Trader thoughts - the long and short of it

The tone of the weekend press has really centred on US trade relations, with Peter Navarro promoted to assistant to Trump, while there has been a focus on reports Trump is backing the toughest possible restrictions on trade tariffs pushed out by the US Commerce Department on steel and aluminium tariffs.

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Source: Bloomberg

Whether this news flow becomes a slight headwind for further appreciation of risk assets is another thing and the lack of any move in the early parts of G10 FX open suggests S&P 500 futures also open in a similar manner. Asia should therefore largely feed off the positive backdrop seen in US equity indices on Friday, where the bulls have regained control and we see S&P 500 implied volatility (or the “VIX” index) falling to 16.5%. When we see the S&P 500 closing up 1.6%, with 94% of stocks in the index closing higher and on fairly healthy volume, then this is the sort of lead equity bulls will take every day.

Even more so when we see high yield (HY) corporate credit working nicely, with the HY index falling 10 basis points. That said, this is a big week ahead of us and a macro dominated one, where we can look at a raft of key data points from the US and Europe, with both economics hitting the market with inflation data, while in Australia the focus turns to the early inputs to the Q4 GDP calculation, with private sector capital expenditures due on Friday.

Without a doubt, the bigger issue will navigate exposures through US Federal Reserve chair Jerome Powell’s’ Congressional hearing, where he testifies to both the House and Senate, although his vision to the House (Wednesday at 02:00 AEDT) will be the potential market mover. I say ‘market mover’, as Powell will be highly cognisent of the spike in risk aversion in late January and will be keen not to rock the boat too greatly. The fact we saw the differential between Eurodollar December 2018 and December 2020 interest rate futures tighten four basis points (bp) on Friday to 41bp, and therefore pricing in less implied policy tightening from the Fed in the years ahead, which suggests rates traders are not expecting Powell to signal a more aggressive response.

We can also see good buying in the US fixed income market on Friday, with outperformance from the long-end of the Treasury curve and notably this week the trade seems to be playing a flatter 2/30’S curve (i.e. short 2-year Treasury’s, long 30-year Treasury’s) and this is a trade I think can work well over the next few weeks. The USD still managed to close up 0.2% on Friday, in what was a very messy day in G10 FX, and with the AUD/USD unchanged on the day, while we saw the CAD the star performer and NZD finding better sellers. Whether the USD can add to its 0.9% weekly gain is yet to be seen and the greenback may actually struggle if we are going to see a flatter yield curve, with additional focus on the fact that ‘real’ (or inflation-adjusted) Treasury yields fell fairly sharply on Friday and one suspects equity traders took this as an additional positive.

Of course, we have the small matter of an Italian election on Sunday, as well as further colour around the make-up of a German government. So while most will be focused on the Italian election and the fact it probably isn’t a binary event, there is the prospect of gapping risks on next Mondays FX and DAX/MIB open. EUR/USD continues to respect the 2008 downtrend and 9 February low of $1.2205 should act as minor support, ahead of trend support (drawn from the April 2017 low) coming in at $1.2066. I would favour buying dips into these levels for now and remain of the view that EUR/USD trades higher in the months ahead. Traders will also be watching the European bond markets closely and specifically the yield differential between Italian and German debt, with the 10-year yield differential widening from 1.20% to 1.41% in recent times, showing some hedging of the event risk.

So aggregating Friday's US trade, we can see Aussie SPI futures closed up 0.5% at 6004 and our call for the ASX sits at a constructive 6030. As a backbone for the index, the various ADRs (American Depository Receipts) have BHP and CBA both opening 0.4% higher. Japan should come to the party, with an open just north of 22,000, while the China CSI 300 was the outperformer last week and should build on its 6% weekly gain. A strong move higher in US crude won’t hurt the region and the uplift in sentiment seen here.

Certainly, we can see good participation in the moves of late and the internals in the ASX 200 are fairly bullish, with the percentage of ASX 200 corporates trading above their 20-day moving average heading from just 8% last week to currently sit at 65%. We can also see 6% of companies trading at 4-week lows and a mere 3% trading with a 14-day RSI (Relative Strength Index) of 30 or lower. So market breadth has been ok, although that said, I would still be expecting a far higher conviction for sellers to emerge into 6100 to 6150, with consensus earnings expectations having been revised slightly higher of late and the consensus 12-month EPS (earnings-per-share) of the ASX 200 sitting at a new high of $3.72. It feels as though there is scope for the market to push into this range before we start seeing the same index multiple we saw in January.

The stock specific issue should play a lower key role this week, with 84% of companies have now reported earnings, although QBEs numbers will get some focus today. As mentioned earnings have been revised higher of late and that is reflective of a reasonable earnings season, with 58% having beaten on the EPS line, 57% on sales and on aggregate we have seen 14% EPS growth.

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