Behind the scenes the VIX (or volatility index) index is trading at 12.6% and testing low levels thematic of complacency, so it’s worth taking a look at a number of the key questions traders are asking right now.
Will future action from the Federal Reserve cause a ‘super taper tantrum?’
This has been highlighted by the IMF and the notion subsequently rejected by Federal Reserve president Dennis Lockhart that when the Fed target a higher funds rate we will see a re-run of the moves in the bond in May 2013. Clearly this isn’t an issue that is a huge concern right now, but it could well be if the US data starts to turn in the coming weeks.
The ‘taper tantrum’ was in reference to the huge moves seen the in mid-2013, where the market expressed concern that the US economy would not handle an end of QE. In turn, we saw the US ten-year treasury move from 1.61% to 3% in 87 sessions.
Many focus on the fed ‘dot plot’, which effectively highlights where the US central bank presidents are forecasting the funds rate for a future date. Traders will always focus on misalignments in markets, so the fact fed fund future (December 2015 contract) is priced some 29 basis points below the Fed’s median projection could be a key risk. I sit closer to Mr Lockhart’s point of view, but the Fed will need to be strong in the art of communication if (and it's a big ‘if’) US data potentially turns more positive. They will continue to be volatility managers.
- Is the USD likely to correct some more?
The US dollar index has fallen 1.7% this week, as a number of US data points have been softer than forecast. If we blend this out and look at the Citigroup economic surprise index (which measures the actual data point relative to consensus) we can see the index fell from 40 to -73 (a four year low) this year and is currently sitting a touch higher at -56. This index has had a poor correlation with the USD over the past 12 months or so but seems to be getting more attention.
The fact that the US ten-year treasury commands a 180 basis point premium over German bunds is keeping EUR/USD from moving materially higher. German 10-year bunds are now at eight basis points and likely to go negative soon, with the US treasury now able to borrow for two years at the same rate as investors would lend to the German government for two! In the short-term
EUR/USD could squeeze somewhat higher, but as long as this spread is in play and the ECB maintain a strong view to buy asset through to September 2016, then rallies should be capped at $1.09.
US CPI ex food and energy is released at 22:30 AEST and a number above 1.7% could put a better bid in the USD. University of Michigan inflation expectation and the March leading index are also in play.
- Is Greece a genuine concern for the broader markets?
Outside of Greek assets (notably three-year bonds) it seems there is little stress in other markets, largely as function of ECB action. Still, I expect that to change if we don't get clearer signs of resolution soon. The Greek government have a mandate to stay in the EMU and they simply can’t leave. However a view from certain parts of the market is to distance themselves from the rest of Europe and to actually be forced out.
Markets still believe Greece will stay within the union in some form, but the risks are growing and a full ‘Grexit’ won’t be pleasant. The market is not prepared at all for this.
- Can Chinese markets keep moving higher?
After yesterday’s bullish outside day reversal (i.e. price trading below Wednesdays low and closing firmly above the high) we have seen follow through buying with good gains in the mainland market. Statistics showing a further 1.68 million new A-share accounts were created last week have helped boost markets, not to mention the levels of cash in Chinese bank accounts, speculated at around $20 billion! These markets are going higher it seems and could it be the case that growth will actually be supported by real wealth effect?
Again another case of markets potentially driving economics.
Certainly many are questioning just how much further markets can go without economics playing a more important role. In the short-term, however, I am not sure economics matter too much given we should see further easing measures from the PBoC.
- Will the RBA cut in May and can the ASX break 6,000?
Markets are pricing a 61% chance of May cut, while the economists community are sticking by their guns with a view of easing. Next week’s Q1 CPI is expected to see 1.2% headline inflation (range 1.6% to 1%) and 2.2% trimmed mean and this could seal the deal for the Reserve Bank.
The ASX 200 continues to search for direction, but as things stand the March uptrend at 5908 has given way and this seems to have resonated with traders and buyers have simply shied away from trade today. We could see a further move down to the 30 March low of 5828 next week, where a break would suggest looking at short positions with greater interest.
Certainly price action today suggests the bears are getting the upper hand right now.
- Can we see further upside in oil and what will the ramifications be on FX and ultimately central bank policy?
- Will the UK election really be a sterling negative? We are firmly in the eye of the storm and IG’s grey market has a Labour minority government as favourite.
- Can US earnings push the S&P 500 through the February high of 2119 – Earnings from GE will be closely in play