributing this to Morgan Stanley who put out a sell recommendation on USD/JPY for a longer-term move into ¥105. A punchy call, with the consensus for year-end sitting at ¥112. It's also interesting to see the cost for USD funding (as seen in three-month USD/JPY cross currency basis) has narrowed significantly of late. Morgan Stanley argued that this could incentivise foreign investors to sell out of Japanese government bonds, which in-turn could see many of the FX hedging policies put in place (to neutralise the effects of holding a Japanese asset) unwound in the process – a JPY positive. One to watch, as USD/JPY at ¥105 would have interesting implications for Japanese markets and certainly validates the ultra-cautious stance of the BoJ.

As mentioned yesterday, the short USD, long commodity trade is still one that is taking centre stage. That said, the USD event risk ramps up tonight with US December manufacturing ISM (due at 2:00am AEDT), with calls for another elevated read at 58.2. It seems the balance of probability is either for an inline print or a modest downside miss, but to be fair, the way the USD has been sold of late the market is seemingly more sensitive to an upside surprise and there could be a reasonable short covering move if the data points comes in closer to 59.

We then get the December FOMC minutes at 6:00am AEDT, and while the market is not expecting fireworks here (judging by USD/JPY implied volatility), one wouldn’t want to be too short USD’s if the Fed give a more confident assessment of their inflation outlook. Notably, one needs to focus on US fixed income markets, where we can see a strong sell-off overnight, with longer-term yields really underperforming. The US 10-year Treasury is up 4bp overnight and at 2.46% is now eyeing another test at the 2.50% mark, where it failed to push through in December.

Importantly, we can even see US inflation expectations moving above 2% for the first time since October, having moved progressively higher from 1.84% in November. This sell-off occurring in bond markets that requires close attention, especially with inflation expectations building. We can also see the market getting excited about March rate hike from the Fed, with the Fed fund future now pricing in a 75% chance of this occurring. So, if it weren’t for the fact that data from other parts of the world has been inspiring, then I would be covering short USD positions and reducing commodity exposure as a short-term trade. That may well still occur in the session ahead, as commodities are stretched, so one to watch.

We can still see US equity markets rallying, despite selling in fixed income and much of this has been centred in tech, where the NASDAQ 100 is flying. Interestingly, volumes have been strong for this time of year and whether you look at the NASDAQ, Dow or S&P 500, they are in-line with the 100-day average (for this time of day). We can also see decent gains in energy (+the sector is currently up 1.5%) and materials (+1.1%). This may spill over into Asia, with BHP’s ADR sitting up 2% and indicative that the stock trades north of $30 for the first time since May 2015. Keep an eye on price here, as a pop into the $30.25/50 area makes the stock clearly overbought and it may be an opportunity to fade the move for a quick mean reverting trade. Gold stocks will also require close attention, as a few have run hard of late and one questions if these names can close at their highs, or whether some profit taking kicks in later in the day.

NST (Northern Star) is one gold stock that’s on the radar, with price closing at an all-time high yesterday and trending beautifully.

Aussie SPI futures are currently up four points, so with BHP expected to fire up and Value’s US-listing up 4% (will FMG be a $5 stock today?) there will be disappointment from certain areas of the market and one suspects financials could hold us back a touch. That said, US crude is a touch lower on the session, so I would expect ASX energy names to not react in the same vein as S&P 500 energy names and could see far more sanguine moves. It promises to be an interesting day, while AUD/USD requires close attention too, and again price is trending beautifully and as mentioned yesterday as long as the price can hold above the 5-day moving average (EMA) on a daily closing basis then its onwards and upwards, but with the US data in play ahead the prospect of a short-term reversal is naturally elevated.