Trader thoughts - the long and short of it

Looking across the spectrum of financial markets this morning it’s hard not to go past the fact that the US short-term Treasuries have bought, resulting in the USD being sold fairly aggressively, at least relative to where implied volatility had been, and supporting the positive flow we have seen in the commodity complex.

Market data
Source: Bloomberg

The highlight of the night was the November FOMC meeting minutes, although the impact into markets was merely an extension of the trends we had already been seeing going into the event. Reading through the headlines there are a number of aspects that we can take out.

Firstly, the view that “several members of the Fed are concerned about low inflation expectations” reinforces the notion that the Fed are looking closely at the markets pricing of inflation expectations, which have fallen about 16bp since late October. Consider that Janet Yellen spoke during Asian trade yesterday with the market focusing on her view around the decline in inflation expectations and re-iterating a desire to lift interest rates gradually as a consequence. If we look at US inflation-adjusted (or ‘real’) bond yields in either the 5- or 10-year treasuries we can see yields falling fairly sharply and this is presumably exactly what Janet Yellen wanted to see.

Keep yields low and further incentivise business investment given the use of the risk free rate in assessing the net present value (NPV) of future projects. Lower yields make projects seem more profitable.

It was interesting to hear that a “few participants judged that the prospect for significant tax cuts has risen recently” and the market is already sensing that with Donald Trump recently detailing he wants to give America a tax cut for Christmas. Tax cuts, not tax reform seemingly the view of Wall Street at this stage.

We can slice and dice the narrative in far more depth, but the wash-up is the market has seen few reasons to alter its ‘a done deal’ approach to a December rate hike and we see little change in the pricing in the fed funds future (or US interest rate markets). We can see however, that short-term US Treasuries have had a strong day, with surprisingly strong volumes traded, also assisted by poor US durable and capital goods orders (-1.2% and 0.5% respectively), while a slight fall in the University of Michigan inflation expectations survey has also been noted.

The moves in US fixed income has seen the USD index lower by 0.7%, with the greenback falling against all G10 currencies, where USD/JPY has taken a bit of a hammering and lower by 1.1%. Technically, the pair looks set to close through the October lows of ¥111.65 and the USD bulls are going to needs to see price stabilise pretty quickly here as the trend here is firmly lower and short positions are preferred.

EUR/USD and NZD/USD have worked well too and while AUD/USD has lagged other G10 (currently gaining 0.3%), we have actually seen a decent rally through US trade, with price moving off $0.7555 and through $0.7600. Traders will be looking at better levels to sell this pair and I would be watching to see if market fades the pair into the 27 October low of $0.7625.

So with yields lower and the USD offered the commodity space has performed nicely. US crude has gained 2% and this has helped put a bid in the S&P 500 energy space (+0.6%), although looking at the chart of crude most of moves took place during Asia yesterday. The crude price is still up 0.5% since the yesterday’s ASX 200 close, so this needs to be priced into Aussie oil plays. Traders are managing positions and exposures ahead of next Thursdays OPEC meeting, but overnight we have also seen the weekly Department of Energy inventory report showing a draw of 1.83 million barrels of crude, which perhaps isn’t as big a draw as we had been expecting after yesterday’s API report.

We also heard that the US oil rig count had increased by nine rigs to 747, but again, this has failed to dampen sentiment. It’s also worth highlighting that there has been a focus on the narrowing spread between Brent and US crude, with the premium coming in by $1.64 through November.

Elsewhere spot iron ore played catch-up to strength in iron ore futures markets, putting on 4.3%, and in overnight trade we have seen Dalian iron ore futures up a further 3.2%, with steel and coking coal up 0.8% and 4.3% respectively. The S&P 500 materials sector is actually lower by 0.1%, although I see the Aussie materials sectors more in-line with the FTSE materials space, which closed up 0.5%. BHP, by way of example looks set to open 0.6% higher and Vale’s US-listing is 3.3% higher.

By way of index leads for Asia and while we have seen mixed moves in Europe (although the DAX fell 1.2%), it’s the S&P 500 that will always guide SPI futures and this index is flat on the day. Tech looks supported, which will happen when we see lower treasury yields but that shouldn’t influence the ASX 200 to any great degree.

That said, Aussie SPI futures are up six points at 6006, which (given the fair value involved) suggests we should see the ASX 200 opening just below 6000. Asia could impact sentiment as well, as it did yesterday, although the Nikkei 225 faces the headwind of a strong JPY and as things stand the Hang Seng and China CSI 300 look set for flat opens.

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