Trader thoughts - the long and short of it

The big consensus trade of being short USDs into 2018, and long European and US financials continues to work in earnest. This remains the key focal point in the week ahead. Perhaps, given the magnitude of the moves in Friday’s session, some have questioned if the selling in USDs was actually a capitulation sell-off.

Market data
Source: Bloomberg

Certainly the US data did not warrant a 1% decline in the USD index, although, let’s not forget that the EUR makes up over 50% of this basket of currencies (traded against the USD).  The EUR is being buoyed, not just by positive political developments in Germany, but also by a slight hawkish turn from the ECB.

A 1% decline in the USD index was actually the biggest sell-off since 27 June, with price closing below the 8 September pivot low and it just shows how much sway the USD bears have right now. US core CPI printed 0.3% in December, taking the year-on-year rate to 1.8%, which was 10 basis points above consensus, although we did see a slight miss to the headline inflation rate at 2.1%.

We also saw the December retail sales report coming in slightly above the Street's forecast at 0.4%, as did the retail ‘control group’. It's the element of spending that feeds directly into the Q4 GDP calculation and this print would have seen economists revise up their real-time GDP forecasts by around 20 to 30bp.

The US data actually initially promoted a decent spike in the USD, with good selling in all parts of the US fixed income curve. However, after a brief moment of USD euphoria, the market changed its tunes and sold straight into the move. Everyone seems to be looking for any strength at all in the USD to average into new short positions and low, and behold the consensus trades for 2018 are all working nicely in this early stage of the year.

Despite the slightly strong US data, we can see that in the interest rate markets the Euribor futures December 2019 contract widened relative to the December 2018 contract to 39bp. This suggested the market sees further confidence above a move away from such accommodative monetary policy settings in Europe. We also saw a slightly more hawkish turn in US interest rates, with Eurodollar futures widening 1.5bp through December 2018 to December 2019 contracts, but even so the difference between Euribor and Eurodollar futures has pushed out and, of course, this is supporting EUR/USD.

There is a movement of capital out of the US, and into Europe and Japan. The market is not compelled by the Federal Reserve hiking two or three times in 2018, at this juncture. They want to be long currencies where the central bank should move policy to far less unconventional settings, although this isn’t the case in Australia, where AUD/USD sits above 79c. This is where traders like the moves in commodities, emerging markets and the improving government fiscal position. We can also see that the speculators are all over the EUR move, where the net EUR long position has increased another 13% last week to hold a new record long position of 144,691 contracts.

The knock-on from a falling USD has once again been good strength in precious metals, while US crude closed up for a fifth day at $64.30. US equities found a bid, helped by good numbers from JP Morgan, who closed up 1.7%. We can look forward to the US Q4 earnings season fairly high on expectations and with the street looking for around 11% earnings growth from the S&P 500 companies (on aggregate). Should this pace of earnings growth materialise, then it would be the second strongest pace of growth since 2011, although there will be a number of one-off charges related to tax reform that analysts will need to work through. Keep in mind that around 8% of the S&P 500 report numbers this week, with the financials dominating, so the focus will be on the XLF ETF (US financial sector ETF).

A new high for the S&P 500 has been seen, although the Dow Jones index was actually the stronger of the two markets, where we saw the Dow close up 2% relative to the 1.6% gain for the S&P 500 on the week. On Friday though, we saw good volumes going through markets, with S&P 500 consumer discretionary the star space (closing up 1.3%), with financials (+0.9%) and energy (+0.7%) also working nicely. Materials actually closed on a flat note, but I feel the ASX 200 materials sector should perform well on open despite both iron ore closing 1.3% lower at $78.05, with BHP’s ADR suggesting the miner opens around $32.02 (a gain of 1.6%), while gold stocks should work too.

We can see Aussie SPI futures closing the Friday night session at 6049, up 31 points and our opening call for the ASX 200 index sits at 6097, just shy of the figure. There has been little in the weekend news flow to suggest futures (SPI, S&P 500, crude or gold) markets move to any great degree and we can see a muted open in G10 FX this morning.

Financials should hold in OK, with CBAs ADR closing up 0.4% and we know materials and energy have a lot of momentum at present, but we really need financials to push higher if the ASX 200 is going to hold above 6100. It’s no surprise that we underperformed global equities by a reasonable margin last week (ASX 200 fell 0.9% on the week vs a gain of 1.3% for the MSCI World index) when the ASX financial sector fell 0.8% on the week.

In terms of event risk, we can see the Melbourne Institute inflation read at 11:00am AEDT, although this won’t move the dial to any extent and really the only domestic data that could genuinely influence this week will be Thursday’s December employment data (consensus 15,000 net jobs created, unemployment rate at 5.4%). The bulk of the event risk comes from China, with Q4 GDP (consensus at 6.7%) and industrial production also due Thursday. FX and rates traders will be focusing on inflation data from the UK and Europe (revision to last week’s initial estimate), as well as the Bank of Canada meeting, where the bank is widely expected to hike rates by 25bp. There are no real game changers from US data flow, so Q4 earnings will be the dominant theme in a market that is seemingly only going one way, that whatever you throw at it the buyers step straight back in.

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