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ASX 200 up again on promising bank bid

The S&P/ASX 200 (AUS200) is having another run higher today, with bank stocks flying. A strong session on Wall Street set the tone for another solid risk run here in Australia.

We had keen interest from clients in the AUS200 yesterday, many noticing an approach towards the 50% Fib level of the Feb-March selloff at the 5800 handle. While price couldn’t make it this high in yesterday’s session (5780 was the session high), we are seeing price easily through 5800 today.

While the 50% Fib level is often talked about, the 38.2 and 61.8 retracement levels are much more important (Fibonacci’s Golden Ratio). So we watch for a test of 6125 and from here the 200-day MA (red line) at 6350, but with pullbacks minimal it feels like the path of least resistance is higher.

It’s noteworthy that bank stocks are flying today, with a shift from aggressive growth stocks into value. Banks reflect the real economy, and these stocks have been unappealing due to repayment holidays and low yields at the long end of the curve squeezing bank’s lending margins. A bid higher in bank stocks reflects a broader bid on a strong recovery. If we were to see the yield curve steepen, these bank stocks could really go for it.

The fact we are seeing a strong rotation out of growth and into value is what the index bulls really want to see. When one sector gets too hot, the market flips into a sector that has lagged. Cyclicals brought us out from the lows, value is taking over, but is it sustainable?

The sentiment follows signals from Wall Street overnight, where the small-cap Russell 2000 (US2000) gained nicely while the aggressive tech index NAS100 moved lower. The move in small-caps is a robust sign that this rally has legs, rather than the tech-led rally we had seen so far in this recovery.

Traders continue to look through poor data prints and shake off geopolitical risk, instead betting on a strong recovery as economies come out of lockdown.

Sean MacLean

Research Strategist

EURMXN: Why the carry trade is back

As implied FX volatility (vol) falls and risk sentiment improves a touch, traders are seeking payment to be in a position, with the carry trade staging a strong comeback. My personal preferred carry vehicle right now is EURMXN, given the high swap received for being short this pair.

The EURMXN daily chart shows a gentle grind lower over the last week as the MXN has appreciated against the euro, a move that will be further exaggerated if the carry trade gains popularity. The pair is trading at a lower level not seen since mid-March, just before the pandemic sell-off.

The MXN is strengthening here not because markets like domestic economics in Mexico, but because the MXN is a high-yielding currency and traders are seeking profit from interest-rate discrepancies through the carry trade.

Emerging market (EM) currencies are extremely sensitive to global risk appetite, and we’re closely watching the US-China relationship, but markets are comfortable with MXN appreciation here while global risk appetite improves. But if risk appetite rolls over, so too will high-beta currencies like the MXN.

A solid gage for risk appetite is the S&P 500. If this world-favourite index can break the 3000 level, we should see a boost to risk sentiment. If price can’t break above and pushes lower, that will tell us global risk appetite is rolling over and we’d expect EM currencies to decline too. Also note that equity volatility remains fairly high, so a big move here would lift FX volatility.

The carry trade

The carry trade appeals when implied volatility is low as traders are paid a swap rate to be in a position, and can profit off interest rate differentials even if the exchange rate barely changes. Of course, the trade will run at a loss if the exchange rate moves against your position. Swaps are paid/charged daily Monday-Friday on rollover at 12am server time.

To be paid in a position, traders go long a high-yielding currency such as the Mexican Peso (MXN), currently with a 5.5% interest rate, while funding the trade with a low-yielding currency such as the EUR or GBP.

Generally, the higher the interest rate differential, the greater the swap rate. You can find swap rates on MT4 or MT5 in the Market Watch section by right-clicking the symbol and hitting specifications. In cTrader, search the symbol’s name and and click the information icon.

Central banks have suppressed implied FX volatility through global coordinated expansion and near zero-rates. While many are tapering QE programs, most remain open to further expansionary measures, including negative rates.

Sean MacLean

Research Strategist

S&P 500: Awaiting the break

US equities are powering on as economies start to re-open, despite an uncertain economic outlook and simmering geopolitical tensions. Last week the S&P 500 (US500) consolidated between 2940 and 2975, just shy of the 3000 level. Where the index is headed is anyone’s guess but if it breaks higher, we’ll all know about it.

As price moved sideways and consolidated not far below the 3000 level, last week’s daily candles were capped by the 100-day MA (red line). The 200-day MA (black) sits today at the 3004 level. This puts quite a cap on the 3000 handle, where a successful break above on a daily closing basis, will be a powerful sign the index is confident to resume its bullish trend.

The US500 settled above the 61.8% Fib retracement level (2932.5) last week, which had been a strong resistance level. Watch to see if the market can turn this level into support or if it falls below, just as it did late April and early May.

We can better understand these failed breaks above the 61.8% Fib level on the 4-hour chart. Price has held better this time but has been unable to move any higher than the April break. If the 3000 level is too high a barrier in the short-term, price could retreat yet again towards that 2785 level.

US stocks are performing better as economies, particularly within the US, begin to re-open, with improvements in the oil market also helping. But US-China tensions are an increasing market risk. US Secretary of State Mike Pompeo called Beijing’s new national security laws, which would tighten its grip on Hong Kong, a “death knell” on the financial hub’s freedoms. Pompeo said the US would reconsider its free-trade agreement with Hong Kong if Beijing pursues the proposed laws. Not only would this hurt Hong Kong, but also the 1300 or so US companies that do business there.

On Friday, the US500 and the Australian dollar closed in different directions for the first time this month (US500 higher, AUD lower). The US500 managed to shake off uncertainty around US-China tensions, but the AUD fell alongside the off-shore Chinese yuan (CNH).

Volumes will be lighter in the US session today, due to the Memorial Day public holiday.

Either way, price is consolidating - a break either side will be very telling so put this index on the radar.

Sean MacLean

Research Strategist

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