Trader thoughts - the long and short of it

The markets' main focus remains pre-positioning ahead of Thursday’s (4:00am AEST) FOMC meeting and the blueprint of US tax reform, which may include further colour about a reduced repatriation tax rate below 20%.

Market data
Source: Bloomberg

With US corporates holding some $800+ billion of cash in offshore accounts, if the market genuinely feels a lower repatriation tax could get through, then the US equity markets should find support through this week, although it does open up the prospect of a ‘buy the rumour, sell the fact’ scenario playing out next week. Let’s see how far the bulls can take the various indices this week, but playing the markets from a tactical perspective seems prudent. 

One interesting development overnight has been pushback from two central bankers whose exchange rate has been increasing of late. Certainly, this has been the case in Canada, where Bank of Canada member Timothy Lane detailed the bank was paying ‘close attention to how the economy responds to both higher interest rates and the stronger CAD’.

His view was premised on the idea that the recent economic strength was predominantly driven by exports, so a strong CAD could derail further expansion. The BoC remains another central bank who are beholden on the Fed and would be desperately keen to see them hike in December. USD/CAD has been the big mover on the day gaining +0.8%.

In the UK we have seen some weakness in GBP, with GBP/USD, the GBP pair most actively traded by clients, finding better sellers activity and lower by 0.7% on the session. BoE head Mark Carney gave a speech at the IMF and while he re-iterated his guidance of hikes to come in the ‘coming months’, he also put in the caveat that the cycle would be gradual.

Of course, there were far more insights than that, but on the whole, his comments provided little new material to push GBP higher after the stellar run it has had since 25 August and we have seen GBP/USD testing $1.3500. It's worthy to note that the interest rate markets haven’t moved on his speech and continue to price in a 60% chance of a November hike, while there has been no real move in the UK 5- or 10-year gilt.

There hasn’t really been a huge amount of news in the US to focus on, although geopolitical headlines are never far away. On the day we have seen the S&P 500 gaining +0.2%, with financials, again, the superstar here, with the sector pushing up 1%. We have also seen the S&P 500 materials and energy sector gain 0.6% and 0.4% respectively and this should bode well for the Asian markets on open too. US treasuries have been sold across the curve (hence the bid in financials), with the US 10-year moving three basis points (bp) higher to 2.23%, which in turn has caused a modest bear steepening of the fixed income curve and supported USD/JPY, which looks super bullish at present and looks to be targeting the ¥112.50 area.

Interestingly, we have seen the implied probability of the December rate hike moving to exactly 50% and this probability is a reflection of higher equity prices. Although we have also seen further selling of volatility, with the VIX index looking ominously poised to break below 10% again. If we take away inflationary concerns at the Fed and focus purely on financial conditions then the Fed would be raising rates in December, no question.

So the wash-up of overseas equity moves has been SPI futures gaining a modest six points; so a flat start is expected. The Nikkei 225 should open nicely above 20,000, while the market that has really been firing has been the Hang Seng, which has broken out of the August to September consolidation and is trading at the highest levels since May 2015. If you like trend you trade the Hang Seng, if you like range trading then you trade the ASX 200, they are your weapons of choice.

The event risk today is the RBA minutes, although the market is not expecting any fireworks if you look at AUD/USD implied volatility. We can see the market priced for a 35-point move on the day. We also go into the meeting with the swaps market pricing a 27% chance of a February hike (Goldman Sachs base case on rates), with a 58% chance price in for June. We can see this reflected in short-end Aussie bonds, with the Aussie 3-year treasury sitting at 2.16% and the highest since December 2015. The speculative FX players in the market are also very long AUD’s, however, today's RBA minutes shouldn’t be the catalyst to unwind this sizeable position and AUD/USD should be limited to a $0.8000 to $0.7920 range on the session.

On the materials front, we should see BHP pushing about 1% higher (based on its ADR), with US crude holding firm at $49.91. However, we have seen good flow into natural gas and from a technical basis being long Nat Gas here makes a lot of sense. Dalian iron ore futures gained 1.3%, with steel futures +0.3% and this should be the stronger input for iron ore stocks, over a fall of 0.5% in the spot iron ore price.

Copper has bucked four days of losses and put in a 60 bp gain on the day, although traders may use this strength to sell into. Gold is the underperformer, trading lower by 0.9% thanks to the continued move higher in US interest rate expectations and the moves in ‘real’ bond yields. Key support at $1299 (the 38.2% retracement of the July to September rally) to $1295 (April high) needs to hold here.

All-in-all there should be some mixed moves in materials plays, but the leads don’t seem to be the catalyst to see a reversal of the recent rotation in Aussie financials.

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