Having been bullish on global equities and risk more broadly for a while, I am seeing a few red flags that make me feel a little hot under the collar.
The backdrop is still one where the news flow is not causing massive gyrations in markets, but we have seen the VIX index (that is the 30-day S&P 500 implied volatility) push into 14.28%, and no doubt, some of the shorts (in VIX futures) I mentioned yesterday would be keen to reduce holdings here. Higher implied volatility (vols) is an equity negative, and we can see that the S&P 500 cyclical/defensive ratio has fallen for the first time in 11 trading sessions, showing a stronger outperformance from defensive sectors of the market. We have also seen small caps underperform large caps too, with the Russell 2000 falling 1.2% on the session relative to the 0.7% drop in the Dow Jones index.
Dow Transports fell 0.9%, and again, this won’t inspire the bulls. Certainly, this sector rotation, not to mention slight move higher in the VIX index to a more defensive structure, would not have gone unnoticed by JPY traders, who continue to see a sizeable short position in the weekly CFTC data.
A buyers strike takes hold
Again, I have to come back to the notion of order book dynamics. That being, there are few reasons to buy risk, while there have been a number of negative market themes that have compelled money managers to part de-risk portfolios. Concerns of global growth are indeed back in vogue, premised on a new downgrade to global growth to 3.3% (from 3.6%) from the ever-behind-the-curve IMF - its third growth downgrade in six months. Perhaps the big concern here is that the organisation sees downside risks in 2H19, and this will resonate with the bears and accelerate the thematic of slowing growth as the big headwind for markets.
Warnings from Vladimir Putin on regarding oil and EU-US trading relations, also weighed and we had a situation where there were no reasons to buy, and a few to sell.
USD/JPY has been sold by clients today and is testing trend support, ahead of the top of the I-cloud at 110.75. Its all eyes on US CPI (22:30aest) and FOMC minutes (04:00aest) in upcoming trade, although the market feels, on balance, that USD/JPY should move no further than 35-point move on the session - such is overnight implied vol. I do think that there are risks to higher vols here, and specifically if we get a headline CPI print below 1.6% or core below 1.9%, and then the calls for Fed rate cuts will increase, and we may even see some of the braver sell-side banks pencil a rate cut from the Fed over the coming 12-months.
The FOMC minutes will explore the more dovish-than-expected March FOMC meeting, where the bank went above and beyond market expectations. The FX strategists will be pouring through the narrative to understand the dynamics around the future composition and size of the Fed’s balance sheet. However, I question if there will be a more in-depth discussion, notably from the doves (within the Fed), about potential triggers required to be in play to ease rates to boost inflation. There seems little doubt that any discussion around triggers to ease will get the lions share of the headlines.
EUR/USD remains trapped in the wedge pattern, which I have portrayed on the weekly timeframe. This needs to resolve and play out, but once the pattern completes it should be respected, as it could be quite powerful. Let’s see if tonight’s (21:45aest) ECB meet proves to be a driver of volatility, because at this juncture the market forecasts a move no greater than 57-points in EUR/USD on the session, and traders understand that Mario Draghi is the man when it comes to promoting a weaker currency and volatility suppression.
That said, the ECB threw almost everything at the March meeting and given that European economics haven’t shifted too greatly with European 5-year inflation expectations about ten basis points lower than where they sat at the March meeting, it’s hard to see too much of a shift from the previous meet. However, at 1.35%, EU inflation expectations must be a huge concern for the ECB, who like all DM central banks want to be in a position to hike rates. But how on earth can you hike when inflation expectations are trending lower?
The fact German 10-year bunds trade at -1bp tells a woeful story in itself. Where it has been widely debated from economists that Europe is looking dangerously similar to that of Japan. That being, it may be many years before the ECB is even remotely in a position to tighten policy and that will no doubt be explored in the ECB statement, with a discussion on the long-term outlook.
AUD/USD fails to react to consumer confidence but likes the sentiment from Debelle
We looked at traders fading AUD/USD into 0.7150 yesterday, and that played out well, with the high mid-point of 0.7152 at 23:00 aest. We saw a 1.9% pop in the April Westpac consumer confidence report, however, it has failed to inspire, with AUD/USD falling to session lows of 0.7110. RBA member Guy Debelle spoke after lunch and promoted a 20-point spike in price, with views that forward indicators suggest the Aussie employment market will remain solid, and thus, if the labour market is key in pushing the RBA to ease, then, perhaps the 28bp of cuts priced into the Aussie swaps curve is a tad rich.
GBP/USD remains unchanged on the session at 1.3056, with GBP/AUD still very much on the radar, with focus on the European Council meeting tonight, starting around 1 am aest, with a working lunch expected to start an hour later. Theresa May will state her case on where we are with cross-party talks with the Labour party and the other avenues that may eventuate, and from here a press conference will grip GBP traders post lunch, with the market expecting to hear on the duration of the next extension. The 200-day MA in GBP/USD has been the buy trigger point of late, and there is a natural support zone here as no deal Brexit is such a low probability in the eyes of the market. That said, the series of lower highs suggests traders cannot be long in any decent size.