An Action-Packed Week Ahead With Plenty Of Downside Risk
Pepperstone | Mar 04, 2019 13:59
It’s an action-packed week ahead of us, and while the event risk is plentiful, if I look at my one-week implied volatility (vol) matrix, aside from pound, I can see limited expected moves. Is this misplaced or are we right to be so calm?
More colour on US-China trade /h2
Well, we’ve certainly started on a positive note with S&P 500 and crude futures gaining around +0.4% and 0.6% respectively. Early in the session, a WSJ article speculated that a trade deal will involve the US removing most tariffs against China and that China would open up its auto sector, reducing tariffs on imported vehicles. This should help the German DAX to perform well, which as we can see already looks bullish. This narrative seems above expectations, and it feels like talks should build to a crescendo for the Xi/Trump showdown on 27 March.
A big week ahead for the Australian dollar /h2
The implied move over the week in AUD/USD is 78-points, which seems quite low, given we have an RBA meeting tomorrow, Q4 GDP (Wednesday), and retail sales (Thursday). Throw in China’s February trade data, a highly anticipated ECB meeting, the (February) US services ISM and, of course, the non-farm payrolls and the implied move looks even more questionable. This low vol environment is not new though, and I have for one, been writing about it for a while now and how the major central banks have moved in alignment, while day-after-day we get drip fed news of ‘progress’ in the US-China talks.
Many also question the economic schedule, with Aussie Q4 GDP released the day after the RBA meeting. The fact vols are low here suggests the market sees the RBA meeting as a non-event and the narrative should remain unchanged from the prior meeting. That said, the Q4 GDP print does pose a threat to AUD exposures, as the consensus of 0.5% QoQ (or 2.7%YoY) holds downside risk, specifically, after last week’s awful construction numbers.
I continue to watch the S&P 500 and specifically moves into 2817, especially on the weekly timeframe. A closing break here, and we can start having a conversation about new all-time highs, although there is some wood to chop and on the weekly timeframe, we can see signs of indecision. So, should price roll over from here and funds should start to de-risk as a consequence.
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Should supply kick in into 2817 and we see a key momentum shift then naturally implied vol will rise and carry trades will be unwound, and that generally means buying yen.
h2 China on fire/h2It not just US equity markets that we focus on and China is on fire, also helped by MSCI’s recent announcement to increase China’s equity representation within the MSCI indices, with talk passive funds will need to buy some $80b of Chinese stocks when the benchmarks re-weight. We can also look at the fact few domestic players want to be short Chinese stocks into the two-week National People’s Congress, which starts tomorrow, and it’s hard to think the market will hear any bad news from this forum.
The S&P/ASX 200 is another market at an interesting juncture, with all trend indicators suggesting more juice could be in the tank for the bulls. That said, as I write the index sits at 6223 and despite a move to 6240 in early trade, and above huge horizontal resistance, the bulls have just failed to gain the impetus to hold this level. A session close through here would open up a move into 6300/50, and again, this would be largely spurred by the S&P 500 and how it acts around 2817.
Aside from comments that progress has been made in US-China talks, the FX markets have been focused on the latest Trump tweet. That being that the USD is too strong and as a result, prohibits business with other nations through their loss of purchasing power. While these comments are not necessarily new, but they have been the key factor behind USD weakness thus far, although the moves aren’t particularly pronounced and USD/CNH is lower by just 0.2% and eyeing 6.7000. Be careful what you wish for Mr Trump because a decent decline in the USD would, by its very nature become inflationary and equities would not like that, although this largely depends on the reasoning for the fall.
One would also see headwinds for the US consumer as a result of a strong decline in the USD, who would see additional costs to imported goods, which invariably lead to higher interest rates.
I am not sure which USD read Mr Trump would look at, but if I look at the Federal Reserves trade-weighted USD, we can see this metric sits near multi-year highs. Compare this to the USD index, and we can see this some way off the 2001 highs. Of course, we all want a weaker currency, but we can’t engineer a stronger economy, especially when there is so much fragility elsewhere, and not expect a stronger currency as a consequence.
(White - Fed's trade-weighted USD, yellow - US Dollar Index)
With the US economy in mind, and after Fridays’ below par (February) ISM manufacturing read, and personal spending report (-0.5%), it does throw additional consideration to this week’s services ISM and the (February) US payrolls report. Equities are rallying as they believe the move from key central banks to ease financial conditions is front running better economics ahead that will promote better earnings growth. That’s a big ‘if’, but moves in financial conditions indices do have a pedigree of influencing economics. One to watch, because there was a strong sell-off in global fixed income markets last week, notably in the German bund, where on the week the 10-year bund moved from 9 to 18 basis points. What’s more, US 10-year Treasury completely overlooked the poor ISM manufacturing and moved up 4bp to 2.76% - all eyes on the 18 January high of 2.79%.
Another interesting dynamic is that of gold. Whether we are looking at gold priced in USD, AUD or euro terms the uptrend that commenced mid-2018 has broken, and we have to be cautious in the short-term. The pool of negative yielding debt contracted by 4.2% on Friday to $8.43t, which is the largest one-day move since 4 October. Marry this with the move higher in both nominal and ‘real’ yield, and it was a red flag for the yellow metal. With volatility so low and sellers seen in the global bond markets, the attractiveness to hold gold in the portfolio is declining. Now, this could change, but it requires economics to fail to respond to the moves from central banks and the lead from financial conditions.
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