Trader thoughts - the long and short of it

There’s been a fairly muted response to the German political news flow that two-thirds of the SPD party have voted in favour of joining into a coalition with Angela Merkel’s CDU party.

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Source: Bloomberg

This was the expected outcome, and while it’s still early days EUR/USD has pushed up 41- points or so into $1.2358, with the focus turning to the Italian elections where the results should start rolling in from around the open of the futures market at 10:00 AEDT. The market is not expecting this election to be a binary, or should we say volatility event, given the low probability of the Five Star Party forming a controlling government and most feel the prospect of a hung parliament and perhaps a government formed from the centre-right is the greater surprise.

Clearly, the dominant macro driver is traded tariffs. It was the strong market mover last week and as traders, we are always keen to ascertain how much weight market participants ascribe to a thematic and the sensitivities involved. Therefore, when we see tweets from Trump targeting the European car industry, should the EU retaliate to the announced tariffs on steel and Aluminum last week, which was the case on Friday with Donald Tusk (President of the Council of the European Union) detailing that the EU was "ready to take swift and effective measures to safe guard EU economy if necessary”, then one can expect the market may be on edge. This, despite the seemingly soothing rhetoric on Friday from US Commerce Secretary Wilbur Ross on trade, although most of his communication was aimed at quashing a view that the tariffs will impact consumer prices.

Keep in mind that the EU’s largest export market for the auto industry is the US, equating to some 25% of €192 billion exported in 2016 (source: BBC), so the potential impact on the German DAX is real. A definite must-watch equity index this week, where a close through 11,900 opens up the downside prospects.

Trump has stepped up the aggression with talk the tariffs will apply to all allies, including the UK, Canada and Korea and a formal announcement is likely this week and, of course, the reaction from trade partners is key, just as it was in 2002. Trump has made it clear that the US is in no mood for negotiations here and while many in the markets have put contrast with the strong reaction seen in financial markets in 2002, when President Bush slapped on steel tariffs at a time of declining steel imports, the market is again on edge as the prospect of rising inflation in the later stages of the economic cycle, with a fiscal stimulus, while potentially coexisting with a global trade dispute is not a messy backdrop and not great for semantics towards risk assets.

Amid the focus on trade we also have a plethora of data points and other event landmines, with a number of central bank speeches seen through the week, notably from Fed Governor Lael Brainard who speaks at 11:00 AEDT on Wednesday, with a compelling speech titled “Navigating Monetary Policy as headwinds shift to tailwinds”. This is a must-watch speech for macro-watchers given the market is just so focused on the March FOMC (22 March) and every piece of news and data is aimed at understanding the probabilities of a hawkish shift from the Fed to lift its median projection for the fed funds rate and to signal four hikes this year. With the January fed funds future currently yielding 2.14%, which is marginally above the Fed central tendency of 2.125%, then this debate is real.

Friday's US payrolls are the main game in town, with the market having shown its sensitivity to the average hourly earnings (AHE) element back on the 2 February. So, the fact most see downside risks to last month’s 2.9% wages read could suggest many will be sellers of volatility spikes this week, although a global trade dispute makes selling vol a hard trade. While we may also see a number of traders exiting a fairly crowded short US Treasury position and it’s hard to see the US 10-year moving too much above 2.90% given these dynamics.

The USD lost 0.4% on Friday, largely assisted by combative comments from Donald Tusk, but it’s hard to make a tactical play on the USD right here, especially with the ECB meeting on Thursday and it seems the likely path for EUR/USD (being the key influence on the USD index) is to carry on trading its $1.2500 to $1.2200 range. Keep an eye on the US services ISM index (due 02:00 AEDT tonight), which is expected to grow at a slightly slower pace, although at 59.0 is still thematic of an economy seeing good growth.

The AUD is another currency where the event risk is real this week and can see AUD/USD slightly bid on the interbank open at $0.7776 (+16 points). Firstly, China’s National Party Congress (NPC) commences today and we may hear more on their economic targets, although these are not likely to change. On the data side, there is a whole barrage of focal points, with the market seeing Q4 inventories (consensus is calling for 0.5%) and Q4 company operating profits (+1.5%), as well as January building approvals (+5% mom) - all due at 11:30 AEDT today. Tomorrow is a biggy, with January retail sales and the Q4 Balance of Payments and with it the all-important the net exports as a percentage of GDP, which are expected to shave 60 basis points (bp) off Wednesdays Q4 GDP print (2.5% yoy or 0.5% qoq). While we also hear from the Reserve Bank tomorrow of course. 

In terms of technical considerations, traders reduced their long AUD exposures last week and we now see a speculative position of 9,584 net long AUD contracts (source: CFTC data), which shows a fairly neutral position held by the speculative element of the market. In the rates market, we can see just 2.5bp of hikes priced for the August meeting, while rates traders have reduced expectations for hikes this year, with December now priced at 11bp, or a 44% chance of a hike, so again fairly benign pricing in the rates market and not a lot for the AUD to key off.

So, aggregating this back-drop we can see Aussie SPI futures sitting up 12-points on Friday night session and our call for the ASX 200 sits at 5932, with BHP and CBA called -1.2% and -0.1% respectively. As things stand, USD/JPY is lower by some 26 points, which suggests we could see small weakness in S&P 500 and Dow futures at 10:00 AEDT, although I suspect we shall see good interest from clients to trade our German DAX and Italian MIB indices, which we open at the same time. Trade despites amid political headlines seems the order of the day and this could keep a few to sit on their hands, despite US equity market closing Friday on a somewhat positive note and close to the highs of the day.

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