Market Volatility Continues To Compress

The US Independence Day holiday kept trading, market activity and volatility subdued for much of last week.  In any case equity markets and risk assets have been struggling on the topside and appear to be losing momentum.  Markets are being buffeted by conflicting forces; economic news has beaten expectations. For example, the US June jobs report was better than expected though total job gains of 7.5 million in recent months are still only around a third of total jobs lost.  In contrast, worsening news on Covid 19 infections, with the WHO reporting a one day record high in global infections, threatens to put a dampener on sentiment.  Consolidation is likely, with Summer trading conditions increasingly creeping in over the weeks ahead. As such volatility is likely to continue to be suppressed, aided by central banks’ liquidity injections.

Over recent weeks geopolitical risks have admittedly not had a major impact on markets but this doesn’t mean that this will remain the case given the plethora of growing risks.  China’s installation of new security legislation into Hong Kong’s basic law and the first arrests utilizing this law were in focus last week.  A US administration official has reportedly said that the president is considering two or three actions against China, and markets will be on the lookout for any such actions this week, which could include further sanctions against individuals are more details of what the removal of HK’s special trading status will entail.  Meanwhile the US has sent two aircraft carriers to the South China Sea reportedly to send a message against China’s military build up in the area, with China’s PLA conducting a five-day drill around the disputed Paracel Islands archipelago.

Data releases and events this week are unlikely to lead to a change in this dynamic.  At the beginning of the week attention will focus on further discussions between the UK and EU over the post Brexit landscape while in the US the June non-manufacturing ISM survey will garner attention.  So far talks on a trade deal between the UK and EU have stalled though there were hints of progress last week, even as officials admitted that “serious divergencies remain”.  The US ISM non-manufacturing survey is likely to move back to expansion (above 50) but is increasingly being threatened by the increase in Covid infections, which could yet again dampen service sector activity. On the policy front there will be fiscal updates from the UK and Canada on Wednesday against the backdrop of ramped up spending, and monetary policy decisions by the Reserve Bank of Australia (RBA) and BNM in Malaysia on Tuesday.  The RBA is widely expected to keep policy unchanged while BNM may cut rates by 25 basis points.

 

Waiting For US Jobs Data

Ahead of the US jobs report later today and following a lack of leads from US markets after the 4th July Independence Day holiday, markets are likely to tread water, at least until the employment report is released.  However, there are plenty of factors lurking in the background including the ongoing US-China trade war, US-Iran geopolitical tensions, and growing trade spat between Korea and Japan.

Markets continue to be supported by expectations of monetary easing globally.  This week, bond markets have continued to rally, helped by President Trump’s nomination of July Shelton and Christopher Waller for the Board of Governors of the Federal Reserve, both of which are considered dovish.  Separately, markets applauded the backing of Christine Lagarde to lead the European Central Bank after weeks of wrangling by European leaders.

Immediate attention will be on the US June jobs data.  Market expectations are for a 160,000 increase in non-farm payrolls, unemployment rate at 3.6% and average earnings growth of 0.3% compared to the previous month, 3.2% compared to the year earlier.  Anything much worse, for example an outcome below 100k would likely lead to an intensification of expectations that the Fed FOMC will cut by as much as 50 basis points later this month.  An outcome around consensus would likely result in a 25bp easing by the Fed FOMC.

Separately trade tensions between Japan and Korea have intensified. Japan is implementing restrictions on exports to Korea of chemicals essential for chip making. Japan is Korea’s fourth largest export market. The new approval process required by Japanese exporters of three semiconductor industry chemicals will hit Korea’s tech industry at a time when it is already suffering.  The trade spat could also have widespread implications given the wide range of products that South Korean chips are used in, impacting supply chains globally.

USD weaker except versus JPY, EUR gains unsustainable

Risk aversion is creeping higher whether due to weaker data and budget concerns in the US, political uncertainty in Europe or tensions in the Korean peninsular. Central banks continue however, to do their utmost to keep monetary conditions sufficiently easy to facilitate recovery.

The Bank of Japan was the latest to do its part under the helm of governor Kuroda, with new measures including a major increase in asset purchases, delivering a positive surprise to markets while pushing the JPY sharply weaker.

Only the ECB appears to lag in terms of central bank activism keeping policy on hold last week despite weak economic conditions are ongoing austerity pain. A series of industrial production releases across the Eurozone including German February IP scheduled for release today will not change the picture materially.

The much weaker than expected US March jobs report in which payrolls increased by only 88k, concern that economic activity is following a similar pattern to previous years ie strength in Q1 followed by weakness in Q2, has intensified. I do not believe this is the case but the jury is still out.

At the least the data will embolden Fed doves who will use the data as evidence that any tapering off in asset purchases should not occur quickly. A series of Fed speeches this week including one by Fed Chairman Bernanke tonight will be listened to very closely to determine whether the jobs report has provoked further caution from the Fed. Moreover, Fed FOMC minutes will be scrutinized to determine how the Fed will adjust the flow rate of asset purchases to the changing outlook.

The overall tone to FX markets is one of broad based USD weakness, with the notably exception of the JPY where the relatively aggressive BoJ stance has provoked a bigger reaction. The EUR has taken advantage of a softer USD but is unlikely to sustain gains around the EUR/USD 1.3000 level given the political problems across the Eurozone and relatively weaker economic conditions.

Indeed, news that Portugal’s constitutional court rejected austerity measures has put at risk the ability of the country to achieve its budget targets and regain access to international bond markets. Meanwhile Cyrpus’ bail in continues to leave a sour taste among depositors across the region while Italy continues to edge towards fresh elections.

Currency frictions

I would like to apologise for the lack of posts over the last couple of weeks. I have been on a client roadshow presenting our macro and markets outlook for 2013 to clients across Asia. Having returned the mood of the markets is clearly bullish as risk assets rally globally. Recovery hopes are intensifying as tail risk is diminishing while central banks continue to keep their monetary levers fully open.

A heavy slate of US data releases this week will keep markets busy but overall I see little to dent the positive tone to risk assets over coming sessions. The main events this week include the US January jobs report (forecast +160k) and Fed FOMC meeting (no change likely) while consumer and manufacturing confidence, Q4 GDP and December durable goods orders are also on tap.

In the Eurozone attention will focus less on data but more on Eurozone banks’ balance sheets, with further capital inflows likely to be revealed, marking another positive development following last week’s strong payback of LTRO funds. Elsewhere, industrial production in Japan is likely to reveal a healthy gain while an interest rate decision in New Zealand (no change likely) will prove to be a non event.

As fiscal and monetary stimulus measures are largely becoming exhausted or at least delivering diminishing returns the next policy push appears to be coming from the currency front. The issue of ‘currency war’ is once again doing the rounds in the wake of Japan’s more aggressive stance on the JPY leading to growing friction in currency markets.

In contrast the easing of Eurozone peripheral strains have boosted the EUR, in turn resulting in a sharp and politically sensitive move higher in EUR/JPY. Central banks globally are once again resisting unwanted gains in their currencies, a particular problem in emerging markets as yield and risk searching capital flows pick up. Expect the friction over currencies to gather more steam over the coming weeks and months.

In the near term likely positive news in the form of large capital inflows into Eurozone peripheral banks and sovereign bond markets will keep the EUR buoyed. The USD in contrast will be restrained as US politicians engage in battle over the looming budget debate and spending cuts despite the move to extend the debt ceiling until May.

GBP has slid further and was not helped by the bigger than expected drop in Q4 GDP revealed last week which in turn suggests growing prospects of a ‘triple dip’ recession. The lack of room on the fiscal front implies prospects for more aggressive Bank of England monetary policy especially under the helm of a new governor and in turn even greater GBP weakness.

Bullish INR but other Asian currencies held back

Although the European Central Bank (ECB) left policy rates unchanged the post meeting press conference effectively opened the door to a rate cut in Q1 next year following sharp downward revisions to growth projections and well below target inflation projected over the medium term. A major casualty of the shift in ECB tone was the EUR which dropped over one big figure from a high of around 1.3089. Technical support for EUR/USD is now seen around 1.2885.

The Baltic Dry Index has continued to decline over recent days sending an ominous signal for growth ahead. Meanwhile, once again politics cast a shadow over European markets as Italy’s government overcame a confidence motion, with ex Prime Minister Berlusconi’s PDL party threatening to withdraw support and bring down the government.

Trading is likely to remain thin today as markets await the US November jobs report. The report will undoubtedly be soft (consensus is for an 85k increase in November payrolls) but as much of the weakness in jobs growth will be due to Hurricane Sandy the market impact is likely to be muted leaving a likely constructive tone to risk appetite going into next week.

Asian currencies continue to take direction from the CNY, with the lack of upside traction in this currency leaving most Asian currencies within ranges despite the fact that equity flows to Asia have been very strong over recent days, with inflows of over $2 billion registered this week alone. The implication is that central banks in the region have become increasingly active in preventing Asian currency strength.

One currency that has a limited influence from the CNY is the INR and this currency continues to outperform on reform hopes. The passage through India’s lower house of parliament allowing foreign investment into retailers was encouraging and hopes have grown that it will be followed by passage in the upper house. Further gains in the INR are seen over coming sessions, with a short term break below USD/INR 54.00 looming.

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