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Post-FOMC hangover setting in?
Summary: Friday’s session was a watershed moment for global markets, with a sudden across-the-board acceleration in volatility from extremely low levels.
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.
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.
Trading interest
Long JPY via short AUDJPY and USDJPY as long as weak risk appetite persists.
Less confident in USD outlook – going flat here outside of downside interest in USDJPY.
Lifting any EURNOK shorts as this sudden vicious turn in risk appetite is not NOK supportive.
The G10 rundown
USD – a case of whiplash as USD trades all over the shop depending on the pair in focus. Weak risk appetite would favour USD strength against EM, but less so elsewhere. Watching US 2-, 5- and 7-year treasury auctions of gargantuan size this week with interest.
EUR – less weak than one might have thought, given the terrible flash PMIs for March on Friday. Uptick in the German IFO survey this morning. One angle is that the euro could find support on weak risk appetite due to the unwind of carry trades funded in euros.
JPY – the yen is the high beta currency to current market drivers as we discuss above.
GBP – the market looks optimistic on sterling’s prospects, given the swirling uncertainties. See my Friday article on Brexit for further thoughts.
CHF – the franc is suddenly playing its old safe haven role and may remain correlated with the JPY in the crosses, but EURCHF soon at painful levels for the Swiss National Bank if it hits the 1.1200 area, the lowest level since the summer of 2017.
AUD – Friday’s session saw less pressure on AUD than one might normally expect, even as Australian yields are in freefall, pricing in coming Reserve Bank of Australia accommodation. Next step mostly likely whatever awaits from US-China trade negotiations.
CAD – the USDCAD rally in good order even after a small CPI upside surprise on Friday (offset by an ugly Retail Sales print from January and downward revision of the December data). But USD momentum not impressing elsewhere in the G10 space.
NZD – kiwi priced for near perfection, given the backdrop and we fail to see how the Reserve Bank of New Zealand would serve as a positive catalyst, especially if the market mood sours further this week. That said, the market has overcome prior dovish broadsides from Orr and company in recent months.
SEK – the path lower for EURSEK made a bit challenging by weak Eurozone data and the rocky ride in risk appetite – watching 10.40-35 zone in EURSEK as the next important test for whether a more profound SEK rally can materialise.
NOK – the Norges bank last week very supportive for NOK, but the market backdrop turned hostile with Friday’s risk-off tone. Next couple of sessions a pivotal test for whether NOK can overcome and resume its rally against the euro.
Upcoming Economic Calendar Highlights (all times GMT)
1000 – US Fed’s Harker (non-voter) to speak
2115 – Australia RBA’s Ellis to speak
2145 – New Zealand Feb. Trade Balance
0030 – US Fed’s Rosengren (Voter) to speak
Long JPY via short AUDJPY and USDJPY as long as weak risk appetite persists.
Less confident in USD outlook – going flat here outside of downside interest in USDJPY.
Lifting any EURNOK shorts as this sudden vicious turn in risk appetite is not NOK supportive.
The G10 rundown
USD – a case of whiplash as USD trades all over the shop depending on the pair in focus. Weak risk appetite would favour USD strength against EM, but less so elsewhere. Watching US 2-, 5- and 7-year treasury auctions of gargantuan size this week with interest.
EUR – less weak than one might have thought, given the terrible flash PMIs for March on Friday. Uptick in the German IFO survey this morning. One angle is that the euro could find support on weak risk appetite due to the unwind of carry trades funded in euros.
JPY – the yen is the high beta currency to current market drivers as we discuss above.
GBP – the market looks optimistic on sterling’s prospects, given the swirling uncertainties. See my Friday article on Brexit for further thoughts.
CHF – the franc is suddenly playing its old safe haven role and may remain correlated with the JPY in the crosses, but EURCHF soon at painful levels for the Swiss National Bank if it hits the 1.1200 area, the lowest level since the summer of 2017.
AUD – Friday’s session saw less pressure on AUD than one might normally expect, even as Australian yields are in freefall, pricing in coming Reserve Bank of Australia accommodation. Next step mostly likely whatever awaits from US-China trade negotiations.
CAD – the USDCAD rally in good order even after a small CPI upside surprise on Friday (offset by an ugly Retail Sales print from January and downward revision of the December data). But USD momentum not impressing elsewhere in the G10 space.
NZD – kiwi priced for near perfection, given the backdrop and we fail to see how the Reserve Bank of New Zealand would serve as a positive catalyst, especially if the market mood sours further this week. That said, the market has overcome prior dovish broadsides from Orr and company in recent months.
SEK – the path lower for EURSEK made a bit challenging by weak Eurozone data and the rocky ride in risk appetite – watching 10.40-35 zone in EURSEK as the next important test for whether a more profound SEK rally can materialise.
NOK – the Norges bank last week very supportive for NOK, but the market backdrop turned hostile with Friday’s risk-off tone. Next couple of sessions a pivotal test for whether NOK can overcome and resume its rally against the euro.
Upcoming Economic Calendar Highlights (all times GMT)
1000 – US Fed’s Harker (non-voter) to speak
2115 – Australia RBA’s Ellis to speak
2145 – New Zealand Feb. Trade Balance
0030 – US Fed’s Rosengren (Voter) to speak