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Volatility Begets Volatility

Published 31/05/2018, 11:07 am
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Originally published by IG Markets

Volatility begets more volatility. Just as dramatic as the breakdown for US indices was on Tuesday, the subsequent recovery rally was enjoyed its own remarkable pace.

Wall Street readily revives its bid-the-dip mentality as global risk ebbs: Volatility begets more volatility. Just as dramatic as the breakdown for US indices was on Tuesday, the subsequent recovery rally was enjoyed its own remarkable pace. The S&P 500 led the charge with a gap higher on the open that essentially wiped out the 2,700/2,705 breakdown the bears had fought so hard to earn at the start of the active trading week. The subsequent run put the market on pace for its best single-day advance in three weeks. The question is whether pace is indicative of conviction? There clearly wasn’t a persistent intent with Tuesday’s tumble, so applying different logic to a different day would be unrealistic. Conviction arises from fundamental motivation. The spark for risk appetite this past session was not isolated to the US, so it is unlikely the source was local data like the better-than-expected showing from the April trade figures. The global retreat was prompted by Italian political concerns to start the week, so encouraging headlines suggesting the economy minister designate remove his name from contention suggested a swing back towards stability. Absolution from a growing crisis is not the same thing as motivation for more risk taking however. This market is far more cognizant of its flaws, so traders should be wary about how optimistic they are willing to be on markets.

What happened to trade risk? While markets have yet to see how the trade debate between China and the US or the US and Mexico and Canada play out, investors seem little concerned. Overnight, investors saw much of Tuesday’s wash-out recovered despite Donald Trump adding additional tariffs on China. While the Italian story has taken the headlines, it may be that only China is pricing in the additional risk from the new tariffs. When looking at Chinese shares traded in Hong-Kong, the segment traded to their lowest levels of the year. Additionally, the MSCI Asia Pacific Index dropped below its 200-day moving for the first time in years. In other words, it may not be that the market does not care about trade risk, but rather it is presently distracted by the acute risk at the moment in Italian politics.

Euro strongest daily rally in over two months: The euro posted a strong bounce through Tuesday. A more significant rise for air was inevitable given how badly the world’s second most liquid currency has been pummeled these past few months. The motivation was clear: the headlines surrounding a ray of light through the storm clouds of an Italian political situation that could lead down the track for a Eurozone crisis of confidence. The 5-Star Movement’s leader called on the economy minister candidate put forward by the coalition and rejected by the President. This signals a willingness for flexibility rather than drive towards yet another election and perhaps even a more moderate key concerns of EU and euro participation. This topic will continue to trigger dramatic response with any flare-ups moving forward, but in the absence of new news, perhaps another theme will direct the world’s second most liquid currency. On tap, we have both the Eurozone consumer inflation (CPI) and unemployment updates. These are the key economic ingredients behind the ECB’s policy bearings. With recent central banker rhetoric suggesting the next meeting may address the close of QE and progress of normalization, this data will be digested hungrily by the markets.

Bank of Canada surprises markets with a hawkish bias…and Loonie rally: Monetary policy and monetary policy expectations have taken a notable slide across the major central banks these past few months. From the RBNZ warning that it could just as readily cut rates as hike to the BoJ’s scrapping the time frame for meeting its inflation goal to the slide in Fed Funds futures, there has been a notable dovish shift in the spectrum. It is this context which makes the Bank of Canada’s update on policy this past session even more remarkable. Heading into the event, the bias for this particular central bank was for the repetition of caution on the foundation of trade concerns which could readily exacerbate uneven economic performance. Instead, the ‘cautious’ language was removed and the outlook was raised. The probability of a rate hike in July readily jumped in swaps markets and the Canadian responded in kind. A hawkish lean is a particularly unique position to be in at this point in the global financial system. But does it draw enough contrast to support a lasting run for the Loonie? Reminders of just how unique the BoC’s stance is could keep it marking pace and the diminished outlook for its peers could supply exactly that. Keep an eye on Fed forecasts heading into Thursday’s PCE deflator (Fed favorite inflation read) and Friday NFPs. Meanwhile, back in Canada, the March GDP reading is due and it will round out our assessment of the first quarter.

Australian dollar rally keeps pace with euro, kiwi the day’s best showing: On a day where the euro charged higher across the board, it may surprise that it was not the best performing major. The New Zealand dollar was the day’s top bull, but it certainly wasn’t the RBNZ’s transparent confidence for the country’s financial health or the slide in building permits that earned the Kiwi its climb. It looks much more a sentiment oriented move whereby the swing in risk appetite sought out excessively deflated risk/carry currencies. That same wind would carry the Australian dollar to a wide advance. It was a performance that fell short of the NZ dollar and approximately even to the euro, but moves like those for AUD/USD and AUD/JPY signaled the appetite.

Crude posts a tentative rebound as OPEC walks back output increase: Coming upon an important technical support – the $66 per barrel area that represents the confluence of trendline support and approximately the 100-day moving average – the US-standard WTI oil made an admirable effort to carve out lows through the opening two days this week. On Wednesday, it started its bid at an actual recovery. There was news on hand to help carry the commodity’s best daily move since April 18. Having initially contributed to the decline over the past week, OPEC decided to walk back suggestions that it was considering a ramp up in its collective production to offset the slide in output from Iran and Venezuela.

Australian shares are set to rebound after Wednesday risk-aversion: While AU stocks traded lower alongside regional equities on Wednesday, futures show a strong open is in store with a move back toward 6,030. Futures do still point to pain for Chinese shares however as the CSI 300 looks set to trade lower by ~2.5% as trade concerns unique to China mount in the latest round of Trump’s tariffs. Wednesday saw four stocks in the S&P/ASX 200 hit a 52-week low while the index as a whole fell below the 6,000 mark. The index has traded above the 6,000 mark for the majority of May with a monthly high of 6146.8 on May 14. Overnight trade has BHP (AX:BHP) and Rio Tinto (LON:RIO) set to trade higher on the open by 2.8% and 2.0% respectively.

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