Trader thoughts - the long and short of it

We head into the new trading week, with the S&P 500 a mere 70 basis points from the recent all-time high of 2597, having found stability after the US benchmark looked like it might build on the 1.5% pullback into 2557.

Market data
Source: Bloomberg

However, with little to inspire this week, as we find little on the economic data releases to focus on, so again tax reform remains at the epi-centre of market considerations.

On tax reform, it was positive, albeit expected, to see the House vote through its own version of tax reform last week, but the Senate plan clearly faces greater hurdles and we now heard from a number of Senate Republicans (including Susan Collins over the weekend) that they have strong concerns about the bill, with some gripes ranging from increased tax treatments for small businesses, the inevitable blowout in the deficit and the repeal of the Affordable Care Act. Recall, the Republicans have a two-seat majority in the Senate, so in its current form it seems unlikely to pass and will clearly need some tweaks and negotiations. US publication Forbes, even went as far as saying (in an article released Sunday) that the GOP tax bill is the “end of all economic sanity in Washington”.

One to watch through this week though, notably as the economic calendar is light, with leading index, November FOMC minutes and Janet Yellen’s speech to the Stern Business School (Wednesday 10:00am AEDT) the standouts. It’s hard to see the market keying off this data to any great capacity, so this may give scope for funds to sell volatility, with the US VIX index closing +1.2% on the week at 11.43%, although this masked what was a reasonable range of 11% to 14.51%. Another factor to assess is the markets pricing of futures Fed hikes. With a 94% chance of a December hike the market feels a hike is a done deal and given the barrage of Fed speakers of late and the reluctance to push back on market pricing, you’d have to be the deepest of contrarians to feel they won’t go in December.

The greater focus then needs to be on what is priced in around tightening through to the end 2018 and 2019 and this is what markets are more interested in. Of course, there is so much focus on the US Treasury curve as well, with funds continuing to sell short-end Treasuries, with the two-year Treasury pushing up seven basis points last week to end at 1.72%, while staying positive on duration with the 10- and 30-year Treasury closing the week at 2.34% and 2.77% respectively. We therefore see further flattening of the 2’s vs 10’s Treasury curve and 5’s vs 30’s and this continues to be one of the big macro stories.

The other big story of late has been high yield credit, but a calmness has returned to this market and we see spreads largely unchanged on Friday, where a 2.7% rally in US crude would have certainly helped. Turning the focus to Europe, I thought it was incredible to see utility firm Veolia issue €500 million in 3-year debt with a negative yield of -0.026%. This is the first time ever a BBB-rated issuer (one of the lower rated investment grade debt) has affectively been paid by the market for issuing debt! What a world we live in and applying this same logic it would be great if I could take out a mortgage from an Aussie bank and be paid interest by that institution to do so.

The moves in US fixed income on Friday have weighed on the USD, with the USD index falling 0.3%, although it was USD/JPY which has attracted the bulk of the selling, closing -0.9% and taking the weekly loss to 2.8%. AUD/USD, on the other hand fell 0.3% and the AUD continues to find little love and this feels fair, although AUD/JPY has been the bigger mover and is trading at the lowest level since June. Rallies in the AUD crosses should also be sold this week, with little on the economic docket to drive shorts to cover with any great conviction. I will be keeping an eye on the yield differentially between Aussie and US debt this week and one can see that the US two- and five-year Treasury yield may be above that of the Aussie debt this week, for the first time since 2000.

Refocusing on today’s Asia open and the Nikkei 225 faces the headwind of a weaker USD/JPY, although any genuine weakness will likely be propped up by the BoJ, who have scope to increase purchases of domestic ETF’s, should the market fall 0.5% or more. SPI futures closed four points lower on Friday at 5959, and if we focus on the early interbank FX open we can see USD/JPY, EUR/USD and AUD/USD all very much unchanged in early interbank FX trade, which gives us conviction that the re-open of S&P 500 and SPI futures should also be a very sanguine affair. Commodity markets give the bulls some hope though for a bid in the market, with oil finding good buyers, while spot iron ore closed +1.7%, although we have seen mixed moves in Dalian futures, with iron ore, steel, and coking coal closing -0.9%, -0.2% and +0.7%. Copper closed up +0.6%. BHP’s ADR, by way of a guide looks set to open at $27.35 +0.8%

Hard to be long the ASX 200 with any conviction here as price as the five-day moving average (currently 5958) is headed lower and despite a rally above this very short-term average on Friday, we saw the index subsequently offered for a close back below.

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