Fading the USD move and buying longer maturity fixed income instruments means fighting a powerful tape. However, there are some signs that we may see some reversion to the mean in the short-term, although this should just provide better levels for traders to express the clear macro trade – short US treasuries, long USDs, long US (and global) banks and short gold and emerging markets (I have been promoting the EEM ETF).
It could be a pivotal session ahead, as it looks as though we could have seen something of a blow off top in US bond yields, with the ten-year treasury reaching 2.30% before coming back to 2.22%, although it is still up seven basis points on the session. It’s not every day you see the benchmark bond trade 59 basis points higher in close to three days, so some exhaustion in the selling must be kicking in. The 30-year treasury traded to 3.06% before settling below 3%. While yields have come firmly off their high, the USD is still king and has rallied a further 1%, with the USD index (DXY) trading through the 100 barrier for the first time since December 2015. Pullbacks should be bought, and again, watch US fixed income, as a move lower in yields could offer a more attractive entry point.
China should get further attention today for two key reasons. Firstly, USD/CNY is now trading above the 2008 to 2010 USD peg, and the further strength in the USD should see the People’s Bank of China (PBoC) ‘fix’ its currency weaker again today. The talk on the streets is that Donald Trump will bring in his campaign finance chair Steven Mnuchin as US Treasury Secretary, and traders are keen to understand if Mnuchin holds the same view as Trump in that China are a currency manipulator. The markets will not be too concerned with Trump maintaining his view, but if the US Treasury ultimately put China on the ‘manipulator list’, then tensions could rise, with a greater push to increase tariffs on China’s imports.
Secondly, we had been suggesting watching metals and bulks traded in China (on the Dalian exchange) as moves had gone too hot too quickly. In overnight trade, some fragility has kicked in and price has started to roll. Spot iron ore has fallen 2.6%, while iron ore and rebar futures have lost 1.4% and 3.7% respectively. Keep an eye on these commodity futures markets today, because there is an elevate possibility of traders all rushing for the exit door at once. We suggested a more cautious approach to materials and this still seems prudent. In saying that, BHP should open on a flat note.
The broader Aussie market is likely to open some 15 points lower, so given the call on BHP, one suspects we may see banks modestly weaker, with energy holding in. There is little in the way of data to inspire (the Reserve Bank of Australia minutes shouldn’t rock the dial too greatly), but we could see Asia as somewhat of a leading indicator. Watch the fixed income market as a guide, because if traders start to fade the recent sell-off, we may see some profit taking in the Nikkei, financials and some easing back in long USD positions. Keep in mind that the US interest rate markets are now pricing a 94% chance of a December rate hike and a 40% chance of two hikes in 2017 (from the Federal Reserve). While I remain a USD bull, we have to think that much is now in the price and I stand by the view that doing the opposite of what feels right has worked well all of 2016.