Volatility forces carry trades

Volatility, or rather  the lack of it, is driving the show again and traders are adapting to this.

Bank of England
Source: Bloomberg

The Bank of England has maintained the dovish central bank narrative, in turn causing cable to test the June 2013 pivot high of 1.5751. EUR/USD and USD/JPY seem to have got the big headlines recently; for trend followers, however, short GBP/USD looks a better trade right now.

Fundamentally, sterling has its attractions and the fact that the market has paired back its call for a move in the cash rate to Q4 2015, seems fairly dovish. That’s when you weigh it up next to the consensus among economists, who still feel Q2 is a possibility.

It seems logical though that the BoE will move on rates before the Fed, which is a trend that has occurred since 1970. With volatility subdued, the carry trade is working wonders in the forex market. The weekly chart of NZD/JPY looks so bullish right now. It’s not only set to close the week (as things stand) at a new high for the year; the various momentum indicators also suggest the 2007 high of ¥97.78 is achievable in the coming months. Naturally, this will depend on volatility remaining contained. Short GBP/AUD is also one on my radar, with the pair testing the October lows.

Some of the heat however, has come out of the AUD today, with RBA member Christopher Kent saying he has not ruled out intervention. We initially saw sellers move in but traders are questioning whether this is jawboning at best. Glenn Stevens recently told us intervention is in their ‘toolbox’, so we know they can use it. Now, however, is absolutely not the time.

Westpac a headwind for the ASX 200

Asia has been generally mixed, with China gaining modestly, while the ASX 200 has struggled as investors felt some disappointment at Westpac’s highly respected CEO Gail Kelly stepping down. The fact the rest of the banking sector has fallen, suggests there were other forces at play, as logic would suggest some switching into CBA bank if the issue was specific to Westpac. 

Better buying has been seen in the resource space. It’s hard, however, to distinguish these days between pure short covering, trading capital or genuine investment. The latest data series (from November 6) shows names like Fortsecue Metals has around 17% of float adjusted shares outstanding sold short and Atlas Iron at 13.5%. Rio Tinto has seen a sharp pick-up of late, as well. Our clients seem to believe that these names are due a bounce and take a name like FMG and 75% of all open positions are currently long.

The China/Hong Kong Connect program continues to support. While there is a quota around the level of funds that can trade between the two markets, the combined market will soon be the second largest equity market globally. In terms of cash turnover, it will be the third biggest. These daily quota’s will increase with time but the actual scheme will create a whole new way that institutional traders can trade from a tactical perspective. There will be natural arbitrage between dual-listed companies. Take a name like Citic Securities that trades on both exchanges, and international investors can now get access to its A-Share listing where there is a valuation discount. Traders can also get access to names that may be a much cleaner proxy of Chinese growth. There are also many high yielding names that actually provide really good levels of growth and trade on single digit multiples that will also be looked at closely.

Chinese growth in focus

On the subject of Chinese growth, there seems to be a growing view that Chinese officials are due to downgrade the 2015 GDP target soon. There has been some talk that a 7% target could come into force at some stage. If they did target 7%, then the market should be fine with this but a target below 7% would be cause for concern. On a more bullish note, The People’s Daily has reported that central government inspectors have been visiting local ministries and suggested ‘investment is being stepped up’. Traders are also still looking out for industrial production, retail sales and fixed asset investment. This comes out after market.

Japan continues to creep higher, with further headlines coming out about the potential for pushing out the sales tax decision until 2017, with an election to be called for either December 14 or 21. There is certainly elevated noise at present but we should hear more next week after the Q3 GDP print. It seems more likely than not that Abe will return from his overseas tour on Monday and make an announcement early next week. I still feel the market hasn’t fully caught on to the fact that the BoJ are actively targeting a higher equity market to try and drive aggregate demand. The Nikkei, in my opinion, could trade much higher from here.

It seems to be an on-going theme that European markets open on a flat note, but such is the subdued volatility. The US labour market takes centre stage with the weekly jobless claims and the JOLTS (Job Openings and Labor Turnover Survey). Fed chair Janet Yellen will speak at the ECB/Fed conference, with New York president Bill Dudley speaking in Abu Dhabi. We also get the ECB monthly bulletin and survey of professional forecasts, so EUR/USD will be in play and the possibility of a break of the $1.2400 level.

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