After a brutal week/month for risky assets, we turn the page and look to trade all the grenades that are thrown at us in the new week – the dynamic remains one of further fundamental downside risk, amid technically oversold conditions, which suggests any resemblance of good/less bad news should see pronounced upside moves.
That said, much will need to go right for risk hedges to unwind partly and risky assets to bounce – better growth-focused economic data, inflation expectations headed lower but also US real rates will need to turn lower and promote a deeper sell-off in the USD - after the moves in United States 5-Year real rates last week (+37bp to 1.97%), this is a big ask.
Rates volatility did pull back a touch on Thursday and Friday, and we will need to see that follow through to cause a real turn in risky assets.
One trading consideration is that mean reversion may work better this week across asset classes. We already see signs of that in FX markets – In equity indices, the S&P 500 is tracking over 10% from its 50-day MA – take out the ferocious moves in March 2020, and this is over three standard deviations from the long-run average.
Market internals is shot to pieces with 1.7% of S&P 500 crossovers above their 20-day MA, 32% of crossover with an RSI below 30, and 35% of cos at new 4-week lows. This ultra-bearish sentiment plays into the risk vs. reward trade-off, and it suggests if we hear something remotely positive and we see better flow, the result will be a pronounced equity counter-rally, and this may incentivize funds to reduce USD longs.
Conversely, it could also be another brutal week. One suspects if it is, it will get truly ugly and see market chatter around coordinated policy response increase – liquidity remains a core consideration that exacerbates moves as funds try and get out of positions – spreads in the underlying market have widened in response, and the cost to trade for institutional funds has increased.
In this backdrop, it pays to take the timeframe down, understand that markets can turn on a dime and on little news, and quite often, these moves make little sense – nail your position size, have an open mind, and react with intent – this will serve you well and keep you in the game.
While we watch the USD, US real rates, the Fed’s balance sheet dynamics, and measures of volatility, we assess the key known event risks traders need to navigate portfolio through this week.
The Week Ahead
Aussie home loan values – the data is unlikely to be too impactful on the ASX 200 or AUD, but the cooling in lending is a big macro consideration – this is not just indicative of a slowdown in the demand for loans for residential property, but also business loans – The market expects home loan values to fall 3% in August, with owner-occupier loans seeing the bigger falls -3.5%.
RBA meeting – the market prices a hike of 44bp, with 16/21 economists calling for the 50bp hike, so a 50bp is largely priced – We look at pricing for the November RBA meeting and see this is finely balanced at 35bp, where I lean towards a 25bp hike - we see that expectations are that the RBA cash rate pushes to 4.10% by June ‘23 – this is the ‘terminal’ pricing.
AUD/USD 1-week implied volatility is close to 52-week highs, so the market looks for movement, suggesting reduced position size. Given the sky-high correlation between the AUD and equities, where the S&P 500 futures trade, AUD/USD will follow.
RBNZ meeting – the market prices 52bp of hikes for the meeting, with the economist’s consensus, firmly aligned – NZD/USD was destroyed on Friday (-2.3%), closing below 0.5600 – similar to the AUD/USD, NZD/USD will just track the US 500 – keeping an open mind on the direction of play in the US 500, with sentiment shot to pieces, but it can easily get worse.
UK Tory party conference (2-5 Oct) – all eyes on chancellor Kwarteng’s speech on Monday (16:00 BST / 02:00 AEDT) – the situation in UK politics is fluid, and the inability of the Truss govt to connect with the capital markets is telling – GBP/USD traded an 884-pip range last week.
The reversal from <1.0500 caught a lot of momentum-driven accounts off guard. Moves from the BoE to temporarily buy 20yr+ gilts and portray a monster rate hike in Nov have reduced cable vol. Still, we also know the bond-buying program is supposedly a stop-gap measure – there is no easy trade here – fundamentally, the bear case in GBP looks strongest, but technically there’s a two-way risk.
OPEC meeting – the first in-person meeting since March 2020, it could be lively and one for crude trade to put on the radar - talk of output cuts to the tune of 0.5-1.0 million BPD is making waves, with Russia pushing for a 1m barrel cut – as always we react to news flow here – I like a re-test of the Sept lows of $76.22. Still, the bigger the output cut, the less likely the lows will be hit.
US ISM manufacturing – the market looks for the diffusion index to print 52.1 (from 52.8), where we look into the sub-components for real context, notably the ‘prices paid’ and ‘supplier delivery’ sub-surveys – however, unless we see the headline index below 50.0 it shouldn’t cause any major ripples, but with sentiment so shot the unexpected can easily rip.
US JOLTS report – with the US labor market such a hot topic, we go into the labor report expecting 11.075M job openings. This would be a modest decline from the 11.239m job openings we saw in July – risky assets would find relief buying/short covering on a below consensus number.
However, we’d need a dramatic downside miss to start the party. A hotter number would be a USD positive and see fresh lows in the US500/NAS100.
ISM services – not typically a market mover, but we are watching to see if the service sector shows any clearer signs of fragility – the consensus expects a read of 56.0 in September (from 56.9), which, if comes to fruition, is still solid expansion and supportive of risky assets.
US Non-farm payrolls – the marquee (known) event risk of the week – the consensus expects 250k jobs to be created, with the economists forecast range seen between +389k to 200k – perversely, a number below 200k would likely be taken as a positive for risky assets and would pull the USD lower.
We also consider the unemployment rate with the consensus expecting this to remain at 3.7% - with inflation still top of mind, average hourly wages are expected at 5.1% (from 5.2%), so ahead of the Sept CPI print (13 Oct – expecting headline CPI to print 8.1%), the wage data could be influential. Risky assets (like equities) would find buyers on a sub-5% print.
14 Fed speakers – hard to see too much change from the recent Fed chatter. Still, inflation expectations have been cooling amid the tighter financial conditions, so any acknowledgment of these moves could be positive for risk. Rates markets are signaling we are closer to a top if rate hikes.
ECB president Lagarde speaks – we price 70bp of hikes for the ECB’s Oct meeting, so we question if Christine Lagarde alters this pricing.