After six consecutive days of the VIX (US volatility index) falling, we have seen volatility come back with a vengeance.
Whether we see the VIX push back into the 30% level is something that is absolutely on traders’ minds, and rightly so, higher volatility should be at the center of everyone’s strategy. With volatility increasing, there has been an unwinding of yield and income positions (Aussie financial sector -2.2%), with modest selling in AUD, which is always going to happen when volatility picks up.
Tomorrow’s Aussie Capex could be a catalyst for AUD/USD, but volatility remains the key driver of the AUD and there has been a slight change in the AUD’s investment case since yesterday.
The two key markets for me continue to be oil and the S&P 500 from here. However, given the 10-day rolling correlation between US crude and the S&P 500 is 0.70 (or 70%), trade oil and you may as well trade the S&P 500. Importantly though, the S&P has failed again at the key 1947 to 1950 area, effectively marking a triple top, and there is real risk that the bears jump on this technical failure. I would back this view, and would use this strong resistance at 1950 as a guide for stops. Add to shorts on a break on the 1820 area, but it seems the pain trade is to be short, and seemingly in 2016, doing the opposite of what feels right is generally the most profitable.
The same issue has been seen in Australia, where once again the ASX 200 has failed at 5000 and stocks have been hit hard today. There is an even better set-up in the SPI futures, where a clear double top has been formed – a move through 4650 would be very bearish. BHP has been the heavily traded name today with volume 150% above the 20-day average, and has had its worst one-day decline since December 2, 2008. While many are attributing this to Aussie traders getting it very wrong yesterday, if you overlap a chart of BHP and WTI one can see oil has been the bigger driver.
Fortescue Metals (AX:FMG) has also been well traded, with much focus on the $13 per ton cost guidance, which is pretty incredible and shows what a fantastic job management have done to become one of, if not the lowest, cost producer around.
BHP chart with 1-day percentage changes
There has been some good interest in cable from clients, with many selling the break of $1.4000. Some focus has been on the good buying at A$1.9400 in GBP/AUD and we’ve had questions about how much ‘Brexit’ risk is now priced into sterling at current levels. The truth is no one really knows, given the level of hedging taking place, and one suspects growing interest from momentum focused funds, whose rule-based approach means they have to be short sterling. $1.3000 (in cable) could be realistic, even if this level is some 500 pips below where even the most bearish GBP/USD forecast sits.
The market is pricing in around a 40% chance of ‘Brexit’ and the bookies slightly less. However, if we do see an exit, it promises to get very messy indeed, specifically given the current positioning within the Tory party and the fact the party will effectively be all over the place. If the bookies' base case proves to be correct, then GBP/USD is probably good buying at these levels, but that’s a trade I would not be advocating.
We have also seen a pick-up in interest around the US elections, and one expects even more intense focus ahead of ‘Super Tuesday’ on March 1 and also March 15 - the point in time when traditionally the candidate with the highest delegate count has gone on to win their respective party nomination. One suspects we will see Clinton-Trump race to the White House, but financial markets would clearly prefer a Clinton-Rubio race.
It seems we are set for follow-through selling when European cash markets resume trading, with S&P and oil futures pushing modestly lower through Asia. As things stand, our calls are FTSE 5930 -32, DAX 9370 -46 and CAC 4209 - 29.