Trader thoughts - the long and short of it

It’s steady as she goes, with no real moves in US equities, with the S&P 500 closing up 0.19% and trading in an extremely tight range, and with little in the way of moves in FX and fixed income.

Market data
Source: Bloomberg

These limited moves are a reflection of low impact data releases (we have seen US PPI, weekly jobless claims and the monthly budget statement). Perhaps, also a reflection that in latter European trade (released 10:30pm AEST) when we get the June US CPI (ex-food and energy), in which the market expects stabilisation and an unchanged read of 1.7% yoy, or 0.2% mom. While, as we know, the Federal Reserve prefers to focus on core PCE as their inflation input, the market is far more sensitive to CPI print, so the US session and also for Asia based traders, today is just a day of pre-positioning in rates and USD positions and assessing the risk in the portfolio. Of course, second derivatives of these markets, such as gold and silver, will also be in play.

The economists’ estimates range (for the CPI print) fall between a tight spread of 1.7% to 1.8%, so the market would be a surprise and react if we saw 1.6% or below. Recall, there has been three downside misses in a row in this data point, so a fourth would not be taken well at all. ‘Real’ (or inflation-adjusted bond yields) could have a sizeable drop, with traders suggesting there is an elevated chance of a turn in the Fed’s language and more voters join Patrick Harker’s camp and re-consider whether a December hike is such a good idea. Market pricing (in the Fed funds future) on the probability of a December hike would drop from where it sits now at 50% to closer to 40%.

It will be interesting to see how influential a weak or somewhat stronger inflation read would be taken by equities, notably tech, where a move in bond yields should throw this sector around. If running positions in the Nasdaq 100 at this data point pose an event risk.

One could suggest that Fed chair Yellen’s second testimony has reinforced this message of close inflation watching, with mentions in the testimony of “we’re watching inflation very carefully in light of low readings. I think it’s premature to conclude that the underlying trend is falling well short of 2%”. Janet Yellen went on talk about the tight labour market and inflation being two-sided, but the Fed still have faith in the current flat Philips Curve (i.e. the model used showing the relationship between employment, wages and inflation) is still valid and we will see inflationary pressures starting to build. As many have rightly suggested, it’s somewhat of a gamble reducing its balance sheet and hiking again in December to bring the ‘real’ fed funds rate towards the neutral real Fed fund rate, if inflation then subsequently moves even lower.

With these dynamics in play, traders are also keeping a very beady eye on AUD/USD, although AUD/JPY trending nicely to the upside and we have seen EUR/AUD and GBP/AUD finding sellers too.

However, it’s AUD/USD which always gets the markets attention first and foremost, and we can see price moving nicely into and through some very interesting levels. One level to focus on is the 2016 downtrend at $0.7720, where it looks as though the pair should close the session above. A weak US CPI print could push the pair into 78c and we start considering the implication of a potential break above the 2016 high of $0.7835.

Ok fine, we have seen spot iron ore have a good day, closing up a sizeable 2.9% (it’s not often we see spot more volatile than the Dalian futures) and of course we have seen solid trends in China’s trade data and next week’s Q2 GDP print should come in at 6.8% or 6.9%. But the clear driver for me has been super low implied volatility, a general ill-will towards holding USDs, renewed outperformance of emerging markets (of which AUD is a proxy in G10 FX circles) and there is  the propensity and desire to pick up yield or ‘carry’. Unless the RBA genuinely feels the AUD threatens their inflation outlook they are powerless to stop this move and that means shifting not only to an explicit easing bias, but the market has to believe they will ease.

So we look set to open the last trading session of the week on a flat note in Asian equities and it’s been a whippy ride, at least in the ASX 200, where we have had further confirmation that the market just doesn’t want to close (on a weekly basis) through 5675. Our call for the ASX 200 sits at 5732 (-4 points), with SPI futures down nine points (at the time of writing), with small gains expected in Hong Kong and Japan, with Japan helped by a modest move higher in USD/JPY.

The banks are seem to be dictating index moves, although we did see healthcare rediscover its mojo yesterday, so we should watch to see if we can follow-through buying today. AUD sensitive stocks are on the radar, especially with the trade-weight AUD moving higher here. This is not just a weak USD story and of course yield sensitive names (such as SYD) are also being re-evaluated, especially in light of tonight’s US CPI print and the impact that it could have on Aussie fixed income.

Oil has seen modest upside in the session, closing above $46 and this may support energy names, while gold has seen a touch of selling kick in, although remains at the mercy of tonight’s CPI print ad  and the impact on US fixed income.

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