Trader thoughts - the long and short of it

The weekend focus has been squarely on the G20 meeting in Hamburg, and while the meeting has been all about frosty relations we can see USD/JPY (if we use this as a proxy for risk) opening the new week on a flat note.

Market data
Source: Bloomberg

This provides some confidence S&P 500 and US crude futures should open largely unchanged, although crude does have the benefit of a seven rig increase (to 763 rigs) in the weekly Baker-Hughes oil rig count.

Looking ahead, traders will continue to watch fixed income like a hawk for further knock-on effects into FX and equities. Specifically with Fed governor Leal Brained (Wednesday at 2:00am AEST) due to speak on monetary policy and chair Janet Yellen set to aggregate the backdrop into hopefully a somewhat clearer playbook in her two-day semi-annual testimony to Congress starting on Wednesday at 10:30pm AEST.

Let’s not forget the moves we have seen of late in fixed income have predominantly been driven by a re-pricing of expectations on a global basis, not specifically around the Fed, but this week the US takes over as the centre of the universe and the USD will be interesting viewing. Especially if we can see ‘real’ (or inflation-adjusted) bond yields breaking out and moving higher from here. Whether we still see the US and global equities moving higher on this development I am less sure, as it does pose a tightening of financial conditions. As we know and likely to hear again from Yellen, financial conditions, or should we say loose financial conditions, are at the very heart of markets.

Friday's (10:30pm AEST) release of US CPI ex-food and energy will also be a strong catalyst for markets and traders are positioned here for stability with another monthly read of 1.7% expected. A stronger read and we can find some assurance that the Fed’s glass half-full view of inflation should be somewhat validated and we continue selling the treasuries, and in FX traders buying USD/JPY.

The backdrop for Asia today is fairly constructive and perhaps we can see the ASX 200 halting a three-day sell-off with SPI futures closing up 10 points. The leads are a net positive if we aggregate all the various factors, although China’s CPI (expected to gain 10 basis points to 1.6%) and PPI (unchanged at 5.5%) could influence given how sensitive the world is too inflationary reads right now. Specifically, watch PPI (released at 11:30am AEST) and a big drop could be a small negative for Aussie materials, while AUD/USD might attract a few sellers, with traders keenly watching the 22 June low of $0.7534 with interest.

The S&P 500 has handed us a positive lead, closing up 0.6%, with solid moves in tech, financials and materials, while energy closed down a touch. The US payrolls print was widely noted as an equity positive, with a solid rebound in headline job creation at 222,000, on a revised May print to 152,000 (from 138,000), while wages grew slightly below expectations at 2.5% YoY, or 0.2% in June. Strong headline growth, amid poor wage growth, is seemingly a perfect storm for equities, who are also eyeing Q2 earning season where equity traders this week have to navigate around moves in fixed income while also having to deal with the fact 5% of the S&P 500 market cap this week. Personally speaking, I would prefer long exposure in equities this week, despite some better two-way (i.e. buying and short selling) from clients.

The market goes into Q2 earnings expecting 7% EPS growth from S&P 500 companies, or 4% if we exclude energy, which is expected to see a lazy 370% earnings growth from the previous corresponding period. It seems optimistic to feel we can replicate the 15% growth we saw in Q1, but at 7% this would still be the strongest rate of earnings growth since 2014.

This is incredibly important because in the last two weeks or so, we have markets changing and the catalyst for equities is shifting from a liquidity-induced rally, to one where valuation and earnings growth will be the preeminent driver. It sounds far too obvious and even simplistic, but liquidity has been the reason why everyone has bought dips in the index and why everyone sells volatility on any spikes. 2018 is shaping up where value could do far better and not just to leverage to higher growth, high momentum names. So this earnings season could be telling in setting that platform.

In commodity land, we have solid read-throughs for the iron ore stocks, with spot closing up 1.4% at $62.80, while iron ore futures put on 1.2%, with good gains seen in rebar futures. The fact Australia has secured exception from US steel tariffs is also a positive.

Copper closed down 0.5%, while we can also see modest US crude closing down around 60c lower than where it was trading when the ASX 200 closed – this needs to be priced into the energy sector. Gold and silver, both closed weaker on the session, once again working inversely to US ‘real’ bond yields.

Technically, we can see price closed (on a weekly basis) through the neckline of the April and June double top at $1214, which would target sub $1150. One to watch, but fundamentally it would require a further sell-off in longer-term nominal yields and inflation expectations to remain anchored, which to be fair is not out of the question.  That will largely be dictated to by the views of Janet Yellen and Friday's US CPI print.

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