Chris Weston, Chief Market Strategist at IG Markets
Traders seem to be rejoicing at the mere certainty provided by the Federal Reserve, although I would temper that by saying we have potentially entered a new realm of increased uncertainty.
As detailed earlier in the week, traders have wanted to buy the market but needed a reason not to. And buy they have – with 71% and 75% of all open positions on the ASX 200 and FTSE 100 respectively held on the long side. I have been tactically bullish for a few days, but would be taking part profits and moving stops higher on the remainder.
To be clear, Janet Yellen has delivered, despite the Federal Reserve’s communication channels effectively dysfunctional (given the consistent barrage of conflicting views from both core and regional Fed speakers). If you had suggested months ago that the S&P 500 would rally 0.7% and the VIX would fall 14% on the day of ‘lift-off’, many would have disagreed. Throw in a six basis points (bp) narrowing in BB rated spreads relative to US treasury (five-year) yields, a rally in high yield ETF’s (HYG and JNK), and a very slight flattening of the US yield curve (2’s vs 10’s – see Bloomberg chart) they’d be very happy indeed.
What’s more, there were no dissenters within the Fed’s ranks and I think this is quite important. Raising the funds rate was unanimous and despite most of the commentary being considered ‘dovish’ at the margin, this united view almost makes this meeting neutral. This is certainly supportive of USD flows and it’s interesting that the USD has gained against all G10 and APAC currencies, except the IDR, TWD and PHP. The elevated risk of a ‘buy the rumour, sell the fact scenario’ playing out on the USD hasn’t happened…yet.
Watch the USD in tonight’s session.
Blend these variables all together and the strong improvement in Bloomberg US financial conditions index is there for all to see. This index effectively blends all of these inputs.
The fact is, the market would have found inspiration that there is no pre-set path for future rate hikes and the word ‘gradual’ was used liberally. The board’s projections for the Fed funds rate was unchanged if one is to look at these from a median standpoint. However, using the mean path, we can see projections actually fell 21bp in 2016 (to 1.26%), 33bp in 2017 and 16bp in 2018.
Since the Fed’s GDP forecast has increased 10bp to 2.4% for 2016, while staying unchanged in 2017 at 2.2% and 2% in 2018, we can make the argument that for every unit the Fed funds rate rises, the US economy is achieving a higher rate of growth. In other words, the economy is working harder for less.
If we look at the Fed fund future curve, there is a subtle shift higher, but nothing too aggressive with the December 2016 contract increasing 5bp to 83bp.
The reaction in Asia has been thoroughly convincing with the ASX 200 smashing through the 5100 level. Even the energy sector has gained despite oil prices being savaged after US inventory levels rose to 120 million barrels above the five-year seasonal average. Breadth has been excellent with 90% of companies higher on the day and the seasonal effects of buying the market in mid-December are working perfectly. The question is whether this materialising ‘life is perhaps not so bad’ rally continues, making tonight’s US trade very important. In an event like this, the first move might not be the right move.
Elsewhere, we’ve seen a strong move higher in the Nikkei, Hang Seng and CSI 300. There has been no real dramatic move to sell emerging market currencies, although the People’s Bank of China did ‘fix’ the yuan weaker for a ninth day in a row. The moves in CNY still poses a risk to markets and while we have got the Fed hike out of the way with no real concerns, the sharp drop in oil prices and weakening CNY still gives me a belief that we can expect pockets of volatility.
So oil and the Chinese yuan are the two key risks, but I am especially keen to watch US trade tonight. S&P futures have started to find sellers in Asia and this is taking some gloss off of what looks to be a strong European market open. There is still come nervousness around ‘Quadruple Witching’ on Friday, especially with massive open interest in various options strikes, many too close to current prices for the index bull’s comfort. Today’s US trade promises to hold many answers, especially after traders have had a chance to reflect and really assess if the investment case behind the market has changed. Stay nimble.