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- Traders shorten duration in the bill markets
- Volatility seen in early Asian trade
However, it almost seems as if they are also assuming an end to the shutdown could also be worked into an agreement.
US and European equities found solid buying yesterday on reasonable volume, while volatility readings, such as the VIX index fell 16%. This was all premised on the Republicans looking desperately to do something about their ailing PR and reach out to the Democrats to avert breaching the debt ceiling’s soft deadline of October 17. The fact that there was talk of pushing the debt ceiling out until November was one thing, however the market wasn’t even really interested in whether the White House had agreed to any potential proposal; it took enough heart from the fact that the Republicans were simply playing ball.
Traders shorten duration in the bill markets
The most interesting concept I took out from the agreement, apart from the spike in equities, slight bid in the USD and good selling in gold, was the rotation in duration in the US T-bill market. The three different bills maturing in October have been smashed of late, not really because anyone truly believed the US would default on its bills or even treasury obligations, but from a yield perspective it just made sense to increase duration (i.e. hold slightly longer-dated paper).
Now we could (in theory) see the debt ceiling being pushed back to November; we have seen this trade reversed, with solid buying in the October maturities, while stress is now being seen in the November maturities. The steeping of the bill curve in this instance merely reflects a market that has seen politicians buying time; however the problems will have to be dealt with a month later. Still, if we are to take something out of this, it’s positive that moves are being made to address the issues at hand.
In theory an extension to November 22 would also address the looming coupon payments due on October 31 ($6 billion) and November 15 ($31 billion), while there are a number of expenses around Medicare, pensions and social security which would be addressed.
Volatility seen in early Asian trade
In early Asian trade, in the ‘twilight zone’ between US equity close and early Asian trade, a headline that the President had walked away from the proposal saw futures fall fairly heavily (Dow futures dropped 84 points, S&P futures 12 handles), while USD/JPY dropped to 97.92. This was quickly rectified by House Budget Committee Chairman Paul Ryan who said the President had neither walked away nor agreed to the deal. We wait in anticipation for clarification, however risk in Asia is bid and volumes are good.
Gold naturally has been offered and I would look to add to shorts on a close through $1277 (the October 2 low and 61.8% retracement of the $1180 to $1433 rally). There just doesn’t seem to be many reasons to own this commodity right now as it seems logical that the US will get something in place. It also seems logical that we look at other trades that could work well in the short term and while I see downside in gold, I also like USD/CHF longs on dips, while short EUR/AUD and GBP/AUD looks good.
Sell GBP/AUD and EUR/AUD
EUR/USD is a tough trade, as is AUD/USD (I favour a break of 0.9510 soon), as neither seem to be moving and range-trading is the way to go. However, EUR/AUD could be set to make a move to 1.40 and below in the coming weeks. Firstly, let’s say we do get an agreement and the impact from the shutdown shaves a modest twenty-five to thirty basis points off US GDP, it seems logical that the carry trade will kick back in gear and thus we could see the EUR being used as a funding currency here, especially after Mario Draghi spoke about cutting rates yesterday if ‘money market conditions return to the levels observed in early summer’.
It’s getting tough again in euroland and if the EBA (European banking authority) is serious about penalising banks who rely on LTRO (long-term refinancing operations) funds, then the ECB will have a tough job controlling money market rates, especially if European banks start paying back previously borrowed funds at a faster rate. This in theory is EUR positive, as the ECB’s balance sheet will contract. However, this will mean the ECB will have to offset any potential tightening with even looser rate settings.
Our European equity opening calls have been one-way traffic from clients, with many looking at the solid flows in Asian equities, with China up 1.4%, the Nikkei higher by 1.3% (despite Fast Retailing taking 66 points out of the market), while the ASX 200 is up 1.6%. Financials globally have been on a tear, hence the outperformance of the ASX 200, helped also by a 2.6% gain in Westpac, with the market giving the thumbs up to its reasonably priced acquisition of Lloyds Banking Group’s Australian business.
It’s incredible to think that the DAX is likely to open twenty points shy of its all-time high, the CAC the highest level since 2008, while the IBEX continues its trend north, having rallied 29.5% (if our call of 9722 proves correct) from the June lows of 7508. Clients have centred their buying on the DAX today, and despite the S&P 500 only 1% from its all-time high, you can understand why EUR/USD is where it is when global money managers are centring so much of their attention on European equities. Bear in mind JP Morgan and Wells Fargo report, and given positioning of late, there are upside risks to these names