US investors have come back feeling refreshed and ready to do more of what worked in Q417 and it appears they continue to hold an optimistic mindset.
Despite cries from certain circles on social media about an impending recession, it seems global growth is accelerating and the prospect of any recession occurring in 2018 is very low indeed. China started the ball rolling with its service and manufacturing data, both in its larger industries (as measured by the National Bureau of Statistics) and also the Caixin print, which surveys the smaller end of town and both measures were good enough keep sentiment elevated. In Europe, we have seen manufacturing PMI’s continue to highlight that Europe is in a good spot and the need for negative interest rates and €30 billion a month in asset purchases is diminishing. Although despite the Euro area final manufacturing read coming in at 60.6 – a record high, we haven’t seen any moves in the interest rate markets, with the difference between the Euribor December 2019 and 2018 futures contracts remaining at 35 basis points. This is a great gauge for pricing around future ECB expectations and is a must watch gauge this year in my opinion.
Despite the lack of any move in European interest rate expectations, we did see a reasonable sell-off in German and peripheral European bond markets and this created a tailwind for EUR/USD, with the pair pushing into a session high of $1.2081. We have also seen nice flows into long GBP/USD positions too, with the pair hitting $1.3600 and eyeing a break of the September 2017 highs, despite UK manufacturing PMI’s coming in a touch under expectations at 56.3.
It has been a USD move though and we can see USD/JPY under pressure too, with price testing the 112 handle, with some attributing this to Morgan Stanley who put out a sell recommendation on USD/JPY for a longer-term move into ¥105. A punchy call, with the consensus for year-end sitting at ¥112. It is also interesting to see the cost for USD funding (as seen in 3-month USD/JPY cross currency basis – see below) has narrowed significantly of later and as Morgan Stanley argued could incentivise foreign investors to sell out of Japanese government bonds, which in-turn could see many of the FX hedging policies put in place (to neutralise the effects of holding a Japanese asset) unwound in the process – a JPY positive. One to watch, as USD/JPY at ¥105 would have interesting implications for Japanese markets and certainly validates the ultra-cautious stance of the BoJ.
(USD/JPY 3m Cross currency basis –  or the additional cost for USD funding)

(Source: Bloomberg)
As mentioned yesterday, the short USD, long commodity trade is still one that is taking centre stage. That said, the USD event risk ramps up tonight with US December manufacturing ISM (due at 02:00 aedt), with calls for another elevated read at 58.2. It seems the balance of probability is either for an inline print or a modest downside miss, but to be fair, the way the USD has been sold of late the market is likely to be more sensitive to an upside surprise and there could be a reasonable short covering move if the data point comes in closer to 59.
We then get the December FOMC minutes at 06:00 aedt, and while the market is not expecting fireworks here (judging by USD/JPY implied volatility) one wouldn’t want to be too short USD’s if the Fed offers a more confident (than expected) assessment of their inflation outlook. Notably, one needs to focus on US fixed income markets, where we can see a strong sell-off overnight, with longer-term yields really underperforming and the US 10-year Treasury is up 4bp and at 2.46% is now eyeing another test at the 2.50% mark, where it failed to push through in December.
Importantly, we can even see US inflation expectations moving above 2% for the first time since October, having moved progressively higher from 1.84% in November. This sell-off occurring in bond markets requires close attention, especially with inflation expectations building. We can also see the market getting excited about March rate hike from the Fed, with the fed fund future now pricing in a 75% chance of this occurring. So, if it weren’t for the fact that data from other parts of the world have also been inspiring then I would be covering short USD positions and reducing commodity exposure as a short-term trade. That may well still occur in the session ahead as commodities are stretched, so, one to watch.

We can still see US equity markets rallying despite selling in fixed income and much of this has been centred in tech, where the NASDAQ 100 is flying. Interestingly, volumes have been strong for this time of year and whether you look at the NASDAQ, Dow or S&P 500 they are in-line with the 100-day average (for this time of day). We can also see decent gains in energy (+the sector is currently up 1.8%) and materials (+1.4%) and this may spill over into Asia, with BHP’s ADR sitting up 2% and indicative that the stock trades north of $30 for the first time since May 2015. Keep an eye on price here, as a pop into the $30.25/50 area makes the stock clearly overbought and we may be an opportunity to fade the move for a quick mean reverting trade. Gold stocks will also require close attention as a few have run hard of late and one questions if these names can close at their highs, or whether some profit taking kicks in later in the day.
NST (Northern Star) is one gold stock that’s on the radar, with price closing at an all-time high yesterday and trending beautifully.
Aussie SPI futures are currently up four points, so with BHP expected to fire up and Vale’s US-listing up 4% (will FMG be a $5 stock today?) there will be disappointment from certain areas of the market and one suspects financials could hold us back a touch. That said, US crude is a touch lower on the session, so I would expect ASX energy names to not react in the same vein as S&P 500 energy names and could see far more sanguine moves. It promises to be an interesting day, while AUD/USD also requires close attention, and again price is trending beautifully and as mentioned yesterday, as long as the price can hold above the 5-day moving average (EMA) on a daily closing basis then its onwards and upwards. However, with the US data/event risk in play the prospect of a short-term reversal is naturally elevated.
Originally published by Chris Weston, Chief Market Strategist, IG