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The first thing that comes to mind is the elevated levels of volatility, with the VIX index averaging 18.84% so far this year, while the implied volatility in the bond market is at its highest levels since October. To put this in perspective, the VIX index averaged 14.17% for 2014. However, elevated volatility is hardly a surprise given the evolving macro forces in play.
Friday’s US payrolls report won’t alter anyone’s perceptions around when the Federal Reserve lift the funds rate. That’s because for all the obsessing about the exact month this will occur, no one really knows. When month-on-month wages are falling it is a concern, but recall in the prior month, wages grew 0.4%. Therefore, the January wage data will be hugely important, as will the US Employment Cost Index (ECI) on 31 January. It is also worth highlighting that the US ten-year treasury fell 17 basis points last week, in what has been the best start to the US bond market since 1998. Once again, consensus is that US bonds will see fairly aggressive selling; beware the consensus trade.
The truth is, the global economy has been provided a massive fiscal stimulus with crude prices having fallen heavily and borrowing costs at or near record lows. Perhaps it will once again be a second half story, but there seems little reason for the Fed to raise rates anytime soon. Of course, everything is data dependant and as the year goes on, the market will understand that the actual date of ‘lift off’ doesn’t really matter, as it will be so well flagged by then. It is the pace of the moves that will be seen as the determining influence for the bond market, carry trades and emerging market performance.
Asia starting the week on a sour note
Asia has seen some modest selling of risk assets today, although Japan is offline today for Coming of Age Day which is just as well, as the index would be down 2% or so. The China CSI 300 is down 1.2% and when you hear that investor confidence has hit a record level (gaining 28.1% on the year) the contrarians in the market could make a case for a short-term top in the Chinese market. The price action in the Chinese market is suggestive of a pullback, but with the People’s Bank of China providing active liquidity, injections dips should be mild.
The ASX 200 has seen little interest from the bulls today and has failed to follow through on Friday’s bullish move. The financial sector is at a critical level and is not far from testing levels which in September, November and December coincided with pullbacks of 9.44%, 5.2% and 3% respectively. If the ASX 200 is to clear supply at 5500 and onto the October highs of 5550, the banks need to be the backbone here.
Energy names have been sold with gusto again, with traders selling Brent futures on open today. It’s interesting that we saw the biggest drop in US oil rigs since February 1991. Clearly, however, there is some way to go before the market feels we have reached that perfect equilibrium where OPEC and the US shale producers can co-exist. It feels like we are close to a bottom in oil, but the techincals are not suggestive of this being the case just yet.
European politics looming large
Another key issue which has come into the markets thought process - and will certainly be much more prominent this year – is European political risk. Investment banks will be turning to their political analysts for guidance, while everyone else will try and interpret as best they can how markets will trade up, during and after the raft of general elections scheduled for this year. Greece is the first hurdle and my best guess is we will probably see a second election (similar to 2012) with both Syriza and New Democracy failing to form a coalition after the January 25 election. I don’t see a Greek exit.
The UK election on 7 May is also again anyone’s guess and this is reflected in the fragility in sterling at present. It’s also worth flagging that Spain have a general election in November and in a weekend poll in El Pais, left winged party Podemos (which holds a similar stance to Syriza) has shown a lead for the first time in its brief existence. This could have sizeable ramifications this year.
After Friday’s big moves in European market, we are staring at a mixed start. Technically, the likes of the CAC and DAX are consolidating and we need to see confirmation of a break-out in either direction to form a directional bias. It is becoming fairly clear though that the risks of disappointment from the European Central Bank on 22 January are increasing by the day and while Mario Draghi is about as skilful a market tactician as any central banker, he has led the market into pricing in aggressive easing into assets and seems unlikely to meet them. As usual, the bond market is the leading light.