Trader thoughts - the long and short of it

Today is a fixed income story, with the ramifications of the trends developing in both nominal and ‘real’ (or inflation adjusted) bond yields having increased bearings in equities, currencies and more progressively Emerging markets.

Market data
Source: Bloomberg

The lead we have been dealt from offshore markets is undoubtedly negative and has been driven most prominently from the European bond markets. One just has to look at the German fixed income market, which to be fair was, selling off into the ECB minutes (9:30 pm AEST), but caught another leg higher with the market getting quite upset at the view that the bank was considering removing its easing bias on asset purchases.

This really shouldn't surprise too greatly, but the impact of a market so long duration is that we have seen long-term interest rates selling-off fairly heavily, with the German 10-year Bund up settling at the highest levels since January 2016.

Adjust this for inflation expectations and we can see German (if we use this as a proxy of Europe) ‘real’ yields at the highest levels since February 2016.
In the US, most importantly we are seeing the five-year ‘real’ treasury breaking out to 25 bp and the highest levels of the year and the equity markets has caught on. This really does represent tighter financial conditions - the very thing the Federal Reserve wanted to see! Tech doesn’t like this one bit, but neither does emerging markets and we can see the EEM ETF (iShares MSCI Emerging market ETF) falling 1.2%. Keep an eye on the EEM as a break of $40.90 (15 June low) and the downside momentum should accelerate.

Despite a sell-off in US bond markets we have seen the yield premium demanded to hold US treasuries over German bunds narrow to 180 basis points (the lowest premium since November) and this valuation boost to EUR has driven
EUR/USD into $1.1422 and is subsequently eyeing a break of the 29 June high of $1.1457.

Long EUR/AUD has been the trade though on the session, with the AUD and the NZD underperforming in G10 currency complex, largely due to a 2% decline in spot iron ore and its status of being the G10 proxy of emerging markets. AUD/USD has attracted modest sellers, and all eyes on whether the buyers step in at the key pivot of $0.7535 (the 22 June low), but for now it’s the EUR that is the currency du jour, driven by the strong moves in European government bonds and the talk that we could be staring at another bond ‘taper tantrum’.

European equity markets should underperform in this environment, and we can already see the EU Stoxx 50 trending lower here and that seems to be the directional bias of choice.

While there is now an increased focus on the G20 meeting and relations between leaders, data wise the overnight session has had a fair amount going on. Specifically in the US, where we have seen a weak ADP payrolls report (158,000 jobs created vs expectations of 188,000), while we also saw strong expansion in the US services ISM (the index printed 57.4). Within the index we saw a faster pace of expansion in new export orders (55) and new orders (60.5), although the employment sub-component  showed hiring in service sector grew at a somewhat slower pace, which when we marry off with the ADP report suggests some risks to the markets consensus call for 178,000 jobs in tonight’s non-farm payrolls (10:30pm AEST).

Perhaps the bigger driver for markets will be the inflation aspect of the payrolls report, with traders eyeing average hourly earnings of 2.6% yoy (0.3% mom). This comes ahead of next week’s core CPI (ex-food and energy) report on the 14th, although Janet Yellen’s two-day testimony will also be a potentially strong catalyst. With the US tech sector working inversely to US bond yields (selling in bonds results in selling in tech) one can take a view that equity, FX and EM traders have the fixed income in its sights as it is the centre of the financial universe.

So we turn to the session ahead. For short-term traders, the deterioration in sentiment and the fact that the S&P 500 was 0.9% lower has been noted, with 90% of stocks falling on the session and one suspects the bid could dry up in the ASX 200 and the market may well fall under the sheer lack of buyers. Why would you buy when there are a few storm clouds descending over markets and implied volatility is picking up?

Our opening call for the ASX 200 sits at 5729, so a fall of 0.5% expected, which is hardly the world ending scenario, but there is the real possibility the selling accelerates from 10:15 and the market close out the week a negative footing. As things stand BHP is expected to open somewhat firmer and materials, which have performed well this week, may actually be a relative outperformer today. Spot iron ore doesn’t give us much confidence on this call though, although iron ore futures and copper are largely unchanged.

US crude has had a volatile night, spiking into $46.53 after we saw a massive 6.29minllion and 3.66million draw in crude and gasoline inventories (as part of the Department of Energy) report. We also saw crude implied demand increasing and not far off record highs. As the session wore on though the general risk aversion through markets has seen the oil price under pressure and settling around 20c lower from where the ASX 200 closed.

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