Trader thoughts - the long and short of it

It was all quiet on the Western front by way of overnight leads for Asia. It was so quiet that after the two hours of the S&P 500 and Dow Jones cash session being open, the two indices traded in a meagre 1.9- and 21-point range respectively!

Market data
Source: Bloomberg

In the absence of any economic data, the session was really a pre-positioning exercise ahead of the FOMC meeting (tomorrow at 4:00am AEST) and Janet Yellen’s testimony held shortly after the statement is released. Some focus has been on the UK political situation with chatter around Boris Johnson’s political future, as well as Theresa May’s key speech in Florence on Friday.

While Donald Trump’s UN address has also been a focal point, although this has really been a sideshow and markets haven’t really adjusted to some of the colourful commentary, such as ‘the rocket man is on a suicide mission’. If we focus on US politics, perhaps the bigger market catalyst is the blue print for US tax reform, which is likely to be announced on Monday.

On the day, we have seen very limited stress in markets to hold assets ahead of the Fed meeting, with the Fed funds future selling off a touch in the January contract, therefore increasing the implied probability of a hike in December to 53%. The S&P 500 ultimately closed +0.1%, while US high yield credit spreads narrowed a couple of basis points (bp), showing some positive flow. 49% of stocks were higher on the day, so breadth is hardly inspiring.

However, if we look into the sector performance, we can see US financials have performed fairly well. The S&P financial sector gaining 0.8%, only really eclipsed by the telco space, while materials gained 0.5%. In the fixed income space, we have seen some selling of US treasuries across the curve, with the 2-year treasury now sitting at 1.40% and the 10-year at 2.24%, with the 2’s vs 10’s curve moving a touch higher into 83bp and again putting upside into financials.

The US volatility index (‘VIX’) remains unchanged at 10.15% and highlights that traders simply don’t see the S&P 500 moving with any great degree in the coming 30 days. More short-term, USD/JPY implied volatility (vols) is still quite subdued; the market is implying a 67-pip move in the full session ahead and a 42-pip move in AUD/USD. So hardly screaming that the Fed are going to inject some sizeable volatility in markets. Clearly, we expect the Fed to announce a formal start to reducing its $4.47 trillion balance sheet, but this is in the price and the collective will make sure the market is comfortable with the fact that it will be gradual.

We expect some tweaking of inflation forecasts for 2018, while in the commentary we should hear that low inflation remains transitory. The Fed are watching it closely and we expect some altering of the so-called ‘dots plot’ projection (or the various Fed members forecasts of where the fed funds rate should be in the years ahead).

However, the important view here is whether the median projections for 2017 and 2018 remain unchanged. For the median projection to be lowered, thus causing selling of USD’s, driven by a fall in the probability of a December hike falling to say 35-40%, then we need four members to lower their call on rates and this seems somewhat unlikely. The question then is how much the market interprets the statement and Yellen’s commentary as an urgency to hike in December, and if the 39bp of hikes priced in through to end-2018 is fair. If we look at implied volatility, not to mention limited disdain to hold risk assets and the stable performance of emerging markets, then we can deduce the market is not expecting any shocks at this meeting.

Turning to Asia and SPI futures have pushed up 21 points, indicating a somewhat stronger open for the ASX 200. The event risk today is minimal, with Westpac leading index out at 10:30am, although there is no survey and one expects this to have little impact on Aussie assets. AUD/USD has been bid all through European and US trade, finding itself back above the 80 handle, with the AUD and NZD being the strongest currency pairs in G10 complex on the session. As mentioned, there is little to drive today, but FX traders do need to assess the risks (as they always should) in the portfolio ahead of the FOMC meet.

Things get interesting should the market find the Fed’s tone somewhat dovish (relative to expectations) and we see a push back on a December hike. A move into the July high of $0.8066 could find sellers, but that said, if the bulls can push the pair for a close through this level and it would be a strong bullish development.

Let’s not forget yesterday’s ASX 200 tape was fairly bearish, with the Aussie index rallying into 5742 before traders sold into the strength with the index closing on its lows. This begs the question whether traders will fade moves into today’s opening call of 5723 again. That said, ASX financials look destined to find the buyers this morning, if the S&P 500 is our guide and a simple sense check of a 21-point gain in SPI futures, relative to a 5c gain in BHP’s ADR (American Depository Receipt). Material and energy names have mixed leads, with spot iron ore closing -4.1%, while iron ore futures are 1.8% lower.

Copper has closed 0.2% higher. US crude closed 0.6% lower at $49.60, but we have seen a 30c gain after the official close, with the weekly API inventory report showing a smaller-than-expected 1.4 million barrel build in crude inventories, while gasoline inventories fell a sizeable 5.1 million.

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