There is a certain calm that has washed across markets in the wake of the French vote and traders are asking what the next event or theme to focus on will be. Perhaps one key talking point on this theme of calm and low volatility is the US ‘VIX’, which closed at 9.77%, the lowest close since December 1993.
The interesting and almost predictable price action we saw overnight was the classic ‘buy the rumour, sell the fact’ scenario playing out in French and EUR-denominated assets more broadly. Importantly, the French/German two-year bond yield spread has remained unchanged at 24 basis points and this spread, which has defined the systemic risk portrayed by a Marine Le Pen win, will now be replaced by the Italian bond spread (over German bunds) as the markets guide for European break-up risk. Although that theme is clearly for another time.
EUR/USD looks vulnerable, having printed a bearish outside day reversal, with price trading above Fridays high and destined to close below the low. A move through Thursday’s low of $1.0875 would be taken badly by all those who bought EUR’s on Thursday and judging by the powerful move higher on that day there would be a lot of traders offside there and a subsequent move to $1.0700 would seem likely. One for the radar, with traders, also eyeing potential outflows from European equity funds, with the CAC 40 down 0.9% overnight, although I think everyone is still lining up to buy the dip.
Perhaps the new event risk which is forming in markets and needs to be on the radar is the 25 May (Organisation of the Petroleum Exporting Countries) OPEC meeting in Vienna and unlike prior OPEC meetings, the market is progressively moving towards this meeting with increased expectations. It is now a consensus view that OPEC extends the output cut agreement through to 2018, but there is now a view being explored by traders that we could see OPEC and the Russians perhaps taking the output cuts into deeper territory. Once again US shale industry is the natural beneficiary of this potential action.
That being said US crude is still struggling to break back above the key the March lows of $47.58 and there is clear indecision in the price action.
The theme that still needs to be explored and may have further to play out are the moves in Chinese markets. Chinese traders have a simple trading philosophy and that is to align their trading directional bias with the objectives of central bank and regulator. It is no surprise then, given the tightening of financial conditions and the move to guide short-term rates higher and make obtaining liquidity more expensive, that we are seeing Chinese equities as the perhaps the market of choice to be short right now. When you think so many other markets are trending higher, the CSI 300 is the worst house in a highly liveable neighbourhood.
So the CSI 300 is firmly on the radar and rallies are to be sold here, as one thing is also true in China, that being Chinese traders love trends and the trend here is lower.
For those who use Exchange Traded Funds (ETF’s) look at the ASHR ETF (Deutsche X-Trackers Harvest CSI 300 ETF), which is in freefall at the moment and closed -1.2% overnight, suggesting further losses in China today.
This is also true of iron ore futures (traded on the Dalian exchange), which despite a strong night on Friday have closed lower in the last night's session by the tune of 0.9%, although modest gains have been seen in steel and coking coal futures. Spot iron ore fell 2.6%, but of course, spot price is calculated by a weighted average of the day’s sales, rather than on an exchange. Either way, iron ore futures are at a key juncture and that battle could be resolved today, with the playbook being increased bearish exposure through RMB456 and long exposures through RMB493 and again through RMB537.
Elsewhere in Asia, we see the ASX 200 opening at 5883, with SPI futures largely unchanged. This follows on from a flat lead from Wall Street, with the S&P 500 still eyeing a convincing push through 2400. Tech and energy have outperformed, with materials sector -0.9%. If we look at BHP’s American Depository Receipt (ADR), which closed up five cents, it seems that stronger correlation with crude still holds true. Vale has closed -0.5% lower in its US-listing, suggesting a touch of weakness for the pure plays.
Keep an eye on the Nikkei 225 as well, with USD/JPY pulling above ¥113 and looking like it wants to head into ¥114 - ¥115 in the near-term. The Nikkei 225 actually looks perhaps the most bullish developed market and after having broken out of the March highs is trading at the highest levels since late 2015. If China is the weakest link, Japan is the most bullish. Stay long Japan.
In terms of event risk, it all seems quite light today although some focus will be on the Federal Budget, with consensus expecting a deficit of $28 billion. AUD/USD is the play today, especially with such a focus on all things China again. I am highly sceptical the budget is a big driver of volatility and the details within the budget are likely to hold few surprises to traders.
