A week that potentially builds the foundations for higher volatility and range expansion in the weeks ahead.
We are certainly seeing higher implied volatility in G10 FX markets, with the JP Morgan Global FX Volatility Index breaking a longer-term downtrend. However, implied volatility in the S&P 500 (as measured by the “VIX”) remains focused anchored to 11%. The buzzword last week being ‘protectionism’ and that still has legs to play out, with a focus on Trump’s State of the Union speech on Tuesday, where US press are suggesting the speech will be optimistic and uplifting.
Traders will be focused on any finer details around the proposed infrastructure bill. There has been a noticeable pick-up in not just central bankers directly or indirectly targeting their exchange rate, but political leaders too. This is true in the US, where US Secretary Steven Mnuchin and Donald Trump have tried to convince the market they misinterpreted Mr. Mnuchin’s weak USD being good for the US economy quote.
We have also seen Commerce Secretary Wilbur Ross mudding the waters even further, detailing in Davos that “what was perfectly appropriate in 1945 is singularly inappropriate as we sit here this year. There’s no longer a need to subsidise China, or Japan, or Europe with our money.” One see’s these comments as a slight USD negative.
The USD is naturally at the heart of any markets conversation and rightly so when speculators and other leveraged funds continue to increase USD short exposures. This was true last week, where speculative net USD positioning increased to $13 billion (from $10.3 billion), and longs held on the EUR and the GBP continue to move to what could be considered as extremes. Backtracking and reviewing the data flow on Friday, and by and large US data was supportive of USD flows and modest short-covering, with Q4 GDP printing at below-consensus 2.6% (versus 3% consensus). However, personal consumption grew 3.8%, non-residential investment increased at 6.8% and equipment investment grew at an 11.4% clip, so the market saw the miss to growth as one of still good quality. The 2.6% growth rate in Q4 then subsequently taking the full-year growth rate to 2.5%, which is the strongest pace of growth since 2014.
Aside from the GDP print, we also saw December durable goods orders printing the best pace of growth in six months, at a 2.9% pace. However, this goods data point was partially offset by a below-par December inventories report (+0.2%) and a slightly wider good trade deficit at $71.6 billion. The wash-up of these moves can be seen prominently in the US bond market where we saw decent selling across the curve, notably in the five-year maturity bucket, with the US five-year Treasury closing up 5bp at 2.47%. The US 10-year Treasury closed at 2.66% and the highest since January 2017, although this is part of a broad sell-off in global fixed income, where UK 10-year gilts sit at 1.44% (the highest also since January 2017), and German bunds closing at 0.63% (December 2015). US 5-year inflation expectations are largely unchanged at 2.16% (eyeing 5y5y ‘breakevens’), while US interest rate futures price a hike from the Fed in the March meeting as a done deal and an 86% probability, while fed fund futures pricing in 66bp of Fed tightening this year.
The USD index trades heavy, although the daily chart of the USD index highlights buyers into 88.50, with EUR/USD finding supply easier to come by into $1.2500. AUD/USD is the pillar of strength, closing above 81c and seeing little in the technical set-up to suggest traders are too concerned that a decent reversal is an elevated risk. It certainly feels as though we should see plenty of FX traffic this week from speculators given the plethora of economic data releases, where in the US we get core PCE (Personal Consumption Expenditure), as well as personal spending and income at 12:30am AEDT. We also have to navigate through the Q4 Employee Cost Index (Thursday at 12:30am AEDT), as well as ISM manufacturing (Friday 2:00am AEDT) and the monthly non-farm payrolls (Saturday at 12:30am AEDT). So a big week ahead, although I would not be surprised if the Chinese take the limelight as a key USD driver and given the recent strength in the RMB if the PBoC choose to take some heat out the currency, then it would also affect the USD, where USD has impacted the trade-weighted RMB most intently.
Therefore, I would advise on watching USD/CNH and USD/CNH closely this week. We also get the small affair of Janet Yellen’s last FOMC meeting as Fed chair, although we will see the fed funds rate unchanged and the statement used to firm expectations for a March hike, which as I say is a done deal in the eyes of the market.
As mentioned the AUD/USD is a pillar of strength, but it’s the Aussie rates market that fascinates the most this week. If we look at Australia 30-day bank bill futures we can see a five basis points priced in for the May meeting and one suspects that with the RBA itching to become more hawkish at the margin, a trimmed mean inflation print (due Wednesday at 11:30am AEDT) could see the market selling the May futures contract, which could boost the implied tightening from 5bp towards say 10-12bp. This would, in theory, would make the May meeting a ‘live’ one, which makes life very interesting given the average Aussie household just isn’t having a discussion about higher mortgage payments at this stage.
Personally, I would be a buyer of Aussie interest rate futures should see the May contract price a closer to 50:50 expectancy, with the market expecting a more optimistic Aussie central bank to emerge should core inflation head toward target. So, Wednesday's CPI data is a big event risk for AUD traders, as will be the moves in USD/CNY (and USD/CNH), where there is a strong inverse relationship between the AUD/USD and USD/CNY.
In equity land, the flows into US markets continues in earnest ahead of what is a big week of US corporate reporting, with 36% of the S&P 500 market cap due to report numbers. All eyes on names like Apple, VISA, Alphabet, Microsoft and Amazon to keep the momentum high in earnings beats, where nearly 80% have beaten on earnings, with revenues up around 7%. Given the strong performance of US equities, amid this backdrop of a sell-down in bonds, there are concerns around month-end rebalancing flows, with estimates of $30-45 billion of outflows expected (source: Morgan Stanley).
One to watch, but the S&P 500 has handed Asia with a super strong lead and a +1.2% gain and while good gains have been seen in tech and healthcare, we can also see financials and energy working.
Aussie SPI futures closed up 30-points at 6015 and subsequently, we have the ASX 200 opening at 6076, with the index looking like it may want to trend higher, although not to the extent we have seen in the China H-Shares and Hang Seng. Whether we can hold 6076 is another question, although the weekend news has been on the light side with some focus on a the Baker-Hughes US rig count, which increased by 11 rigs last week and won’t do any favours to US crude futures on open at 10:00am AEDT.
That said, there is little in the price action and trend to suggest aggressively raising portfolio cash levels, or looking at short exposures with greater conviction. That said, with trade protection a growing debate and the prospect of landmines in the form of key economic data and the potential for a lift in domestic rate hike expectations, there are reasons to expect volatility to pick-up somewhat this week.