Global markets continue to push higher, with the MSCI World index trading to a new all-time high on Friday, really led by the S&P 500, although the DAX, FTSE 100 and Nikkei 225 (among others) look attractive too.
Of course, the big news on Friday was the poor non-farm payrolls, which saw 138,000 jobs created in May, with a two-month revision lower of 66,000 jobs to the prior two payrolls reports. Reading between the lines from last week’s Beige Book, the narrative detailed that across the country there are worker “shortages across a broadening range of occupations and regions”, therefore we can loosely make an assumption that the poor jobs report was a function of supply, and an inability to hire the right candidates. We can also see the US unemployment rate sits at 4.3%, although this was driven by a lower participation rate at 62.7%. Average hourly earnings grew at 2.5% and below the 2.6% estimate the market was discounting.
The wash-up is that the numbers themselves were not enough to derail the equity bull market and implied volatility (or the “VIX” index) closed at a meagre 9.75%. With equities finding buyers, driven predominantly by tech, we can see that the fed funds future (July contract) has priced in a near certainty of a hike on the 14th June, but the fed funds curve (the yield on contracts in the periods ahead) continues to flatten in earnest.
If you trade interest rates, being short the Eurodollar December 2017 and long the Eurodollar December 2018 contract has been a great trade and I would stay long here as future rate hikes are potentially priced out of the curve, although this is a very mature trade. Perhaps the bigger talking point has been the strong outperformance of the ten-year US Treasury. If we look at the Treasury curve (the difference between two and ten-year US Treasuries) we can see this sits at 86 basis points (bp) and is the flattest since September 2016 and a marked move since the start of the year from 136 bp. This was never meant to happen under Trump!
With the ten-year Treasury trading through strong support of 2.16%, this was never going to be taken well by the USD and we have seen a strong move lower against a range of currency pairs. It is also not so great for US financials, who borrow at short-term rates and lend at longer-term rates (think lower net interest margins). It is good for tech though (through the use of a lower risk-free rate in the discounting process to calculate net present value) and it’s interesting to see the NASDAQ closed up 1.1%. Being long the NASDAQ has been one big momentum trade.
One questions if this is the week to derail the upbeat sentiment and perhaps shake some life into implied volatility (watch the US volatility index), and while there should be little to upset a June hike (from the Federal Reserve), we do get important narrative from the ECB, an election in the UK and former FBI Director James Comey testifying to the Senate Intelligence Committee, all on the same day. In Australia, the RBA will release its own statement tomorrow on the how it sees the world, although Q1 GDP seems a more prevalent issue, especially when you have a couple of research houses calling for a contraction in growth in the quarter. Oil is also on the radar, as US crude has a shocker last week, with price closing 1.5% lower on Friday taking the weekly loss to 4.5% and weighing heavily on the S&P 500 energy sector.
In FX land, watching and trading the AUD will be interesting this week given growth is front and centre. AUD/NZD shorts have worked well (take a look at the trend on the daily or weekly chart), but I would be cutting back on exposures here, or at least really tightening up on the stop loss given the event risk in Australia. EUR/AUD is similar, where the pair has rallied nicely, but I would specifically be looking at longs here now, only on a closing break of a$1.5227, given the risk the ECB don’t meet the somewhat hawkish view of the market and could easily disappoint. GBP/USD will be closely watched as well, although I feel the market is pricing in a Tory win of 50-80 seats and still the greater probability that Theresa May can gain a majority. We are seeing a slightly softer start to cable this morning, but any moves into £1.3050 to £1.3100 will likely be sold into I suspect.
In Asia, the Nikkei has been attracting good buyers of late, although I like what I see in the China H-Share index too. We see some headwinds to Japanese equities this morning given USD/JPY collapsed after the US payrolls report. The ASX 200 is shaping up for a fairly flat open, with SPI futures closing Friday’s night session up ten points, although our ASX 200 call sits at 5791. Keep an eye on SPI futures through the day and a break of the recent high of the 5808 to 5815 range would be very positive in my opinion.
BHP’s American Depository Receipt closed down 1%, while VALE SA (NYSE:VALE)'s US-listing up 0.2%, so it seems likely that energy will struggle, but some better buying will be seen in select materials given spot iron ore closed up 3.3%, while Dalian futures closed up 2.9%. The lead for banks is also uninspiring. It’s all about the FX and Aussie interest rate markets today though, with Q1 inventories and company profits (+5% yoy) providing key insights into Wednesdays GDP print when released at 11:30 aest. Inventories are expected to increase 0.5%, although the economist's estimates range from +1.4% to -0.1%, so we could see the AUD fairly sensitive to this print.