Trader thoughts - the long and short of it

The strong re-pricing suggests that was clearly the case and it promises to be an interesting couple of months ahead. The market is eyeing important announcements of monetary policy normalisation in this Thursday's FOMC meeting, but also the 26 October ECB and the 2 November BoE meeting.

Arguably the most aggressive market moves have been seen front and centre in UK assets, with the UK 10-year gilt pushing up a further seven basis points (bp) on Friday to 1.30%, taking the increase on the week to a huge 31bp. The hawkish Bank of England statement was given a second wind on Friday when BoE member Gertjan Vlieghe, widely considered the most dovish member of the central bank, detailed that ‘the evolution of the data is increasingly suggesting that we are approaching the moment when bank rates may need to rise’.

GBP took another leg higher, notably against the JPY (GBP/JPY rallied 2% on the day), while
GBP/USD has now reclaimed well over 50% of its Brexit losses and is eyeing a move into $1.3804 - the 61.8% retracement of the Brexit sell-off.

The BoE have a delicate balancing act here, between guiding the market to a rate hike this year. Simultaneously having to deal with what has been a strong tightening of financial conditions and if they get this wrong, it could be a large miscalculation.

The implied probability of a November hike from the BoE now sits at 64%. I suspect, given the recent commentary, that this pricing will gravitate towards 75% to 80% in the coming weeks, but it’s interesting to see how this is now firmly weighing on the FTSE 100 here. Take a look at the daily chart of the FTSE 100, with price breaking below the 7600 to 7300 trading - it has been moving in since May. Unless GBP finds some decent profit taking, the FTSE will be sold into rallies.

The USD lost 0.3% on Friday, largely helped by the poor US August retail sales report (-0.2%). The ‘control group’ element (the basket of retail purchases that feed directly into the Q3 GDP report, when released on 27 October) also fell 0.2%. However, while we have seen analysts cutting their US Q3 GDP tracking estimates by as much as 50bp (or 0.5ppt), towards 2.3%, with the Atlanta Fed’s GDP model now sitting at 2.2%, we actually saw modest selling in US fixed income markets, with the 10-year treasury closed up 2bp at 2.2%.

The implied probability of a December Fed rate hike now sits at 46%, with 37bp (i.e. 48% chance of two hikes) priced through to the end of 2018. This pricing mechanism, around future rate hikes in the US, becomes front and centre this week. This could weigh on the US and emerging market equities if we see the implied probability of a December hike moving towards 60%.

There are a number of catalysts, although the dominant input is Thursday’s (4:00am AEST) FOMC meeting. We will be watching for a confirmation of the Fed plan to unwind its $4.47 trillion balance sheet (23.1% of US GDP) in the October meeting. We will also get guidance on future economic projections, although we will likely only see the 2018 inflation forecasts tweaked lower to 1.9% (from 2%).

The market is also quite excited about tax reform and will continue to position for Monday's announcement from the Trump administration, on what has been labelled as Trump’s ‘phenomenal’ tax plan. Tactically, it won’t surprise to see assets sensitive to tax reform move accordingly into Monday's announcement, only to reverse on a potential ‘buy the rumour, sell the fact’ type scenario, as the numbers and levels are likely to be announced, but will unlikely be the ones that eventually play out. USD/JPY seems to be one interesting way to play this and we are seeing the pair trading even higher this morning and above ¥111.00.

US equities have been warming to tax reform, with the S&P 500 closing up 0.2% on Friday, taking price above 2500, on decent breadth (63% of stocks closed higher), with tech (+0.3%), financials (+0.5%), energy (+0.3%) and telco’s (+1.8%) all working. High yield credit spreads firmed by 1bp, so there doesn’t seem to be too much concern about the more aggressive interest rate pricing in DM markets and the move higher in bond yields (both nominal and ‘real’). As I say, that may change through this week and the Fed will not like the fact that US financial conditions are still far too accommodative; they may be keen to inject a touch of two-way volatility here. 

In terms of the Asia open and SPI futures closed 16 points higher in Friday night’s session and our opening call for the ASX 200 sits at 5710, while Japan should outperform, thanks to the higher USD/JPY. Aussie banks were key to the Aussie index last week, with the ASX financial sector closing +2.9% (on the week). The trend to rotate out of materials and into financials exposures seems likely to continue today, with spot iron ore closing -2.5%, while Dalian iron ore futures closed -1.9%. Steel futures closed -1.9% while coking coal futures were smashed -6.4%. Copper, while a touch oversold, looks set to be sold on rallies this week, with price closing -0.3% and lower for a fourth day.

BHP’s ADR closed lower by 0.5%, so checking the potential weakness in BHP with the move in SPI futures, it suggests that banks will find a further bid today. Energy could also fare ok, with US crude closing unchanged on Friday’s session, although crude still closed the week 5.1% higher. The prospect of firm prices on the futures open, with the US oil rig count falling by a further seven rigs to 749 rigs and giving real confidence that the rig count increase has peaked.