- There has been a lot of chatter and press lately about abnormally low volatility across most financial markets
- Yet past experience tells us that this cannot last
- Dovish ECB comments are hitting the euro
- During the North American session, the US reports March IP and Canada reports February manufacturing sales
- UK reported labor market data earlier today; RBA minutes were released overnight
- Turkey February IP contracted -5.1% y/y; Argentina reports March CPI
The dollar is broadly firmer against the majors on a potential Turnaround Tuesday. Stockie and yen are outperforming, while the Antipodeans are underperforming. EM currencies are broadly weaker. TRY and HUF are outperforming, while INR and MYR are underperforming. MSCI Asia Pacific was up 0.3%, with the Nikkei rising 0.2%. MSCI EM is up 0.5% so far today, with the Shanghai Composite rising 2.4%. Euro Stoxx 600 is up 0.2% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 1 bp at 2.56%, while the 3-month to 10-year spread has steepened to 16 bp. Commodity prices are mixed, with Brent oil flat, copper flat, and gold down 0.4%.
There has been a lot of chatter and press lately about abnormally low volatility across most financial markets. To those of us who trade daily in these markets, this is stating the obvious. Looking at historical volatility data, it’s clear that we are in a period of low volatility that’s resulted in very narrow trading ranges for most currencies.
Yet past experience tells us that this cannot last. Like a coiled spring, these markets will eventually erupt in a period of heightened volatility. The proximate trigger is of course impossible to predict, as is the exact timing.
What will we see when that happens? The dollar and other safe havens should benefit at the expense of so-called risk assets like EM. With regards to equities, the VIX is the lowest since last October. What happened when the VIX reversed higher that month, rising from around 11% to peak near 36% in last December? The S&P 500 sank 20% over the course of Q4. We’re not saying history will repeat itself, but as Mark Twain purportedly noted, “it often rhymes.”
Dovish ECB comments are hitting the euro. Press reports suggest a “significant minority” at the ECB remain doubtful of the H2 recovery scenario that the bank is showing in its March projections. Some went so far as to cast doubt on the accuracy of its models. Just as we saw after the March ECB meeting, so too are we now seeing dovish leaks after this month’s meeting.
The ECB next meets June 6, when new staff projections will be released then. If data remain soft, we suspect this dovish minority will grow and perhaps feed into a more dovish policy stance. In related news, other reports suggest that ECB officials lack enthusiasm for any sort of interest rate tiering under the current negative rate framework. This is just a grim reminder that the ECB, if it were to turn more dovish, simply lacks any strong policy levers to boost growth.
During the North American session, the US reports March IP. A 0.2% m/m gain is expected. The biggest takeaway to be had from recent US data is that the economy is far stronger than previously thought. The Atlanta Fed’s GDPNow model started off with an initial Q1 growth estimate on March 1 of 0.3% SAAR. It now stands at 2.3% SAAR. The Fed’s Kaplan (non-voter) speaks today.
Elsewhere, Canada reports February manufacturing sales and are expected at -0.1% m/m. Recent data have been disappointing, but the Loonie has been underpinned by higher oil prices. The 1.33 area has been tough for USD/CAD to break below in recent weeks.
With the UK Parliament on recess until April 23, markets are getting a much-needed respite from Brexit headlines. Prime Minister May and her government will reportedly still talk with opposition Labour during this recess. As in the case of the Irish backstop, a compromise over a customs union seems insurmountable. The Tories reportedly believe the UK can have a custom union as Labour demands but still be able to pursue independent trade deals outside of the EU. By definition, this is not a customs union, which requires all members to have common tariffs against outside countries.
UK reported labor market data earlier today. The readings all came in as expected, with employment rising 179k and the unemployment rate steady a 3.9%. Earnings remain firm, rising 3.5% y/y (3.4% ex-bonus). Yet the Bank of England is facing the same conundrum that other central banks like the Fed and RBA is facing. That is, a strong labor market has yet to feed into wage and price pressures. To make matters worse, the BOE has Brexit hanging over its head.
March UK CPI data will be reported Wednesday. Headline inflation is expected to rise a tick to 2.0% y/y, while CPIH is expected to rise a tick to 1.9% y/y. For now, the BOE must take a wait and see approach during the Brexit extension until October 31. Next policy meeting is May 2, no change is expected then.
RBA minutes were released overnight. The bank reportedly discussed rate cut scenarios but ultimately decided that there was “not a strong case” to ease near-term. Yet it also admitted that rates were unlikely to have to rise, concluding that steady rates were the best course of action for now. This discussion of rate cuts is the first step towards an eventual most to an easing bias soon. However, market calls for two cuts this year seem overdone. RBA next meets May 7, no change is expected then.
Turkey February IP contracted -5.1% y/y vs. -6.2% expected. The recession should continue to worsen, but the weak lira and rising inflation will prevent the central bank from easing anytime soon. Next policy meeting is April 25. If the lira remains under severe pressure, we think some tightening measures will be announced then.
Press reports that a local Turkish bank obtained liquidity from the central bank yesterday via the Late Liquidity Window. This was the first time that this window has been used since June 7. This is typically used in an emergency since the rate is 27%, higher than the policy 1-week repo rate of 24% and the overnight lending rate of 25.5%. This could be an early signal of building stresses in the banking system, another reason to be negative on the lira. Stay tuned.
Argentina reports March CPI. The peso weakened nearly 10% in March and so inflation is likely to accelerate from 51.3% y/y in February. The central bank has kept policy tight but may need to do more if the peso comes under renewed pressure. It auctioned off USD yesterday and this helped support the peso, at least for now.