Tensions in Europe are subtracting from sentiment, especially with the Ukraine presidential elections on Sunday and the EU parliament elections underway. On the former issue, there seems a real possibility we see a run-off election presumably in June and who wins will determine Russia’s subsequent response, and it’s this point which seems key for markets. With increasing bloodshed, tensions are rising, so traders will continue to monitor news flow here.
Politics dominating play
The EU parliamentary elections are underway, while the UK local elections are also in focus, although there has been limited selling in sterling despite the UK Independence Party looking like they are polling well. The anti-Europe theme is sweeping across the region and despite indications the Dutch Eurosceptic Freedom party could poll badly, there is still a chance we see the raft of Eurosceptic parties across Europe controlling as much as 25% of the seats. The protest vote is coming to reality and while this has been expected, it is interesting as the current total of seats the sceptic currently control is around 15%, so it seems logical that the higher the polling here the bigger the impact on the EUR and other European assets.
EUR/USD has seen limited action through Asia, and has traded in a 19 basis point today. Looking at the options market for signs of concern; five-day implied options volatility is at a low 4.8%. It’s hard to say if the market has sold EUR’s in anticipation of the elections of late, especially given there is a classic ‘sell the rumour’ event going on ahead of the June 5 ECB meeting. However the real issue for the ECB here is around the exchange rate, despite calls from the Bundesbank that this is not an issue for them. If they don’t deliver what is now being priced in then the ‘buy the fact’ part of that equation will be real.
EUR/USD traders watching for a break of the 200-day moving average
Traders will be watching the 200-day moving average at 1.3638, which acted as support on Wednesday. Importantly, this average is starting to flatten out and while the market is clearly getting excited about clear policy divergence at a central bank level, it is worth highlighting that US inflation expectations have started to increase. A simple look at US five year ‘break-evens’, (a fixed income product that is a good guide to bond market pricing on inflation) is currently suggesting inflation in the US will average 2.01% over the coming five years. This has pushed up from 1.80% in mid-April, with the price looking set to break out from the February downtrend. This is a USD positive and suggests that dips in the USD should present itself as a good buying opportunity.
In Asia today there has been focus on Thailand reasonable selling of Thai equities, but the Thai Baht has held in well and is actually up a touch on the day. Elsewhere, further gains have been seen in Japan and Australia, while the Chinese market is flat at present.
The ASX 200 has pushed up a further 0.3% and is up the same amount for the week. The ‘sell in May’ crowd are eating their words as we enter into the latter stages of the month. The market is up 0.1% for May, so after dropping significantly (by an average of 5.6%) over the last four consecutive May’s, the index is bucking this trend this year. A close above 5500 in the coming days would be taken by the bulls, but it seems that they are in control right now and pullbacks will be bought. Global investors are looking at the current level of real bond yields (i.e. inflation adjusted bond yields), accommodative central bank policy, extremely low levels of volatility and improving global economy, and feeling that equities remain the preferred asset class, despite many developed markets trading on a double-digit premium to the long term average (the ASX 200 is currently trading on a price to earnings premium to the five year average of 10%).
European markets look set to unwind at marginally higher levels, although how they close is a flip of a coin. Politics looks set to dominate the news flow, however at a data level we get German growth numbers, while the IFO survey is expected to see a modest decline in the three sub-surveys.
From a pure currency perspective, Canadian April CPI data is expected to tick up a sizeable 50 basis points to 2%, although the core print should move up a more modest 10 basis points (or 0.1%) to 1.4%. USD/CAD is looking more constructive and having broken the March downtrend could be ready to make a move to the 1.1050 area over the coming weeks.