Volatility continues as bulls get the upper hand

Asian markets were supported by a strong move higher in S&P futures yesterday, suggesting some of the 1.8% rally in the S&P 500 cash session is already baked in. Since the close of the S&P 500 futures have pushed higher again though.

Volatility
Source: Bloomberg

Our opening call for the ASX 200 is for a 0.6% gain on open, despite S&P futures actually adding an extra 1.0% from the close of the ASX 200 to current levels. The fact the ASX 200 is looking to underperform this offshore lead is probably more to do with a cautious stance around owning domestic banks, as well as the fact that energy and material names can easily fall 2% as well as rise 2% on any given day; such is the volatility at present.

One just has to look at the US volatility index (also known as the ‘VIX’), which although falling 17% overnight (as traders paired back put options hedges), is still elevated at 26%. Interestingly, if we look at the various futures contracts on the VIX index we can see lower levels, with the October contract trading at 23.7% and January 2017 at 22.86%. This is a phenomenon called ‘backwardation’ and suggests that traders see lower levels ahead. A solid US payrolls number on Friday could mean we see implied volatility fall fairly sharply.

One modest positive today is the fact China is offline for its Victory Day commemorations, so traders and investors will be focused on domestic data, valuations and trying to understand how to navigate these crazy markets. Locally we get Australia July trade data, as well as July retail sales and neither are expected to provide any upside catalyst to the AUD despite positioning becoming quite concerning for those already holding short positions. The trade deficit is expected to blow out to A$3.16 billion, which is shy of the A$4.1 billion recorded in April, but after yesterday’s very average Q2 GDP print one questions how we are going to move towards the market’s consensus of 2.5% real growth in Q3. With such weak gross domestic income a reading above 0.4% growth in the retail sales print would be a surprise too.

It’s no surprise, though, that the market is pricing a 21% chance of an October RBA rate cut, although this blows out above 50% for the November meeting. The interesting situation here is whether the domestic banks will actually pass on any move in the cash rate and there is a belief that if the banks don’t move in alignment then we may have to see a further cut in December. Recall the RBA have actually been quite active in December over the years, cutting the cash rate in 2011 and 2012.

Asia-based traders will also have to position themselves for tonight’s European Central Bank (ECB) meeting, as well as having the US services ISM, trade balance and jobless claims to wade through. The ECB meeting (21:45 AEST) is especially interesting as there is no central banker more respected by market participants than Mario Draghi, so traders are expecting a market-friendly response to the volatility. There is clearly a strong chance of dovish rhetoric given inflation expectations are still not where they need to be, although there are some positive signs emerging in the European economy. The market’s view is we will see Mario Draghi detail the flexibility the bank holds to do more, laying out the foundations to increase the current monthly run rate of asset purchases from €60 billion a month, or increasing the duration of the program, pushing the date of closer through to late 2016/early 2017.

Whether goodwill towards the ECB meeting was a factor in the bullish price action in US markets is not 100% clear but, as mentioned, we are staring at a modestly higher open locally. Price action will therefore be key from 10:15, setting the tone for the rest of the day. Yesterday’s strong rejection of the low 5000 levels and subsequent rally into the afternoon has printed a bullish candle on the daily chart but we will need to see a higher high to really encourage more technical buying. WTI oil is nearly 4% higher than yesterday’s ASX close so that may help, while there is further stability in iron ore. BHP is looking likely to open around 0.7% higher – so higher, but lacking any real conviction.

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