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Trader thoughts - the long and short of it

We are staring at a fairly flat start for Australian and Japanese equities indices on open this morning, although China is the market to watch and another day of reasonably heavy selling may impact sentiment across the region.

Market data
Source: Bloomberg

The CSI 300 is the index showing all the moves at the moment, closing -1.3% yesterday, and breadth, which has actually been poor since around September is now really starting to deteriorate. The aspect of poor breadth and participation was actually the point from Chinese authorities last Thursday, who have been concerned with the equity market continually heading higher on very low participation, with a handful of large index weighted stocks putting in all the points.

Take the far broader Shanghai Composite index for example, where we can see within its 1420 index members, 90% of the gains in 2017 has been driven by the top 10 index weightings. So, it’s no surprise to see authorities target these names as part of their commitment to the quality of China’s growth. The question is whether further downside in Chinese mainland equities continues in the session ahead and will there be a spillover into Hong Kong and potentially even Japan, Korea and Australia.

The Nikkei 225, in itself, is interesting as there is a growing positive feel to owning the JPY in 2018. For the most part of 2016 and 2017 one would really only buy JPY in times of panic and heightened risk aversion and given its status as the dominant ‘funding’ currency, traders used this as a vehicle to be paid as part of the carry trade and the hunt for yield. 2018 is shaping up as a very interesting year for Japan and while the argument among macro traders is around future actions from the Federal Reserve and ECB, the Bank of Japan should also command close attention.

We’ve seen a number of views that the central bank is looking at the potential costs from buying up most of the ETF market and a decent chunk of outstanding government debt. However, now the conversation has moved to whether the bank should look to ‘fine-tune’ its current policy of targeting the yield curve (under ‘yield-curve control’). This has come alive from comments from BoJ board member Hitoshi Suzuki, with the market dissecting his comments and feeling that interest rates could rise before the bank reach its 2% inflation target.

Keep in mind that the Nikkei news publication only recently reported that spending plans from Japanese corporates were up 15.8% yoy and the biggest increase since 1990.

One other debate being had in Japan centres on whether Haruhiko Kuroda will be reappointed as BoJ governor when his term comes up for renewal in April. Of course, Japan doesn’t have a new president like the US, where Donald Trump was keen to make his mark on the Federal Reserve. Shinzo Abe has been a longtime advocate of Kuroda, but whether he is reappointed should get more focus in the coming months. There is a view he could possibly be superseded by Etsuro Honda, who is about as dovish as they come in the Japanese central bank, which is a huge feat in itself!

So the JPY has found buyers in the overnight session and notably against the CAD, which is being weighed down by a 1.7% fall in US crude. USD/JPY is the pair to weigh on the Nikkei 225 on open though, and the price is now oscillating around ¥111 and a break here should see price test support into ¥110.71. Keep in mind price traded above Friday’s high and looks ominously like it will close below Friday’s low – a bearish outside day reversal, which in effect suggests a continuation of the bearish trend. AUD/JPY is the key pair on my radar, as the must-watch FX pair today, as this is your key barometer is of all things risk and technically looks like a strong shorting idea. Price has also printed a bearish outside day, with sellers have faded the pair into the five-day moving average and this would give a heightened probability of a continuation of the strong trend lower since September.

So if I were paying vulnerabilities in the AUD for 2018, short AUD/JPY and long EUR/AUD looks favoured trades.

As mentioned the moves in crude have resonated in FX markets (with selling of CAD and RUB), but we have seen the S&P 500 energy space lower by 1% and this sort of move seems likely in the ASX 200 on open as well. Traders have been buyers of US crude over Brent of late, but that trade has reversed a touch overnight and maybe that’s a reflection of the recent increase in the US rig count or EIA statistics that show US production is running at 9.66 million BDP or just traders hedging exposures ahead of Thursday OPEC meeting, we are seeing US crude under pressure here, while Brent is holding in well.

US equities, more broadly, have held in well despite pathetic volumes, while there has been little change in fixed income or credit markets and we see Aussie SPI futures tracking a mere five points lower at 5986. Commodity markets are not helping sentiment here, with spot iron ore closing -1% at $67.27, while Dalian futures markets are hardly inspiring with iron ore, steel and coking coals trading lower by -1.8%, -0.1% and -1.9% respectively. Copper is also -1.2% and if we look at BHP’s ADR it suggests the miner will open 1.3% lower.

So a tougher day at the office for energy and materials, which has been a good hunting ground for equity appreciation of late and given we have seen both the ASHR ETF (China CSI 300 ETF) and EEM ETF (Emerging Market ETF) tracking lower by more than 1% and moves in key commodities it suggests an elevated risk of a drift lower in the ASX 200 after the open, or at least limited reasons for it to rally. In terms of event risk, soon to be departing New York Fed president Bill Dudley speaks at 11:00am AEDT (on the subject of the US economy: 10 years after the crisis), while the new man at the helm of the Fed, Jerome Powell, is set for his confirmation hearing in front of the Senate Banking Committee at 1:45am AEDT and the market doesn’t know as much about Powell’s view on the economy and policy as they would like – so plenty to explore here.

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