Long US financials the trade du jour

Some of the heat has come out of the ‘Trumpnomics’ inspired rally in equities and sell-off in fixed income.

US stocks
Source: Bloomberg

We are still seeing the Dow Jones index trade to a new record high, while the S&P 500 eyes one of its own. A seven basis point (bp) move higher in the US ten-year treasury has resulted in a further steepening of the US yield curve which is another positive for US financials, with the sector up 3.8%. Long US banks is the trade du jour and traders have been expressing this through individual equity positions or through ETFs like the XLF or KBE.

One of the more controversial issues in US trade was talk that Trump could be positioning JP Morgan CEO Jamie Dimon at the helm of the US Treasury. This seems against the social change underway in the US, with the rise against the establishment and rejection of all things Wall Street, but I feel this would be a fantastic appointment and the financial markets should like this. Any distancing of US financial institutions away from Elizabeth Warren and all things Dodd Frank (ie. higher regulation) will be welcomed by the markets.

In the FX market, the talking point continues to be how the rise in inflation expectations (due to Trump’s fiscal stimulus plans) will result in the Federal Reserve (Fed) potentially having to act more aggressively in 2017. The USD is the natural beneficiary here and we have seen strong USD flows again overnight. USD/JPY has been the poster boy of the USD move and the bulls have pushed the pair into ¥107 overnight. If you want to express a view on a higher USD this is the vehicle of choice and one just has to look at the huge moves in US fixed income to see why USD/JPY has rallied from ¥102.54 to ¥106.80 (at the time of writing). Any Japanese investor craving yield has just seen the spread between the US five-year treasury and the Japanese government bonds widen from 1.44% to 1.70% since 4 November and this can’t be ignored. There is seemingly a rush in Japan to buy US assets again and recall the FX markets are just a play on capital flows at the end of the day. For what it’s worth, the last time we saw the bond market hold this sort of yield differential, USD/JPY was trading around ¥119.00. One for the radar.

AUD/USD has fallen from a session high of $0.7742 to $0.7616 at the time of writing. Interestingly, iron ore had another huge move higher, with spot and futures closing up 4.4% and 2.7% respectively, while copper has rallied for an incredible fourteenth day, putting on 3.5%. Coking coal and steel futures have dropped a touch, but while I am not one to advocate shorting any commodity that is in such a powerful uptrend, I would be cautious here as all of these mentioned commodities are grossly overbought and we are hearing (Source: SCMP) that China’s securities regulator (the CSRC) is trying to take the heat out of the space by banning margin financing by all futures brokers in Chinese commodity futures. This may be a short-term AUD negative, so watch bulks for a reversal.

Equity traders would also be wise to watch price action in steel futures, especially as the leading light for iron ore and other metals. The gains in this space have been pretty crazy as well, although we should see the likes of BHP open around 3% higher this morning. The Aussie banks look supported as well and what didn’t work yesterday (REITS, utilities and to a lesser extent telcos) will likely not work today. The SPI futures are largely unchanged, but I would still expect a slightly stronger open for the ASX 200. Clearly the index is going to buck a four-week losing streak and the bulls have seemingly wrestled back control here.

So it seems all is well in financial markets, with the Dow at all-time highs, credit spreads narrowing relative to US treasuries and the market holding a base case we see a December rate hike. What does make me slightly nervous is while equity has rallied, we are seeing rising concern in emerging markets. The EEM ETF (iShare emerging market) is another 3% lower and presumably we will see another move to weaken the CNY at 12.15pm AEDT (the Chinese CNY ‘fixing’). While US assets seem to be responding to domestic inflation expectation increasing, this may not suit other economies, especially those leveraged to a higher USD. 

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