The Bull

Saturday 25

November, 2017 1:10 PM



IG Research - The long and the short of it

IG Research - The long and the short of it

The grind higher in risk assets continues despite so much good news have been thoroughly discounted.

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07.11.2017 08:43 AM

The grind higher in risk assets continues despite so much good news have been thoroughly discounted.

I have been looking for a pullback of sorts in equities (predominantly based on profit taking), but only prepared to back the view as and when price action and the technical picture confirmed the market was in agreement. This continues to be the higher probability outcome, as every single intra-day dip in US and other developed market indices is supported and the news flow is hardly even creating a sweat for the bulls.

Today though is the turn for commodities names to fire ahead as some of the moves in the commodity complex have been rather punchy and one suspects the reaction in the Aussie equity market could be more pronounced than the moves in the S&P 500 sectors, with the S&P materials actually lower by 0.3%. The clear focus has been on the oil markets, with Brent and US crude gaining over 3% and while most will point to the news flow around the Saudi corruption drive, it feels as though oil had the wind to its back anyhow, with many getting excited about the 30 November OPEC meeting. Throw in a 40-rig reduction in the US Baker-Hughes rig count since August and the trend following futures funds adding to bullish exposures, and you have oil pushing to new highs in this run. The S&P 500 energy space is looking to close up 2%, and I suspect we shall see something of that magnitude in Australia too.


(Source: Bloomberg)

It’s the Aussie materials space that will garner interest on open and I would expect a mix of short covering and new long positions from clients today. BHP looks set for an open some 2.4% higher (based on its ADR or American Depository Receipt), while if we look at Vale’s US-listing, which can be seen as a guide for the Aussie pure plays, we can see its ADR is trading up 4.1%, so better days for FMG this morning it would seem. It’s the whole commodity spectrum though that looks so strong. Spot iron ore has closed up a sizeable 5.8%, while in the Dalian exchange we have seen iron ore, steel and coking coal futures gain 3.6%, 0.9%, and 1.9% respectively. Base metals are doing nicely, while gold and silver have also found buyers, driven by US ‘real’ (or inflation-adjusted) Treasury yields falling a couple of basis points.

So clearly, it’s going to be a good day to be long most stocks in the materials space, and if the ASX 200 is going to find a further bid after the overnight leads are priced in and the index unwinds at 5977 (+24 points or +0.4%), which is the Aussie SPI futures adjusted move, then materials are where you are going to see the points coming in. The index bulls also need banks to find some buyers from somewhere, as the leads from the S&P 500 financial space are hardly inspiring and there are no glaring new reasons to buy this space this morning. If financials can hold in there though, then we may make a tilt at a move into 5980-90, but it seems like there is much wood to chop to pass through here today. Of course, volumes will be on the light side due to Melbourne Cup Day and we will be lucky to see north of $4.5 billion, and this could, in theory, exaggerate moves.

Aside from moves in commodities, there has been little in the way of key news flow to really rock sentiment, although there has been some focus on Senator John McCain who has detailed the House tax plan is literally dead on arrival if handed to the Senate in its current form. That shouldn’t shock to any great degree, although we should hear the Senate release its own tax narrative by Thursday, while Paul Ryan is hopeful of having a bill passed through the House before Thanksgiving recess. Outgoing New York Fed governor Bill Dudley and San Francisco President John Williams, have both been arguing the merits of adopting price-level targeting within the Federal Reserve’s mandate for achieving price stability. This is something economists and strategists have been watching since Bernanke put this debate into the market foresight a number of weeks ago, and to be fair John Williams did put out a research paper on this subject back in May.

A change in the way the Fed set policy around an inflation target would be a big deal for markets and would represent a sizeable change in the way the Fed set monetary policy and it makes it even more interesting given we now have Powell as the new chair.

In fixed income land, there has been a further flattening of the 2’s vs 10’s Treasury curve, with the US 10-year Treasury finding buyers and trading down 2bp to 2.31%. It’s interesting that we have seen both European and US 5-year inflation expectations (I’ve looked at 5y5y breakeven) trading lower despite oil and commodity prices so strong, and this needs close attention going forward. The USD has had a mixed night as a result of moves in fixed income, with USD/JPY coming 100 points off the session high of ¥114.73, which could impact the Nikkei 225 to an extent.

AUD/USD has found the $0.7650 level a solid platform to progress into $0.7690 and we now see resistance kicking in at $0.7704 (the Tenkan-Sen line on the Ichimoku cloud – the pink line), before the 2 November high of $0.7729 – A close through here would open up better upside. Clear support for the pair can be seen on the daily chart between $0.7640 to $0.7625 and the pair needs to close through here to re-establish the bearish trend we have seen since 8 September. Of course, a lot will hinge on today’s RBA statement at 14:30 aedt and given the benign Q3 inflation data, uninspiring wage and retail data and signs of cooling in the housing market there are reasons for the RBA to dampen its language which could cause a move lower in the AUD, especially with the Statement on Monetary Policy out on Friday. 


FX traders have their eye though firmly on the reaction in rates and Aussie bond markets, notably after the slight widening of the yield premium demanded to hold Aussie 10-year bonds over US Treasuries overnight to 25bp has been the backbone for the moves in AUD/USD. One suspects if the RBA maintains its neutral, yet optimistic outlook, then that may actually cause a slight upside move. Whether we can get a close above $0.7729 is another thing.  

(AUD/USD – orange, Aus/US 10-year yield spread – white)


Originally published by Chris Weston, Chief Market Strategist, IG
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