Traders unwinding G20 hedges, but can the good-will last?

Throughout most of last week, we focused on the risk that the G20 Summit held a gapping risk, knowing that the bar was low for a positive surprise.
Chris Weston
Currency exchange notice board

Now, while the bulk of what we’ve seen was in-line with expectations, and aligned with what was reported in the Chinese press last week. However, risk assets have warmed to what they’ve heard, and traders are clearly unwinding their G20 hedges today.

Looking around the markets, we can see the S&P 500 and Nasdaq 100 futures are up 0.9% and 1.2% respectively. Asian equity markets are firmer, notably in China, which is over 2%. In FX land, USDCNH (offshore yuan) is 0.3% lower, although it has come firmly off it’s earlier low and perhaps reacting to the contraction in the Caixin and NBS manufacturing report. USDJPY has followed S&P 500 futures higher and is tracking at 108.24.

Interestingly AUDUSD is a touch lower on the day, as is EURUSD, resulting in the USDX up smalls. The NOK is the best performer in G10 FX, largely as a result of a strong move in crude on the open, while the TRY is finding buyers as volatility sellers encourage carry to outperform.

G20 review

In my mind, there are too many questions that remain, and there’s been no real progress on the key sticking points to feel this is in any way a game changer, at this stage. Certainly, the US and Chinese corporate sector, or the Federal Reserve, will have not heard anything that gives them real confidence that the G20 Summit changes the script. However, the highlights that spring out:

• Trade truce – there will be no new tariffs, for now, on the remaining $300b of Chinese exports (to the US)

• Trade truce – A commitment to resume talks that recently fell apart – when do these formally start?

• Political landmine – the US will loosen restrictions on US tech company sales to Huawei and the wider China tech space. There is a credibility angle here, and we have already seen huge condemnation from cross-parties from the likes of Chuck Schumer and Marco Rubio.

• In return, the Chinese will commit to buying increased amounts of ag products from US farmers

• Improved visa treatment for Chinese students in the US

We are most focused on the schedule and future meetings between the two respective trade teams, in the search for real substance and the leaders to agree. Like many, I am cautious, as it feels these policies are cosmetic and designed to keep financial markets in check. We are watching domestic pushback, notably on the political fallout from Trump’s easing of pressure on Huawei – it has already been met by angry protests from the Democrats (specifically Chuck Schumer) and on Trump’s Republican side, namely Marco Rubio, who is threatening to put the restrictions (on Huawei) back to Congress.

Fed speakers to watch

The question we need to ask is whether these outcomes give the Fed any clarity and I’d argue not really. It will, therefore, be interesting to hear the thoughts, direct from the source, with Fed vice-chair Richard Clarida due to speak shortly at 16:10aest, and then NY Fed president John Williams speaks tomorrow at 20:35aest. It feels too early to believe the G20 fully removes the threat of a 50bp cut, especially when we get the US ISM manufacturing (00:00 aest) and non-farm payrolls (Friday (22:30aest) this week. So, expect the USD, gold and equities to be sensitive to this narrative.

We can also add the fact that we’ve heard agreement between Russia and OPEC to extend the production output curbs into 2020, and we’re currently seeing Brent and WTI crude gaining 2% apiece.

I focus on the Fed here, but consider tomorrow’s RBA meeting (14:30aest), as this is a genuine risk event for traders holding an AUD or AUS200 exposure over the announcement. The AUDUSD set-up looks constructive, although the risk of a failed break above the neckline of the double-bottom is increasing. As far as the playbook and the key considerations that I feel should be assessed, it feels as though the AUD upside should be greater than that of any downside move. Although the case for a cut or for rates to be held for this month is finely balanced, and I wouldn’t like to be too exposed to this meeting.

AUD playbook:

• Looking at Aussie cash rate futures pricing, a cut tomorrow is priced at 69%. We can make a strong case for the RBA to cut or to hold. But this pricing suggests we could get a decent spike higher or lower at 14:30aest, and it poses a risk to traders holding AUD exposures over the announcement.

• AUDUSD overnight implied volatility sits at 13.03%%, residing at its 57th percentile, but the period in May masks the reality of its current elevation. Through options pricing, we can see this equates to a 42-pip move (with a 68% degree of confidence) in either direction, with the one standard deviation range at 0.7042 to 0.6958. I have charted this, as well as increasing the level of confidence to 80% of how far price may move (from spot) and see price contained in a 0.6930 to 0.7066 range.

• 18 of 26 economists are calling for the cut, with all of the ‘Big-4’ forecasting easing.

• A quick glance at the weekly futures trader’s report (CFTC data), and we can see ‘non-commercial’ traders (predominantly those who use FX futures to speculate) hold a net short position of 66,320 contracts

The bottom line is this is a genuine risk event for traders. Some love this backdrop and will trade around the announcement. Others will see the implied vol and binary nature of the event risk and reduce exposures. But this is the crux of event risk management.

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Chris Weston, Head of Research at Pepperstone (Read Our Review)

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