US equities are trading modestly lower, although we are seeing a stronger move lower in small caps, with the Russell 2000 down over 1%. This shouldn’t surprise though, given everyone has been playing the ‘make America great’ trade through this index, as most of the earnings of the constituents are sourced domestically. This is in contrast to the S&P 500 where we find around half of earnings are sourced offshore. We have also seen some profit taking in the financials space, and like the Russell 2000, both spaces have been running red hot of late.
In fact, one of the key questions is whether there is simply too much love for US equities (and many other global equity markets) right now? One can look at the call/put (options) ratio and see this at the highest level for years. Last week, the National Association of Active Investment Managers (NAAIM) index highlighted the highest exposure to US equities (from fund managers) we have seen for years. Effectively these money managers who need to benchmark their performance have gone all in trying to chase this rally and etch out as much performance ahead of the new calendar year. There is a genuine fear of missing out underway and this should keep equities supported on dips as we enter the business end of the year.
We can look at the FX markets for perhaps the clearest read on positioning ahead of the Fed meeting. Certainly, the USD has seen good profit taking despite no real moves in US fixed income. The broader USD index has fallen 0.7%, with good buying seen in EUR/USD, NZD/USD and AUD/USD. AUD/USD has also been given a slight tailwind of spot iron ore gaining 2.4%, while iron ore and steel futures rallied 1.1% and 0.8% respectively. Technically, the AUD/USD four-hour chart is worth focusing on and we can see a ceiling at $0.7500 where the market is happy to sit and offer AUDs, so a break above here means we could be looking for $0.7600 fairly quickly. One for the radar.
Will the Fed acknowledge not just the improvement in the recent data flow, but also the view that we could see fiscal measures complimenting an already stretched central bank balance sheet? The key will then be whether they increase their 2017 and, more likely, 2018 GDP forecasts from 2% respectively. One suspects if they do they will also lift their central forecasts for the Fed funds projection in 2018 from 1.875% to 2.125%, and pencil in an additional rate hike. Given the market is positioned somewhere closer to 1.5%, this would be seen as a USD-positive and we could see good selling in the bond market, with a negative knock-on effect in emerging markets and the likes of gold.
Clearly the moves today suggest traders don’t see this more hawkish stance materialising and that the Fed are likely to maintain a slow and steady course on tightening policy. This seems fair and is the base-case.
The event risk increases somewhat in Asia today, with the NAB business confidence reading (11.30am AEDT) getting more attention given the poor quarterly Australian Q3 GDP read we saw last week. The confidence reading has looked a bit vulnerable of late, so a move closer to the zero level may get a few of the Aussie economic bears quite excited. We also get the monthly China data dump at 1pm (AEDT), which includes industrial production (expected to print 6.1% year on year), retail sales (10.2% year on year), and fixed asset investment (8.3% year on year). Industrial production will be the metric that gets more attention given it can be quite volatile and has a tendency to miss consensus expectations.
All the talk of late has been around capital outflows from China and the government intervening to limit this capital. Increasing inflation, specifically at a business input level, is also a hot topic and is starting to hurt downstream producers. The outflow issue is something that is a must-watch macro factor for 2017.
Locally, we see the ASX 200 opening closer to 5550, although it promises to be quite a messy open and there seems to be no discernible. Oil prices are up nicely on the session, but most of the gains have been priced in and US crude is actually 1% lower than the ASX 200 cash close (at 4.10pm AEDT), so it will be interesting to see how energy stocks take that lead. BHP’s ADR is +0.9%, while CBA should see a flat open.