Post-FOMC hangover setting in?

This unsettling shift to a negative mood just two sessions after the very dovish turn at the Federal Open Market Committee meeting suggests market calm isn’t about to return.

Friday’s ugly acceleration in volatility and sell-off in global equity markets unfolded on a quad-witching (expiry of futures and options) day in the US and was especially jolting as it emerged just a day after an acceleration higher in equities. But attributing all of the action to this quarterly instigator of tactical flows looks a bit misguided and it is more likely that the most important event of last week – the fresh, profoundly dovish turn from the Powell Fed – aggravated the intensity of witching flows. Linking the market action to the FOMC meeting offers a more compelling story: that the market’s kneejerk celebration of the Fed’s extremely dovish turn was quickly rejected on Friday – suggesting a loud signal that Fed accommodation is fully priced.

Now, the most important factor from here will be the trajectory of the economy. If the economy continues to roll over and threaten recession, in other words, growing anticipation of Fed rate cuts may not offer support as the market instead frets about earnings growth and classic end-of-cycle developments like widening credit spreads, default risks, etc.

If the economy continues to limp along at the low growth levels suggested by the Fed’s GDP measurements (Atlanta Fed’s model showing 1.2% for Q1 while the Ny Fed’s shows 1.3% ), then Fed easing may be slower to emerge than the market anticipates, and instead the positive output gap/tight labour market lead to higher inflation and wage growth numbers that likewise erode earnings prospects and the inversion of the yield curve. 

In FX, Friday’s ugly market turn saw the JPY rallying sharply, taking its cue from the ideal combination of very strong US treasuries and weak risk appetite, with the 110.00 level suddenly in play in USDJPY. The euro was also sharply lower earlier in the day Friday on the very weak flash March PMIs, particularly the sub-45 print in Germany’s Manufacturing PMI. Emerging market currencies pivoted violently as well, most prominently in the Turkish lira, which tumbled as much as 7% versus the USD on Friday before trying to find support today on Erdogan’s threats to “bankers” and speculators selling TRY.

Brexit uncertainty will likely either very dramatically improve this week or get extended out over the horizon (assuming a delay) as we await a third vote on May’s deal as soon as tomorrow. Stories of mutiny among ministers over the weekend were pushed back against this morning, but it would seem that May’s days as prime minister are numbered, even if her deal is approved. We have little to no visibility, other than the thought that a sterling relief rally on May’s deal passing might underwhelm in scale, given the long-term damage done to the UK economy during the last two years.

The risk of more news flow on the outcome of US-China trade negotiations could pick up quickly from here, now that the Mueller investigation has wound down and he doesn’t face any immediate threat from that angle, as no collusion or obstruction charges appear imminent.

Chart: USDJPY

USDJPY sold off to an interesting area, the psychologically significant 110.00 level and the Ichimoku daily cloud level. The two pivotal areas here look like 111.00 to the upside and the 110.00 area to the downside for risk toward 108.00. A deepening deleveraging move across global markets could see the unwind of JPY carry trades and a test lower. The opposite, meanwhile, is most likely only a risk if markets quickly calm and if US yields rise sharply, for example on weak US treasury auctions this week.