Weekly Thoughts on Markets : First Week of December

Copper Prices Still Falling—Daily Chart of Australian Dollar (Yellow), Copper (White)

​Australian Dollar Prone to Further Weakness
Although Australia recently has produced strong job growth figures on the November 12 release with strongest job growth since 2010 (58K actual vs 15K projected) and a drop in the jobless rate from 6.2% to 5.8%, which helped prop up the AUD by helping reduce further need to ease for 2016, the currency remains at risk for further declines. Across the past year, the AUD has been sensitive for obvious reasons with commodity prices—specifically, copper and iron ore prices. Copper and Iron ore are continuing to hit new lows, while the AUD is currently having a relief rally from the overall down-trend, producing a short term divergence.  Sure the RBA might not be expected to cut rates heading into year-end, but they will most definitely refrain from reacting to just one month of jobs data. We believe that the AUD is poised for further declines, possibly aiming for the 0.7000 figure within the next two weeks. In addition to further commodity price pressure to the downside, 2-year bond  yield spreads also show a similar picture, where the AUD has to play catch-up, to the downside. In addition to this, risk-reversals also indicate a possible exhaustion in short-term bullishness for the currency, trading at 2015 highs on the 1-month risk-reversal. 

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AUDUSD 25-Delta 1-Month Risk Reversals Beginning to Curl

Daily Chart of AUDUSD (White) vs. 2y Bond Yield Spread

GBPAU D Tracking 2Y Rate Spread (GBPAUD Yellow, 2Y Rate Spread White)

GBPAUD Daily Chart with RSI At 30 Threshold

Expressing a view short via the AUDUSD seems to be alright, although it might be a good idea to diversify away from the USD, due to the incoming NFP event risk, Fed meeting, as well as the prospect of net USD positioning which are now at highs again. Because of this, we view that expressing the bearish AUD view via long GBPAUD should prove optimal as well, especially with the recent sell-off in the GBP driven by BoE dovishness on a lowering of growth and inflation forecasts. The GBPAUD cross remains largely reactive to monetary policy expectations from the BoE and RBA, with the pair tracking 2y rate spreads well in recent history. Arguably despite the recent downward revision in the UK’s inflation projections by the BoE, the trajectory for possible hawkish surprises is by far, still skewed towards the BoE vs the RBA, which should support the GBP/AUD.  The technical picture looks to complement the bullish bias as well with a recent touch of the 30 threshold on the 14-day RSI, which has produced reasonable re-entries to the uptrend. ​Although we should not expect any large directional moves on spot as we head  into year end, a trade back to 2.1500 seems reasonable for the pair.

10YR US-UK Bond Yield Spread at 40bps highs

​10yr UK-US Bond Yield Spread Widening 
​​The two bond yields have exhibited a tight co-movement over the past couple of years, moving generally in lock-step. Matt Roberts-Sklar,Senior BoE economists from Bank Underground comments that this is due to reasons such as the expectation of correlation of the policy rate path between the UK and the US,  the correlated movement of advanced economy risk-premia, and a globalized attitude towards risk.
The spread between the two bonds has been largely rangebound for two years between 40bps and 20bps, roughly. The recent short-term repricing of the BoE’s stance on monetary policy has also widened the spread between the yields on the 10yr US and UK bonds.  Arguably, if the Fed is expected to embark on its tightening path, despite talks of Brexit, etc the BoE could move towards to more of a hawkish tone in future commentary, which could push the spread back down to around 25bps, presenting quite an enticing RV trade.

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USD Long Positioning At Highs Courtesy of BNZ FX Research

​Risk:Reward to be Significantly Long USD Not There 
It is difficult to express a clear-cut bias on the USD, especially before we see accompanying commentary from Fed officials after the December meeting in regards to the overall hiking cycle. With the Dollar Index at the 100.00 figure along with net-long positioning at highs, the dollar looks ripe for some profit-taking, and a short-term retracement. @TheGreatGama mentions a good point that market participants underprice the correlation risk of very similarly Fed/USD driven trades reversing, which are namely: Long Dollar, Short EM Equities, and Short commodities. For the upcoming week, the NFP event risk may present itself with an opportunity to fade a positive USD spike for a short term retracement in the USD’s recent gains. If the Fed were to hike in the December meeting, there should be very little reason for them to be duly bothered by a single month’s jobs report, and hence is not one to affect the decision, providing a decent fading opportunity.

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EDZ6 Reaction to Past 2 NFPs

EDZ6 Recently Fading NFP Releases
Not that I normally ever cover fixed income/STIRs, but a quick glance on the EDZ6 (3-month Eurodollar futures, Dec-16) shows quite an interesting post NFP-spike reaction of fading almost all of the move on the hour of the release for the past 2 releases. Worth a punt perhaps for a third time fade for Friday’s NFP?

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