The big debate that materialised on Friday and throughout the weekend has been around who will lead the Federal Reserve when Janet Yellen’s tenure comes to an end in February.
The focus really started with a Wall Street Journal (WSJ) article that first detailed that Kevin Warsh had met with Donald Trump and Treasury secretary Steven Mnuchin, and then later in the session a piece from Politico that stoked an already lit fire, by saying the meeting between the three individuals had been “very positive”. The WSJ went on to write another article disclosing Jerome Powell had also been interviewed for the Fed chair and we are left with a clear shortlist of four candidates for what is arguably the most important role for markets.
Trump has said that he will disclose who is appointed in the next two to three weeks, but as things stand it looks likely it will be either Janet Yellen (for a second term), Kevin Warsh, Gary Cohn or Jerome Powell. The fact we saw strong selling in the 5- and 7-year part of the US fixed income curve, after the WSJ and Politico articles were released, suggests the market see’s Kevin Warsh as a genuine front-runner now and he has made a strong impression on Trump. One suspects Mr Warsh is not going to come in and shake things about too drastically, if he does get the gig, but his views on policy are well known to market participants and he is certainly more hawkish than Yellen, although that isn’t hard to be fair.
The speculation around the Fed appointment saw bond yields rise across the curve, while in the interest rate market we saw the probability implied for a December hike increasing to 76%, and we now see two hikes priced in until the end of 2018. This change in rate pricing also came amid fairly uninspiring US data, with personal spending rising 0.1% and if one adjusts for inflation then we saw ‘real’ spending actually fall 0.1%, while August core PCE also edged up 0.1% or 1.3% yoy. The University of Michigan sentiment survey came in at 95.1 and was also a little underwhelming.
The wash-up of the various news flow was an unchanged USD, while the S&P 500 closed out the quarter with a gain of 0.4% on the day at 2519 and printing another all-time high. Tech, healthcare, and financials contributed the bulk of the points and the trend higher continues in earnest and this is a market where shorting is super tough work and the path of least resistance seems for higher levels. There has been absolutely no change in market anxiety levels with the VIX closing at 9.51%, despite the prospect of a new Fed chair, but rightly so as the VIX measures implied volatility in the S&P 500 over the coming 30-days, and the market isn’t going to be too concerned for now about Mr Warsh’s policies, given he hasn’t actually been appointed.
Keep in mind the S&P 500 and Nasdaq are up 12.5% and 20.7% ytd, so don’t rule out the prospect that hedge funds chase this market into year-end, especially with the benchmark for Q3 earnings season set fairly low, with consensus earnings estimates sitting at 4.5% and 2.5% ex-energy. Of course, this will only really materialise within the discretionary players within the hedge fund industry, but to put this into perspective this is still an industry with $270 billion in assets under management. It’s not just hedge funds though and as one investment bank put it, this is the fifth year in a row active mutual fund managers have failed to deliver any significant alpha. So don’t rule out US equity market moving higher into year-end purely on the idea of active money managers chasing performance.
SPI futures closed at 5682, which was a change of 22-points from where at 16:10 aest – the official close of the ASX 200 cash market. With this in mind, we should see a test of 5700 on the ASX 200 open, although the Labour Day holiday in Sydney will subtract from the level of market participation today. S&P 500, gold, copper and crude futures open now at 09:00 aest, so this will give us a clearer idea of how the weekend news flow impacts our open. However, judging by the fact AUD/JPY is higher by a mere 14 points and AUD/USD is unchanged at $0.7835 suggests we should not get too carried away by strong manufacturing PMI data out of China on Saturday. Here we see the index headline print coming in at 52.4 – the highest since April 2012. We can look within the survey and see the new orders and new export orders sub-component working nicely too. We also saw the Caixin manufacturing report (this measures activity in smaller businesses) ticking down 0.6 points to 51, although I suspect the market will place greater interest on the larger National Bureau of Statistics (NBS) manufacturing print.
Keep in mind we also saw the PboC reducing reserve requirements on Saturday by 50bp to 100bp to banks with the specific target of lending to smaller business.
Clearly, there will be some focus on Spanish markets too given the scenes in Catalonia and voters looking to place votes in the independence referendum. EUR/USD (currently $1.1792) and the EUR crosses are only very modestly lower, highlighting this is more a humanitarian issue and not one that is going to knock sentiment too greatly in Europe and while we may see some underperformance from Spanish equities, we shouldn’t see too much stress in the bond market and we shouldn’t see a significant widening of the Spanish/German bund yield spread.
On the commodity front, and by way of leads to price into Aussie energy and materials stocks and we see that US crude closed 0.2% on Friday, although may find a few sellers in the oil futures open (at 09:00 aest) given the US Baker-Hughes rig count snapped three weeks of declines, with the rig count increasing by five rigs. Spot iron ore closed 1.3% lower at $62.05, with iron ore futures lower by 1.5% and recall both China’s equity market and the Dalian futures markets are closed today for National Day, so we lose direction here. If we look at BHP’s ADR we can see this closed up by 8c, suggesting we may see a flat open for the ASX 200 materials sector which is in line with the move we saw in the S&P 500 materials sector. That said, the China manufacturing data should support.