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Trader thoughts - the long and short of it

While we saw a strong rebound last week in most developed equity markets, with high yield and investment-grade credit also tightening (relative to risk-free rates), we finally saw some indecision creep in on Friday ahead of what could be another big week for financial markets.

Source: Bloomberg

S&P 500 implied volatility (or the “VIX” index) sits just below 20, which seems fair given the event risk in play over the next few weeks, with this gauge having fallen in appreciation of the S&P 500 rallying 4.3% last week, with the Dow, NASDAQ, Eurostoxx 50, DAX and ASX 200 gaining 4.3%, 5.3%, 3%, 2.9% and 1.1% respectively. The Nikkei 225 was the clear underperformer on the week, falling 0.8%, with the moves in the JPY a stronger headwind, although we see a high probability the index bounces back a touch in today’s trade. Our call for the ASX 200 currently sits at 5900, with Aussie SPI futures trading a range of 5877 to 5840 on the Friday night session, with the eventual close in-line with where the price was at 16:10 AEDT.

The S&P 500 hasn’t really given Asia much to work with, closing on a flat note and while price closed above both the 5-day EMA (Exponential Moving Average) and the 7 February high, we can see genuine indecision to push price higher, with a ‘doji’ candle printed on the daily chart. This indecision needs to rectify itself and could set a precedent for risk assets in the early part of the week, as will US Crude futures when they open at 10:00 AEDT. Keep an eye on the German DAX this week too, with the bulls having built a base and subsequently pushed the price higher. If EUR/USD heads lower this week (see passage below on EUR/USD price action), then being long DAX/short S&P 500 as a pairs idea should work nicely.

So a flat open expected for the local market, with modest strength in Japan, while China is still offline and this gives us a chance to re-group, catch our breath and think about the event risk ahead. Not to mention what is priced into markets and how the event risk may alter the investment landscape and affect sentiment.

Locally, the main economic event is Q4 Aussie wage data (Wednesday, 11:30 AEDT), where the economist’s consensus is for wages to grow at a constant clip of 2% annualised, or 0.5% on the quarter. The Aussie 30-day interbank interest rate market has five basis points (or a 20% probability of a hike) priced in for the August meeting, with 16.5bp of tightening priced for the full year. This pricing did push up a touch through last week, helped by a broad pick-up in sentiment through markets and RBA governor Lowe giving a fairly optimistic parliamentary testimony, while repeating his view that the next move in rates is more likely to be higher.

AUD/USD is all over the shop at the moment but generally offered against G10 currencies. AUD/USD just failed to print a bearish outside day reversal on Friday, although a move through $0.7892 (both the Thursday and Friday low) next week could see the 200-day moving average at $0.7768 come back into play. A quarterly wage print of 0.3% or below would be a surprise and would, therefore, see AUD head sharply lower, while a print above 0.7% could get the more hawkish contingent in the market quite excited. EUR/AUD (see below) has been on the radar for a while, but again the pair refuses to close through a fairly indestructible ceiling at a$1.5771. AUD/JPY is the weakest link here, with price printing a series of lower highs and holding below the 5-day EMA despite the improvement in risk semantics – shorts favoured here.

Staying on the data side and we can also look forward to the January FOMC minutes, due on Thursday at 06:00 AEDT, with traders, really looking for transparency around the addition (in the statement) of the word “further”, with regards to rate hikes. With a March rate hike priced as a near certainty by interest rate traders, we have to look across the fed funds or Eurodollar future curve to see just under three hikes price for the full calendar year. The minutes take on even more meaning ahead of new Fed chair Jay Powell Congressional Testimony, due on 28th February and 1st March, and where he could guide us to a view that the Fed is looking at four hikes this year. Mr Powell’s testimony is the next big event traders will be watching, it is the new January US CPI print and I am especially interested in Eurodollar interest rate futures and whether Mr Powell can move future expectations to any great capacity.

As things stand a mere 44bp of hikes (or one hike and a 76% chance of a second) are priced in from December 2018 to December 2020, which seems low and Powell has the chance to guide them higher, predominantly based on the idea that fiscal stimulus is now a genuine reality and subsequently needs to play a bigger influence in the Fed’s economic estimates. The US Treasury yield curve comes into play here too, and while the 10-year Treasury fell 2bp on Friday to 2.87%, a move to 3% could be on the cards in the next two weeks.

Macro-watchers will always focus on the USD, and looking at price action on Friday maybe we are seeing some warming to the notion that Eurodollar futures could price in a greater scope for rate hikes in 2019 and 2020, with the USD index printing a bullish outside day reversal (i.e. price traded below Thursdays low and closed firmly above Thursdays high) and off the 88.00 level, which is now such a huge level for markets, as a break really opens the greenback up for an even deeper move. That said, we saw a bearish outside day reversal on EUR/USD off the 2008 downtrend and there is barrier holding EUR bulls back above $1.2500. We also saw a key day reversal in USD/CAD and this could be an interesting long this coming week.

Trump has done what most economists would never expect and unleash a fiscal stimulus (and increase the deficit) into an economy already growing above 2.5%, with five-year inflation expectations (I’ve looked at US 5y5y breakevens) sitting at 2.17%, with wage growth running at the highest pace in years, amid an unemployment rate at 4.1%. So with the sugar rush promoted from Trump’s stimulus, coming at a time when the economy probably didn’t really need it, and one could argue that the end result has to be a more active Fed. The chance of Powell signalling this change is high.

Aussie corporate earnings are also firmly in play this week, with the meat of earnings season upon us. As things stand, 42% of companies have already reported earnings, with 53% having beaten on earnings line and 63% on the sales line. Aggregate earnings growth sits at 15%, but this is likely to gravitate lower through the week, although expectations for full-year earnings are actually firming. So a reasonable earnings season so far, but it’s hardly going to shoot the lights out and really that’s what we need if we are going to reclaim the 6000 level.

If we are going to look at levels on our Australia 200 cash index, interestingly, we found sellers on Friday of the November downtrend at 5938, so this seems to have played into the move and the bulls really need to clear this if we are to see 6000. That said, the price is above the 5-day EMA, while the 9-day RSI (Relative Strength Index) sits mid-range. Put that into the relation of the “VIX” index at 19, the indecision in the price action in the S&P 500 on Friday and the 10-year US Treasury at 2.87% and we have the recipe for an interesting week, especially with the key event risk muddying the waters.

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