A light session in US trade on Friday it may have been, with volumes running some 25% below the 30-day average through the S&P 500. However, one can still make money in a low volume environment and new highs have been seen and we should see Asian markets open on somewhat of a firmer footing.
Predictably, the low volatility environment continues to be a dominant theme, with the US volatility index (“VIX”) closing firmly below the 10 level. “When in doubt sell volatility”, the hedge funds cry and that continues to be a trade that has worked well for some time. Everything from central banks seems so predictable these days, even Trump is predictable when it comes to saying something outrageous and the shock factor is being priced out of markets.
However, throw in extremely low implied volatility (“VIX”), low realised volatility, solid earnings from US, European and Japanese corporates and you can see why so few are expecting range expansion and price volatility to be on-going dominant theme to any great degree going forward.
So the on-going grind higher in the US and developed equities should continue in my opinion. The Emerging market trade I have been pushing is now looking quite good, with the EEM (Emerging Markets ETF) breaking to the highest levels since May 2015 – happy to stay long here for now.
There has also been a renewed focus on the market breadth of late in US equities too, given around 30% of the gains this year in the S&P 500 have come from Alphabet (NASDAQ:GOOGL), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Google and Facebook (NASDAQ:FB). However, if we look at the market internals we can see 18% of companies at a four-week high, which is fairly low considering the index is at an all-time high, but not terrible. If anything, it tells me there is further upside here, especially when you see a mere 59% of S&P 500 companies trading above their 50-day moving average. There are just no signs of euphoric conditions and the index is not over loved in any way.
We can also see broad financial conditions continue to improve, with the Bloomberg US financial conditions index pushing up to the highest level since September 2014. The week ahead see’s Trump back on home soil after a dominant trip abroad and one suspects he, Kushner et al will retain their spot in the limelight for all the wrong reasons.
(Bloomberg financial conditions index – rate hikes are supposed to tighten conditions)
We will also keep an eye on US data points this week with core PCE, consumer confidence, vehicle sales, ISM manufacturing and non-farm payrolls in view. If financial conditions (see Bloomberg chart above) remain at such extremely accommodative levels it really puts the probability of a June hike at a very high prospect.
Recall, the Fed are looking through the weak Q1 GDP print, which was revised up 50 basis points on Friday to 1.2% as “transitory”, but there are a few reasons for them to perhaps play a slightly more cautionary note, and look to hike in July instead, although again the base case remains a June hike. This week’s US data flow could settle that argument.
I would also be focusing on Europe this week given the market love affair with EUR assets. Speculative FX futures positioning in EUR/USD increased a lazy 74% last week and at 64,845 contracts is the largest net long position speculative traders have held on EUR futures since October 2013. If we look at how far EUR/USD has overrun relative to the US/German bond spread it suggests some downside risks this week to EUR/USD and this pair will no doubt get a good working over from clients. Specifically, look to Wednesdays Eurozone CPI estimate, where consensus believes that inflation should fall from 1.9% to 1.5%. This could be a trigger for profit-taking in EUR.
Aside from offshore factors, there is quite a lot for local traders to navigate through, specifically on the Aussie data front. There have been calls from some economists that we are set for a very benign quarter of growth when released on 7 June, although the consensus still sits for Q1 GDP of 60 basis points (or 0.6%). This view could change somewhat this week with building approvals, private sector credit, Q1 CAPEX and retail sales in play.
I would be paying close attention to the Australia/U.S. 10-year bond yield spread, which closed at 16 basis points on Friday and effectively portrayed the lowest premium Aussie 10-year bonds have held over US Treasuries since May 2000. With the swaps market pricing two basis points of cuts over the coming 12 months, these growth drivers could impact this spread and perhaps market pricing around future RBA action and in turn, the AUD will be sensitive to these changes.
It’s hard to pick a range, but we can use the options market as a guide and here we see an at-the-money $0.7450 weekly ‘straddle’ costing 57 pips. That will change when implied volatility kicks in for the start of the week, but for now, the market is saying they expect a modest 57 point move (in either direction) for the AUD/USD and that seems a tad too low for me.
If we aggregate the US leads, include a solid 2.8% reversal in US crude (from Fridays ASX 200 cash close) and hefty sell-off in iron ore (spot fell 3.9%, while Dalian futures were down 1.2%) we should the ASX 200 open a touch higher, with SPI futures closing up seven points. Weekend news has been quite light, although there are breaking headline around further missile tests from North Korea, but thus far limited moves in USD/JPY suggest a flat open to futures markets at 08:00 aest. The bulls desperately need to see a convincing closing break above 5803.