Low volatility unsustainable

February 28, 2014 — Mitul Kotecha

There seems to be a real disconnection between the problems / tensions in China, Ukraine, Turkey, Thailand etc and market sentiment.

Even in the US the market has happily swallowed Yellen’s speech that data weakness is all related to bad weather (US equities rose to record highs overnight while the VIX index has edged lower). Well once the weather improves the data had better improve too otherwise that theory will be shot to pieces and markets will be hit.

In particular there really does appear to be a surprisingly degree of complacency towards events in Ukraine (see earlier comments). On that note even if the Ukraine avoids default via money from US/Europe/IMF tensions with Russia remain a major issue.

In terms of FX reaction JPY and CHF could face more upward pressure while the EUR is looking increasingly exposed. High beta FX EM FX will look increasingly vulnerable against this background.

What is surprising is that both major FX and EM FX implied volatility indices (1m, 3m) are tracking below their historical vol indices. The low level of volatility in both FX and equity markets looks unsustainable.

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It’s all about the weather

February 28, 2014 — Mitul Kotecha

Fed Chairman Yellen helped allay concerns that something more sinister than bad weather was impacting the US economy in her speech to the Senate Banking Committee yesterday. While highlighting that tapering will go on unabated and likely end by the fall, the comments gave hope that the poor run of US data will come to end soon, once the weather impact reverses.

Risk assets liked what they heard, with US equities closing at record highs and the VIX “fear gauge” edging lower. Reduced safe haven demand helped US Treasury yields to move lower undermining the USD in the process. Against this background markets will ignore a likely downward revision of US Q4 GDP today, which will be seen as largely backward looking.

The relief from Yellen’s comments was sufficient to outweigh the increasingly precarious situation in the Ukraine where the regional parliament in the largely Russian speaking region of Crimea was overtaken by armed gunmen hoisting the Russian flag. Subsequently Crimea has now set a referendum to decide whether to opt for sovereignty for the region.

Given the increased jawboning by Russia and military exercises along the border with Ukraine, together with warnings by Western nations for Russia not to get involved in the situation, the risk of a further escalation of tensions are high. Indeed, the scenario increasingly resembles the type of stand off taking place during the “cold war” and markets may be underestimating the potential impact.

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USD undermined, GBP supported for now

February 27, 2014 — Mitul Kotecha

Despite its overnight bounce the USD index is trading close to its lowest levels this year undermined by a series of weaker economic data and related to this a failure of US bond yields to push higher. Alongside this relatively soft USD tone is a generally subdued and range bound tone to FX markets in general.

Even my quantitative models suggest little impetus for big moves in EUR/USD and USD/JPY. However, I expect this to change over coming weeks. Once the US economy shakes off the shackles of poor weather conditions the USD will be in a better position to recoup its recent losses.

In the near term Fed Chairman Yellen’s testimony today will garner some attention but the speech is unlikely to break the USD or FX markets out of their malaise.

GBP is holding up well, taking advantage of a subdued USD tone. As a consequence of firmer data the market appears to be gearing up for an eventual rate hike, with Bank of England members sounding more upbeat, even if it is unlikely to occur anytime soon.

Consequently over the near term GBP looks well supported although eventually we expect the currency to settle back to earth. In particular 3 month interest rate differentials with the USD appear to suggest that GBP/USD gains are overdone.

This doesn’t mean that its time to sell now but market positioning has turned more positive over recent weeks, above its 3-month average, suggesting further short term gains will be more gradual, with strong GBP/USD resistance around 1.6745.

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Awaiting Yellen

February 11, 2014 — Mitul Kotecha

There was very little activity of note overnight, with markets taking on the appearance of grounding to a halt ahead of the first semi-annual testimony to Congress by new Fed Chairman Yellen later tonight. A Japanese holiday today will act as another dampener on activity.

Weaker data and/or emerging market tensions are highly unlikely to deter Yellen and the Fed from maintaining a tapering path but of interest to markets will be any indication that the unemployment rate is to be deemphasized given its misleading fall over recent months. With little else of note on tap until the release of US retail sales and Eurozone Q4 2013 GDP later in the week Yellen’s speech will set the tone for markets over coming days.

The biggest market movers over recent days have been the VIX index, natural gas and gold prices. The VIX has fallen sharply reflecting a major turnaround in risk appetite from an elevated level, which has been corroborated by our risk barometer moving back into risk ‘neutral’ territory from risk ‘hating’.

Nonetheless, although emerging market fears have calmed down the path ahead is still likely to be a volatile one. Natural gas prices have also dropped reflecting expectations of milder weather ahead in the US. In contrast gold prices have rallied further extending gains this year to around 6%. Lower US yields and a weaker USD have helped to buoy gold prices over recent days while news of record gold demand and supply from China has also helped.

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A more constructive start to the week

February 10, 2014 — Mitul Kotecha

Following a period of heightened volatility markets ended last week on a more positive note. Despite another soft reading for US non farm payrolls in January which revealed jobs growth of 142k following a gain of 74k in the previous month, markets took some comfort from a drop in the unemployment rate to 6.6% which for a change was not related to a drop in the participation rate. The participation rate rose to 63.0% in January.

Against this backdrop Fed Chairman Yellen will be giving her first testimony to Congress this week and while there is likely to be little change to the Fed’s policy outlook there will need to be some reassessment of the Fed’s forward guidance, especially given the surprisingly quick drop in the unemployment rate. The USD index slipped last week but we expect a slightly firmer tone to ensue over coming days in line with higher US yields.

Markets will kick off the week much as they left off last week, with a calmer and more constructive tone likely. Aside from Yellen’s speeches, US data will be soft on the whole, with January retail sales likely to post a small decline, while industrial production will record a gain and Michigan sentiment will fall, with consumer confidence weighed down by weaker equity markets.

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