Trader thoughts - The long and short of it

It’s the first day of the new quarter and there are a number of key themes that need to play out through the month and quarter. Economic data and politics (notably US and France) will dominate and one feels implied volatility has to rise at some stage, as this market remains long of risk and complacency, and short of any kind of hedging structures or portfolio protection.

Market Data
Source: Bloomberg

Still, I feel like I’ve been saying that for a while now.

With low volatility in mind, it seems fitting that we are calling the ASX 200 to open at 5864 and therefore completely unchanged, with the various American Depository Receipts (ADRs’) suggesting some buying in the Aussie banks. Materials stocks should find sellers easier to come by a 1.7% fall in spot iron ore, backed by 2.1% and 0.7% drop in iron ore futures and copper will be in play.

China’s economy continues to support global risk sentiment, with manufacturing in larger sized firms at the highest levels since April 2012. However, over the weekend authorities have increased the cost for small- and medium-sized financial institutions to source short-term liquidity through its Short-term Lending Facility (SLF) on overnight loans, seven-day and one-month loans. This is the third time this year they have done this, but at this stage, it shouldn’t be taken as a negative for companies or markets leveraged to China’s domestic demand story. Some in the market are saying global reflation isn’t going to come from Trump’s potential fiscal reforms, but actually China.

US markets have provided a slightly weaker lead with the S&P 500 falling 0.2% and financials at the heart of the move (-0.7%). Data on Friday was fairly supportive, with core personal consumption expenditures (PCE) increasing 1.8% year-on-year, and moving ever closer to the Federal Reserve’s 2% target. Personal income grew 0.4%, while Chicago PMI index hit 57.7, in turn keeping the momentum seen in the regional PMI series to the upside.

New York Fed president Bill Dudley spoke and sounded a touch less hawkish than his Thursday speech (or Friday 7.30am AEDT). This in turn promoted a four basis point drop in the ten-year ‘real’ (or inflation adjusted) yield and a further flattening of the US yield curve, hence the fall in the US banks and 0.5% gain in gold. That will happen when a core member of the Fed starts talking more actively on allowing the Fed’s massive $4.5 trillion balance sheet to slowly contract in 2018 and subsequently removing a key catalyst to raise interest rate aggressively in 2018 and onwards.

More near-term though, we have seen pricing around a June hike close above 50% for the first time and the data this week in the US should be closely followed. Specifically, the US ISM manufacturing data (12:00am AEST tonight) and while this is expected to show a slower pace of expansion in US manufacturing (consensus here is 57.2), it’s worth noting the fairly close correlation between this data point and the S&P 500.

A good number here, with good services ISM and payrolls this week will solidify expectations of a June hike, but also breathe some much-needed life into the stock market. Importantly, traders are seeing increased probability in rate hike expectations as a positive for stocks now. It’s great to see good news being good for markets and bad news being taken negatively. After so many years of bad news resulting in a risk on thematic driven by a belief of increased liquidity and a central bank response.

There are a number of key releases locally for traders to navigate through, although the key thematic in Australia continues to be around domestic housing market and the banks looking at lending. Tomorrows Reserve Bank meet shouldn’t give too much away and I think we start to focus more on the Q1 CPI on the 26 April, where it wouldn’t be a surprise to see headline inflation pushing back above 2%, largely driven by higher base effects.

It seems AUD traders are sensing this move higher in inflationary trends anyhow, with the net long position (detailed by the weekly Commitment of Traders report) increasing 15% to just over 50,000 contracts. The market is certainly long of AUD’s now, but this in itself is no reason to short the currency and actually highlights its attractiveness in times of low volatility.

On a trade-weighted basis the AUD is a touch overvalued (if we use the RBA’s own equations), but not at levels that the RBA would be even remotely worried about.

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