US Markets Had Another Fantastic Week, Trade or Fade?

With the US and China on track to a trade deal and commodity prices well-supported, add China credit infusion to the mix, it suggests this is a market to trade and not fade.
Stephen Innes
US dollar and China Yuan

Ignoring idiosyncratic price action and focusing on the broader picture. The market is taking its lead from China. The bullish knock-on effect of improving China economic data coupled with an expected US-China trade deal should keep the markets in good working order. But in my view, its China’s credit expansion that deserves the closer look, market data suggests there’s a pivot underway from deleveraging to re-leveraging, and if China’s IV liquidity drip continues to flow, it will be hard not to remain optimistic on global equity markets.  With the US and China on track to a trade deal and commodity prices well-supported, add China credit infusion to the mix, it suggests this is a market to trade and not fade.

Oil prices end the week on solid footings, sure the trend is your friend but are we in for a correction?

“Given the markets impression of just how tight supplies are on the back forced supply cuts from Venezuela and Iran, and as we saw on Friday when bombs fell near the Mellitah oil and gas plant, geopolitically inspired bounces could be the flavour of the day as traders continue to hedge against a catastrophic supply shock from Libya.”

The absolute worst thing that can happen for oil prices is an unlikely breakdown in OPEC+ compliance. And while Saudi Arabia is odds on to tow the OPEC’s supply discipline mantra. But in the “where there’s smoke, there is fire” category. Russia could be a different story — keeping in mind that Russian President Putin said early last week that the situation in Iran, Libya and Venezuela would need to be considered as part of the decision on whether to extend OPEC+ production cuts, calling into question Russian commitment to the deal. All of which tells me that OPEC+  meeting in June will be a massive deal for the markets and regardless what level we are trading at Oil prices will likely come off the boil once the market turns focus to that event.

But in the meantime, given the market’s impression of just how tight supplies are on the back forced supply cuts from Venezuela and Iran. And as we saw on Friday when bombs fell near the Mellitah oil and gas plant, geopolitically inspired bounces could be the flavor of the day as traders continue to hedge against a catastrophic supply shock from Libya.

On the macro front, China’s credit bonanza has tempered fears of global economic slowdown and should continue to support oil price. And when coupled with a likely bounce on a US-China trade deal,  it provides a convincing argument to stay long oil this despite the vast US inventories build and more shale oil rigs coming online, suggesting, to me anyway, its time for the Oil market to pare back bullish risk.

Why is this gold bull not champing at the bit just yet?

“While prices continue to hover around the $1300 level within the broader $1275-1325 range I suspect gold market participants are keeping a close eye on macro developments hoping for an extension of lower real interest rates before aggressively chasing gold prices higher.”

After more than two decades trading gold through thick and thin and even staffing the physical desk when gold hit an all-time high of $1,917.90  back in 2011, one thing I can tell you is that the market will be increasing discombobulated and insanely volatile as gold fever continues to kick in. So strap in we could be in for a bumpy stop and go ride this year but when emotion starts taking over, trust me the market is always wrong.

A stupefying amount of ink has been spilled on gold markets of late and while it was encouraging to see gold break above $ 1300, but the market is prone to a case of jitters above that psychological threshold especially with the global growth recovery and improving risk sentiment supporting US equity markets.

But the reason why I’m not champing at the bit just yet as I’m sticking to my end of 2018 view, as I think  USD decouples from Gold as the long US dollar haven hedges unwind on rebounding risk and global growth sentiment. In such a case, the US dollar decline may not necessarily lead to a bullish rise in gold prices over the short term. (Bloomberg TV)

However, the weaker dollar over the long run will most certainly be positive for Gold, but over the near term, we expect real interest rates to dictate the pace of play.

While prices continue to hover around the $1300 level within the broader $1275-1325 range, I suspect gold market participants are keeping a close eye on macro developments hoping for an extension of lower real interest rates before aggressively chasing gold prices higher.

However, China and Russia demand will be convincing backstops not to mention  demand from Turkey and India remains very high as all four colossal purchasers  of gold should continue to diversify reserves away from the USD through 2019

China growth stabilizes, what does this mean for the Yuan and global markets?

“Beyond the obvious bullish CNH play that could see the US remove  200 billion in tariffs and send the USDCNH tumbling to 6.50, the improving economic landscape in China alone should keep the bullish CNH environment in check.”

But when you start factoring in the expected MSCI rebalancing flow coupled with a hard cap contingency mechanism to keep topside USDCNY risk in check as part of the US-China trade agreement, there’s a significant backstop in play which suggests the risk-reward for further Yuan appreciation remains very high over the near term.

Dollar struggles on rebounding risk sentiment, where do we go from here?

Euro

“I’m starting to see value in long Euro on several fronts. The bounce in global economic data that began this month with positive PMI’s. Better IP prints out of the EU and robust data in China especially from the export sector all of which suggest global ” green shoots” growth is well underway. If the market regains some degree of optimism about global growth the Euro can easily bridge the valuation gap and can move closer to the 1.1700 level.“

USD fundamental drivers have changed significantly, it’s now moved considerably up the G10 carry pecking order, and because of surging oil production, it now has a less harmful beta to commodity prices, which means I  don’t believe its merely a haven asset but that’s where the positives end.

I’ve commented ad nauseam that for the Euro’s recovery all roads lead through Beijing and that’s because China stimulus will have a  positive knock-on effect on the EU growth rebound which should eventually translate into the Euro breaking through the top side of our well-worn ranges.

Indeed the Euro is about to get interesting despite implied vols falling to a 5-year low. But with low volatility comes a high level of complacency that suggests even well-seasoned G-10 veterans are having trouble seeing the forest for the trees.

The Euro has been a story of contradiction for years, US vs EU yields, ECB dovishness vs Fed neutrality but top side momentum will inevitably start to build

I’m starting to see value in long Euro on several fronts. The bounce in global economic data that began this month with positive PMI’s. Better IP prints out of the EU and robust data in China especially from the export sector all of which suggest global ” green shoots” growth is well underway. If the market regains some degree of optimism about global growth the Euro can easily bridge the valuation gap and  move closer to the 1.1700 level.”

Of course, I concede the ECB dovishness, but I view growth as the principal driver behind the Euro’s fortunes, and that growth will be generated on the back of China credit expansion. In January, we had stellar credit data out of China, but with the March TSF data suggesting loans have rebounded sharply and with more easing expected, I think it’s safe to conclude that China is shifting from deleveraging to re-leveraging which will be a godsend to global growth and by proxy the Euro.

Of course, we can throw this view out the window if China decides to quash the easing cycle and then at which point I will concede we fall back into the hollowness of a low volatility range trade.

Australian Dollar

“But the long and short of it, China data and credit expansion is flashing buy A$ signals, and the thought of a US-China trade deal is just too juicy of an opportunity to ignore.”

China economic data has traders slowly shifting to a more optimistic global outlook, and as my view on the Euro the Aussie is concerned less about interest rates and more about a growth storyline, so I could care less about the RBA policy as its external drivers that will be key to the Australian Dollar rebound. But the long and short of it, China data  and credit expansion is flashing buy A$ signals and the thought of a US-China trade deal is just too juicy of an opportunity to pass ignore as it will provide a much-needed shot in the arm to Aussie dollar sentiment given Australia’s pivotal role in the global supply chain.

However, there is still a lot of wood to be chopped to get through  .72 AUDUSD as the local perma Aussie bears are overly active in the options markets around next week Jobs data suggesting any disappointments on that front could see the Australian dollar tumble that would play into the dovish RBA narrative. But I would be a buyer again on that dip.

Malaysian Ringgit bearishness building

“The economy has dug itself into such a big  hole that the odds have greatly increased that the BNM will cut interest rates next month.”

The market is now on BNM watch especially after the downward shift in their growth forecast, while benevolent inflation prints have triggered a discernable dovish change in BNM rhetoric. Although I do expect some relief from the incoming bond flow, I’m not entirely convinced those flows will be enough to prop up the Ringgit.

However, I do think a significant sell-off is very unlikely. Support from should come from  US-China trade deal, which is reportedly around the corner, while the MYR should piggyback Chinas reflating economy, but it will take time for these benefits to filter through into the economic data which might not provide immediate nor lasting relief.

After being stuck in long stasis,  the government has made a constructive move, and economic relief should be on the way as   Premier Mahathir Mohamad has thankfully struck a deal with China to restart the East Coast Rail Link which should revive construction and related sectors of the economy.

Political paralysis aside, the economy has dug itself into such a big hole that the odds have significantly increased that the BNM will cut interest rates next month which should send off alarm bells and we could expect the MYR to weaken further despite resurgent Oil prices.

At the end of the day and after a flurry of positive economic data out of  China last week, traders continued to sell the MYR while buying CNH, IDR and PHP  on an aggregate flow basis. That itself is a very valid bearish signal indeed.

This article was written by Stephen Innes, Head of Trading and Market Strategy at SPI Asset Management

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