Trader thoughts - the long and short of it

We have seen a modest pickup in implied volatility, with the US volatility Index (“VIX”) increasing 7% to 11.46%, although this is still far from convincing most likely a reflection of traders reducing what is a near-record net short position in VIX futures.

The positive aspect of the strong selling on Friday in tech, which resulted in a monster increase in NASDAQ futures open interest (the fifth largest since 2000), was that it was driven to a large extent by short sellers, but there has also been a strong rotation into other sectors in the market, such as energy and financials. Looking at price action today in tech, it suggests that the short sellers may not have a huge amount to work with here and that we are not likely to see the 10% decline that many had been talking about on Friday. Buyers are starting to kick back in with the NASDAQ 1.4% off the intra-day lows.

I don’t sit in the camp that we will see a prolonged pullback in tech, but there is a good chance this hot sector now underperforms and I had been suggesting increasing exposure to US financials as a trade. The XLF ETF (US financial sector ETF) has diverged strongly from the US yield curve (two-year treasuries vs ten-year treasuries) of late and we have seen a solid breakout to strongest levels since mid-March, although we have seen an element of indecision creeping in today’s session that requires attention.

This trade will get some increased focus this week with the Federal Reserve meeting this Thursday (4:00am AEST) and the idea that the Fed funds curve is pricing in 37 basis points (bp) of hikes this year and 63.5bp up until the end of 2019. Whether this pricing mechanism proves to be too pessimistic and we actually see the Fed hiking in alignment to their median projection (of 121bp of tightening by end 2018) is obviously yet to be seen, but the FOMC statement and the optimism from Janet Yellen will see traders play the Fed funds futures or eurodollar futures. Specifically look at moves in the January 2018 and January 2019 contracts. Any stronger selling in these contracts could see US banks re-establish a stronger correlation with the interest rare curve and push higher again.

SPI futures have traded both the Friday and Monday night/Sycom session, and sit at 5672 (at the time of writing) and therefore nine points lower. S&P 500 futures are 0.2% lower from 4:10pm AEST on Friday and all things being equal our opening call for the ASX 200 cash market sits at 5669. BHP’s American Depository Receipt (ADR) suggest the miner opens 1.2% lower, while I would expect a fairly flat open for the Aussie banks. Healthcare seems to be the market leader at present, and this has seemingly been a good place to be invested amid some fairly shaky moves in iron ore and crude of late.

Energy had a poor week last week, with the ASX 200 energy sub-sector closing down 4.6% on the week. Comments from the Saudi oil minister Khalid Al-Falih, however, have brought some stability back into the barrel overnight, with rhetoric that inventories are likely to decline in the months ahead. There is a trade in crude on moves into the May lows and we should see traders increasing exposures to energy into these levels, specifically on the idea that OPEC will likely try and jawbone the market and ramp up talk of being able to do more to reduce inventories (such as taking another look at production quotas). Still, we find US crude around 1% higher from where the ASX 200 cash market closed on Friday and that needs to be priced into energy stocks this morning.

In terms of event risks, there are plenty out this week, but few to necessarily trouble today. NAB business confidence is due at 11:30am AEST, but shouldn’t trouble equities in any form and should really only impact the AUD in a very limited way, if at all. AUD/USD seems pretty happy at current levels, having traded in a range of $0.7547 to $0.7527 at the start of the week.