US Equities are Grinding Higher Into Q2 Earnings

That said, we do want to see how price acts, and as we see on the weekly chart of the S&P 500 price is pushing up against trend resistance, and this may be telling. A potential bearish crossover in momentum could indicate exhaustion in the bullish trend, and I would respect that by moving to a more neutral bias. Price is king as always, and while earnings are getting increased focus with Johnson and Johnson, JP Morgan, Goldman’s and Wells Fargo reporting between 20:45 aest and 22:00 aest tonight, our US equity indices could see some increased volatility through European trade.

One chart I always keep an eye on is the spread between high yield credit and US treasuries (white line). This is a great indicator of sentiment and accepted risk, as the narrower the spread, the greater demand for high yield bonds over the risk-free rate (US government bonds). There is an old saying, that ‘equities always follow credit’, and that is unlikely to the change anytime soon. However, at this juncture, while credit spreads are not giving any glaring sell signal for equity, there is a growing divergence which suggests the rally in the S&P 500 may be maturing.

US retail sales the central event risk

As we roll into US trade, we also have to focus on US retail sales (due 22:30 aest), and industrial production (23:15 aest). The retail sales print is a potential volatility event, and, as always, we look to see the outcome relative to expectations of 0.2% MoM. Economists often look at the retail ‘control group’ element, which is the group of goods used directly into the GDP calculation. This number is expected to grow at 0.3%, so should we see the USD more sensitive to this, as a beat may see slight revisions to the Q2 GDP estimate, where the market currently believes Q2 GDP is closer to 1.8% and down from the 3.1% pace of growth seen in Q1.

It should also affect the rates market which are now pricing a 25% chance of a 50bp cut in the July FOMC meeting. This pricing feels fair as the Fed should cut, but the recent data argues for 25bp. The argument is though if the Fed cut by 50bp, then they can try and run their economy red hot as they try and get in front of the curve.

Are we pricing in too much easing from the Fed?

If I look at market pricing for end-2019, we see 64bp of cuts (from the Fed) priced in, which effectively dwarfs the expected easing seen from other central banks. Granted, we have already seen a response from the RBA and RBNZ, and the Fed is yet to start its easing cycle. However, given what we have seen of late from the US data, I question if 64bp (central banks tend to work in 25bp increments) looks a punchy call.

The USD index daily needs work

As we can see in the daily chart of the USD index (USDX), there is no clear trend, and price action is quite messy. We see price oscillating around the 200-day MA, and also the 5-day EMA, so we can understand that there is little conviction to push the USD one-way or the other. The options market continues to favour downside and the premium to buy 3-month USD put (or downside) protection outweigh calls options vols.

The EUR offers a 57% weighting on the USDX, which is a basket of currencies weighted against the USD. So, if we refocus away from the EUR and drill down into the moves over the past five days across G10 FX, we can see that the NZD and AUD are performing quite admirably versus the USD.

China data has boosted sentiment

Yesterday’s China economic data has helped sentiment, with a sizeable beat in the June industrial production, retail sales and fixed asset investment prints. The Q2 GDP print came in at 6.2%, which was in-line with expectations. Liquidity has also been in play, with the PBoC conducting CNY200b in one-year loans at 3.3%. Chinese equities saw modest love to the numbers, and are down a touch today, but in FX markets, the set-ups in NZD and AUD look interesting.

AUDUSD grinding higher

AUDUSD tends to get the lion’s share of attention in the AUD pairings, and this won’t surprise, and there seems to be growing interest here again. The daily chart needs more work before we can truly turn bullish and anyhow being bullish this pair never feels right, largely as the cost of carry means hedge funds are unwilling to be long. That said, with 24bp of cuts priced for the rest of 2019, it’s hard to see rates pricing in any more than this, and we may have to wait until November and the Melbourne Cup before the next move from the RBA.

Indeed, today’s RBA minutes (from the July meeting) which have detailed they will cut rates further “if needed”, go some way to justifying this pricing structure.

Price is grinding higher and sits at the top of the multi-month range. A clean break of 0.7050 offers a potential move into the 0.7100 to 0.7150 area. However, with AUDUSD weekly implied volatility just so low, impulsive moves are just not expected and this has strong considerations for risk and position sizing.

We can see that the market sees, with a 90% confidence level, that price should not get any higher than 0.7130 over the coming five days. We can also see options traders anticipate any downside move confined to 0.6957 with a 90% confidence level. That implied volatility read takes into account Thursday’s Aussie jobs report, where the consensus expects to see 9000 net jobs created with the unemployment rate remaining at 5.2%. Good numbers here and the market will pare back rate cut expectations and cover AUD shorts.

NZDUSD also working well

NZDUSD is threatening to convincingly break through the June highs, and traders are questioning if they chase the move, should we see a firm breakout. Flip the chart to EURNZD or GBPNZD (or EURAUD/GBPAUD) though, and this is where we are seeing the big moves, as order book dynamics take hold, with the buyers staying clear and the sellers having an easy time of pushing price lower.

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Chris Weston, Head of Research at Pepperstone.

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