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Trader thoughts - the long and short of it

There are still too many unanswered questions to think it safe to increase exposures to risk assets with any real conviction, and my view that Monday’s 1.1% rally in the S&P 500 was “unconvincing” is one that I continue to hold here.

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Source: Bloomberg

The overnight session, and the effective lead for Asian markets today is clearly less negative than feared. The best way to view this is through the S&P 500 futures, which traded 1.6% lower and into 2681 by 11:30 AEDT, but then proceeded to climb modestly higher to 2696 by the close of the ASX 200 at 16:10 AEDT. So, S&P 500 futures were down 28-handles (or 1.1%) when the Aussie equity index closed up shop and subsequently the market had already discounted quite a bleak US cash session. As things stand the S&P 500 is lower by 0.2% and therefore has not fallen to the magnitude as what has been priced in by the futures and as a result the ASX 200 should open at 5920 (+19 points) and this call also includes the 11.2 points that come out of the market with QBE and BHP going ex-dividend today.

So a fairly constructive open, but there is little inspiration to be taken from the moves in the S&P 500 sub-sectors where financials, materials and energy are all lower by 0.3% or more and most of the index support has come from US tech. Energy has been the noticeable underperformer and this is clearly a reflection of a 2% fall in crude, with the barrel falling into the low $61 area. Some have attributed this move to the weekly DoE oil inventory report, but this doesn’t make a lot of sense given the sharp move lower firstly happened an hour after the report was published, and, secondly, crude inventories actually gained slightly less than forecast and we also saw inventories held at Cushing falling 600,000 barrels, which is the lowest since December 2014. The market sees what it want to see.

We can also look at the markets to see high yield credit spreads two basis points wider, so there is no real stress here and we can see US Treasury’s largely unchanged across the yield curve. If there was genuine concern about a fall-out in global trade we would not only have seen outperformance from long-end yields and a flatter curve, but we would also have seen future rate hike expectations coming out of the market and looking at the Eurodollar interest rate curve that also hasn’t materialised. The US volatility index (or “VIX”) is unchanged, and we can see the full VIX futures curve under 20. So, implied volatility has no moved at all despite all the talk that Gary Cohn’s departure signals a green light for the Trump administration to punish those nations who run sizeable trade surpluses (or “deficits” in the eyes of Trump) with the US. If S&P 500 implied volatility is telling us anything it is that traders are not convinced this trade saga morphs out into a genuine vol event like we saw in 2002.

That said, let’s keep an eye out for the formal announcement, which is due either tonight or Friday. This should be interesting as the facts are what the market craves and traders really need to understand whether any countries get expectations (there are some talk select countries getting exceptions on national security consideration), will any specific industries be dealt a lighter hand, when will the tariffs be implemented and is the Trump Administration targeting a certain duration or explicit change in the trade imbalances? Of course, there are many more questions that need to be answered and from here the focus turns to any rebuttal from the international community, with the prospect of the WTO being brought into the mix.

Another consideration for market volatility is not just whether the formal announcement can upset a market that has had plenty of time to digest the tariffs. However, the focus also comes at a time when the market has to navigate itself through tonight’s (23:45 AEDT) ECB meeting and tomorrows US payrolls and wage data. In terms of a playbook, if you are bullish stocks and credit then we need to think Trump has had a chance to assess the market’s reaction to steel and aluminium tariffs and subsequently, Trump could look to deploy tariffs in a somewhat market-friendly manner. Recall, if financial markets are the best voting mechanism then Trump will always aim to please where he can. Subsequently, a February wage print below 2.8% could also put a bid in the US bond market, bringing the US 10-year Treasury into the 2.80 to 2.82% support area and pushing the S&P 500 and global equities higher. This is the bull case and it may well be that wage growth pushes above 3%, which would be more aligned with the narrative seen in the Beige Book overnight, while the market also doesn’t take kindly to the actual facts around tariffs, and we see a further bout of risk aversion, which feeds into the initial view that there is currently no conviction to buy into risk assets.

On the FX side, the USD has had a mixed night, where ultimately the USD index is unchanged and the CAD continues to attract sellers far too readily, with traders focused on the Bank of Canada central bank meet which was somewhat dovish and the market lowered its implied probability of a hike in April from 40% to 36%. AUD/USD has traded a range of $0.7829 to $0.7788 overnight, although AUD/CAD, EUR/AUD and GBP/AUD have seen some good flows.

One could argue the market will be eyeing China trade data (no set time), and while this is a messy report given the reporting of the data is terrible and therefore seldom causes an initial reaction in markets, the fact economists are expecting a trade deficit of $5.7 billion is interesting. The last monthly trade deficit was back in February 2017 and prior to that March 2013, so these feats are rare. Perhaps it is not so much about the absolute level of China’s trade data but whether their $21.8 billion trade surplus with the US heads lower and appeases Donald Trump and the likes of Wilbur Ross and Peter Navarro.

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