A New Race to The Bottom Buoying Markets

In hindsight, I was incorrect because when we heard Williams speech, there was little doubt it gave us the impression that a 50bp cut was on the cards. The Fed acting “aggressive” in setting policy for more worrying outlook sounds like 50bp. As do comments that “it’s better to take preventative measures than to wait for disaster to unfold. When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress”.

I guess it’s hard to hear these words, knowing that there is a blackout period from next week and not feel they were designed to guide the market to that the Fed had to do something big on 31 July.

The debate on 25 or 50 rolls on

The fact, then, that the comments promoted a broad USD sell-off, largely driven by a move in rates, pricing the chance of a 50bp cut from 33% to 67%, with equities and gold following closely, and this feels like it was the right reaction. We saw economists alter their base-case for Fed action to 50bp, another sign behind the conviction Williams words were a key signal.

The NY Fed’s message to the market – calm the farm

What happened in the early Asia session has been all the talk on the floors this morning, with the NY Fed putting out a statement that John Williams words were aimed at an academic level, and not a cat-out-bag type policy guidance on behalf of the broader Federal Reserve. This seems incredibly important, and aside from calls that the Fed should be more in-tune with markets, there are two schools as to where we stand. Firstly, we should genuinely take it at face value that the market overreacted and the ‘insurance’ cut we should expect is more realistically 25bp. The second, Williams actually poured his heart out, and gave us perhaps too much insight into the potential actions from the Fed in the July meeting, and where the broader Committee was now concerned that they lacked the shock factor to positively move markets. That being, if they cut by 50bp when it isn’t full discounted, we could see asset prices react positively and importantly the USD heading south.

Asian markets are giving us a message

I’m sympathetic to both accounts, as the domestic data, on balance, warrants no change, although, given the external picture I have been arguing that the Fed was better off going hard than bringing a knife to a gunfight. There is clearly some impetus lost now, but what’s important is the market reaction through Asia. Granted, the odds of a 50bp cut now sit at 39.5%, but we’re seeing the USD remain soft, notably against the AUD, where AUDUSD is eyeing a re-test of the post-Williams speech high of 0.7082. Gold fell back into $1440 but is finding a base and looks likely to head back into $1450, and Asian equities are clearly bid, with the Nikkei 225, Hang Seng and ASX 200 up 1.7%, 1.1% and 0.7% respectively. S&P 500 futures are up 0.4%, despite US treasury futures up 3bp.

Commodities are also looking good, and it is a surprise to see copper up 1.8%, with Brent crude +2.1%, and we are starting to see better buying coming back into iron ore futures. In fact, if we look at the Bloomberg industrial metals index, this has had a cracking run in the past two months and is usually a good indicator of gains in the AUD.

White – Bloomberg industrial metal index, orange – AUDUSD (Source: Bloomberg)

A new race to the bottom?

This may be premature, but it feels like the market is back on with the ‘race to the bottom’ trade. Consider if the Fed does go 50bp, which is a lesser proposition given the NY Fed statement, but it would give the ECB increased incentive to go hard in next Thursday’s ECB meeting. The market has already discounted a 52% chance the ECB take its deposit rate, effectively the charge it passes to European financial institutions to park excess reserves on its balance sheet, down to -50bp. And, that would be considered punchy relative to expectations a week or so ago. We saw the Bank of Korea cutting yesterday, which was somewhat out-of-consensus, and the implied chance of the RBA cutting in November has pushed up to 65%.

Let’s see if there are any material changes from the BoJ, when they meet on 30 July. Because if they offer guidance, that they are ready to do more post-ECB, we just need more from the PBoC and markets will ride a new wave of liquidity. A few hypotheticals, but it’s not out of the realms of possibility.

EURAUD short positions looking compelling

I like EURAUD shorts here into the ECB meeting. The technical set-up looks bearish, and it feels like the AUD has been the best performer in the past two days for a reason – that being, there’s more to come. Rallies offer an opportunity to fade (in my opinion), and I am happy to close and admit I am wrong on a close through 1.6034. Happy to start with a small position, but if this kicks lower, I would be adding. As in life, if something is working, you try and do more of it.

Q2 earnings due next week

With limited US corporate earnings in play tonight, the focus turns to speeches from Fed members Bullard (01:10aest) and Rosengren (06:30 aest). Both are voters, and we’ve heard from Bullard of late, which makes it interesting because if his caution increases, when he’s already stated, 25bp is the best course of action, then some may take this to mean 50bp is on the cards. One to watch.

Sign up here for my Daily Fix or  Start trading now

Chris Weston, Head of Research at Pepperstone.

 (Read Our Pepperstone Review)

Gold, GBP and Inflation Expectations Grabbing My Attention

I touched on this in the chart of the day, but with the world’s central banks watching inflation and inflation expectations incredibly closely, it makes sense macro traders do too.

That is what we saw in US trade, and the wash-up has been a renewed bid in the bond markets, taking the pool of negative-yielding government bonds $239m higher on the day, to currently sit at $12.8t. I’ve looked at this in relation to gold below, and while a two-year regression shows the correlation between the two variables is not overly significant, it’s fair to say there is a shared theme here.


Rates pricing moving towards 50bp of cuts

We can also look at the US rates market overnight, where we can now see a 34% chance of a 50bp cut, and while I should probably apologies for persistently banging this US-centric drum, there is no doubt the 25bp-50bp debate is the big talking point out there right now. If we see US 5-year inflation expectations heading back towards 1.90%, then it markedly increases the possibility of a 50bp cut, despite certain better US data points, and if this materialises, watch the markets fire up.

In fact, we may get a touch more clarity tonight, where at 04:15aest NY Fed President John Williams speaks on monetary policy. Williams is a core voting member within the Fed, so any hints that he is genuinely worried about the external picture and vulnerabilities in the global economy and we may see the interest rate markets move to price a 50% chance of a 50bp. This is an event risk for traders.

With the global growth story in mind, it segways nicely into today’s Bank of Korea meeting, where we saw an out-of-consensus rate cut to 1.5%. Some will point to tensions with Japan behind the easing, but some see the weakness in Korean exports as a leading guide on the external demand thematic, and we can see how this correlates with the MSCI All country index.

Gold to $1500?

Going back to the Williams speech, should we get clues he’s steering to 50bp, which seems unlikely, but should it play out, then in this scenario, gold (XAUUSD) builds on the move we saw yesterday, and we head onwards and upwards towards $1500.

Aussie factors weighing on XAUAUD

In fact, if we look at gold in EUR terms (XAUEUR), we can see the price here has broken to new highs, with an outside period seen in yesterday’s candle. AUD-denominated gold (XAUAUD) has yet to kick higher and hasn’t benefited from the modest AUD strength seen in the wake of the Aussie job’s numbers. Which, when digging into the numbers are a small positive given we saw strong full-time jobs creation and the participation rate was slightly better. The NAB business confidence report also improved.

We always follow price as a voting mechanism to understand why people are buying and why they are selling where they are. But there is a raft of different ways we can assess sentiment towards any market and many in the institutional space like to look at the options world as a guide. I am happy to provide clients information on options skews if it helps, but if I look at the difference (or the ‘skew’) of call vs put implied volatility, we see this sits at an all-time high of 4.

The higher the demand for call options, which give us the right to buy, the higher the implied volatility. So, when the skew is so heavily favoured towards structures that give us the right to buy should the market price be above the strike price, you can see exactly where options traders feel the balance of risk lies for the yellow metal.

Pairs trading – if you’re not doing it and interested let me know

While the bulk of our flow has been in gold and GBP, we are seeing good interest in US equity indices, and the flow is two-way. There is a battle underway in the S&P 500, and the earnings rolling in are not helping to any great degree.

One way of trading an index is through ‘pairs’ trading. Take a look at the S&P 500 (US500)/Russell 2000 (US2000) ratio. Ratio analysis is just one way to look at this, but it gives a guide on how the markets are interacting with each other and the outperformance. In this case, the US500 is the numerator, so when this index is going up, we see the US500 outperforming the US2000.

Being long the US500 and short the US2000 has been working so well that the ratio sits at the highest levels since 2009. If this breaks out convincingly, I will be looking at exposures here.

The math is simple

When looking at pair’s trades, it is key that both legs of the trade have the same notional exposures, or at least as close as possible. So, we, therefore, start with a USD amount, let’s say $10,000 and then divide this by the index level at the time. So, with the US500 trading at 2984 and US2000 at 1550, I would buy 3.4 contracts of US500 ($10,000/2984) and sell 6.5 contracts of US5000. Or, vice versa if you feel the US2000 will outperform,

Trading pairs (or long/short) strategies are lower beta, meaning they don’t tend to have sizeable P&L swings and can be a great way to really hone in on one theme and exploit it.

Anyhow, I find it an interesting way to trade markets and happy to offer more guidance if clients are interested.

Sign up here for my Daily Fix or Start trading now

Chris Weston, Head of Research at Pepperstone.

 (Read Our Pepperstone Review)

US Equities are Grinding Higher Into Q2 Earnings

That said, we do want to see how price acts, and as we see on the weekly chart of the S&P 500 price is pushing up against trend resistance, and this may be telling. A potential bearish crossover in momentum could indicate exhaustion in the bullish trend, and I would respect that by moving to a more neutral bias. Price is king as always, and while earnings are getting increased focus with Johnson and Johnson, JP Morgan, Goldman’s and Wells Fargo reporting between 20:45 aest and 22:00 aest tonight, our US equity indices could see some increased volatility through European trade.

One chart I always keep an eye on is the spread between high yield credit and US treasuries (white line). This is a great indicator of sentiment and accepted risk, as the narrower the spread, the greater demand for high yield bonds over the risk-free rate (US government bonds). There is an old saying, that ‘equities always follow credit’, and that is unlikely to the change anytime soon. However, at this juncture, while credit spreads are not giving any glaring sell signal for equity, there is a growing divergence which suggests the rally in the S&P 500 may be maturing.


US retail sales the central event risk

As we roll into US trade, we also have to focus on US retail sales (due 22:30 aest), and industrial production (23:15 aest). The retail sales print is a potential volatility event, and, as always, we look to see the outcome relative to expectations of 0.2% MoM. Economists often look at the retail ‘control group’ element, which is the group of goods used directly into the GDP calculation. This number is expected to grow at 0.3%, so should we see the USD more sensitive to this, as a beat may see slight revisions to the Q2 GDP estimate, where the market currently believes Q2 GDP is closer to 1.8% and down from the 3.1% pace of growth seen in Q1.

It should also affect the rates market which are now pricing a 25% chance of a 50bp cut in the July FOMC meeting. This pricing feels fair as the Fed should cut, but the recent data argues for 25bp. The argument is though if the Fed cut by 50bp, then they can try and run their economy red hot as they try and get in front of the curve.

Are we pricing in too much easing from the Fed?

If I look at market pricing for end-2019, we see 64bp of cuts (from the Fed) priced in, which effectively dwarfs the expected easing seen from other central banks. Granted, we have already seen a response from the RBA and RBNZ, and the Fed is yet to start its easing cycle. However, given what we have seen of late from the US data, I question if 64bp (central banks tend to work in 25bp increments) looks a punchy call.

The USD index daily needs work

As we can see in the daily chart of the USD index (USDX), there is no clear trend, and price action is quite messy. We see price oscillating around the 200-day MA, and also the 5-day EMA, so we can understand that there is little conviction to push the USD one-way or the other. The options market continues to favour downside and the premium to buy 3-month USD put (or downside) protection outweigh calls options vols.

The EUR offers a 57% weighting on the USDX, which is a basket of currencies weighted against the USD. So, if we refocus away from the EUR and drill down into the moves over the past five days across G10 FX, we can see that the NZD and AUD are performing quite admirably versus the USD.


China data has boosted sentiment

Yesterday’s China economic data has helped sentiment, with a sizeable beat in the June industrial production, retail sales and fixed asset investment prints. The Q2 GDP print came in at 6.2%, which was in-line with expectations. Liquidity has also been in play, with the PBoC conducting CNY200b in one-year loans at 3.3%. Chinese equities saw modest love to the numbers, and are down a touch today, but in FX markets, the set-ups in NZD and AUD look interesting.

AUDUSD grinding higher

AUDUSD tends to get the lion’s share of attention in the AUD pairings, and this won’t surprise, and there seems to be growing interest here again. The daily chart needs more work before we can truly turn bullish and anyhow being bullish this pair never feels right, largely as the cost of carry means hedge funds are unwilling to be long. That said, with 24bp of cuts priced for the rest of 2019, it’s hard to see rates pricing in any more than this, and we may have to wait until November and the Melbourne Cup before the next move from the RBA.

Indeed, today’s RBA minutes (from the July meeting) which have detailed they will cut rates further “if needed”, go some way to justifying this pricing structure.

Price is grinding higher and sits at the top of the multi-month range. A clean break of 0.7050 offers a potential move into the 0.7100 to 0.7150 area. However, with AUDUSD weekly implied volatility just so low, impulsive moves are just not expected and this has strong considerations for risk and position sizing.

We can see that the market sees, with a 90% confidence level, that price should not get any higher than 0.7130 over the coming five days. We can also see options traders anticipate any downside move confined to 0.6957 with a 90% confidence level. That implied volatility read takes into account Thursday’s Aussie jobs report, where the consensus expects to see 9000 net jobs created with the unemployment rate remaining at 5.2%. Good numbers here and the market will pare back rate cut expectations and cover AUD shorts.

NZDUSD also working well

NZDUSD is threatening to convincingly break through the June highs, and traders are questioning if they chase the move, should we see a firm breakout. Flip the chart to EURNZD or GBPNZD (or EURAUD/GBPAUD) though, and this is where we are seeing the big moves, as order book dynamics take hold, with the buyers staying clear and the sellers having an easy time of pushing price lower.

Sign up here for my Daily Fix or Start trading now

Chris Weston, Head of Research at Pepperstone.

 (Read Our Pepperstone Review)

A 360-Degree Guide On US Q2 Earnings Season

On the billing this week we get the following names and the expected times of reporting. Pepperstone offers trading in the pre- and post-market trading session, which allows clients the ability to react to the earnings reports in real-time. The green line represents the companies I feel will get greater attention from clients, notably Netflix, where implied volatility suggests a move of 6.72% on the day of reporting.

A bullish trend

Not a day goes by, seemingly, when US equity indices print a new record high. And, yet if we look at positioning, flow data and the market internals, there are few variables that offer a sense of euphoria in markets, and the contrarian signal of an impending reversal in the bullish trend seen since 3 June.

The clear catalyst for higher equity prices has been the view on the expected path on monetary policy from the Federal Reserve, and the idea of lower interest rates and what it means for leverage. As we can see from the Bloomberg chart, as the level of expected rate hikes (as seen from the blue line) turned to cuts (in December), the S&P 500 rallied strongly, with a clear improvement seen in broad financial conditions (orange line).

The equity market is a voting mechanism, not on fundamentals as most are led to believe, but on sentiment and psychology.

With US Q2 earnings ramping up this week, traders get an opportunity to mark-to-market current valuations with the outlooks from CEO’s and CFO’s and consider if the market is fairly priced for the level of known risk. As things stand, the consensus (source: Factset) is that S&P500 companies report revenue growth of 3.7% (YoY), which would be the lowest growth rate in sales since Q3 2016. On the bottom line, the consensus expects earnings-per-share (EPS) to decline by 3%, led by expected declines in materials and technology.


The market is going into earnings with quite low expectations, which suggests the risks of a drawdown from earnings has been reduced. As always, its level of beats vs misses that will influence and the bulls would be hoping for the percentage of companies beating on EPS of greater than 75% to help fuel valuation re-ratings.

We’ve also seen some 90 companies issue negative guidance on EPS, which is the second highest reading since Factset started compiling estimates from 2006.

Investors will also be keenly focused margins, given the impact of the Trump tariffs, while consider we continue to see the 2018 Trump tax reform roll-off, which has boosted the bottom line from a lower tax rate.

Equities priced for perfection?

Indeed, if we look at the S&P 500 consensus 12-month PE ratio, we can see the index tracking at 18.05x, which, despite being at the highest level since early 2018, is not yet one standard deviation from the five-year average (blue line). Despite some calls that the index is deemed ‘expensive’, with bond yields at such subdued levels and S&P 500 30-day implied volatility (I’ve looked at the ‘VIX’ index here) at 12.39%, an 18x multiple is not yet at genuinely concerning levels.

Sure, US corporates will need to inspire to justify this valuation, but at these levels, the focus and prominent driver of risk will remain fixated on the degree by which the Federal Reserve cut rates.

  • Top pane – consensus 12-month PE ratio, with 1- and 2-standard deviation from the average
  • Lower pane – consensus 12-month EPS forecasts

Assessing market internals

Another method of evaluating sentiment into Q2 earnings is to look at the market internals on the S&P 500. There are many variances of internal indicators we can use, but I have selected a few that I tend to look at.

Again, the internals are not giving off a glaring ‘sell’ signal, and we see:

• Five-day average of the S&P 500 advance/decline line. This currently resides at 42% (the blue histogram). Readings above 250 are of greater concern.

• Percentage of S&P 500 companies at 52-week highs at 50% (orange histogram). I’d be more concerned if we were above 80%

• Percentage of S&P 500 companies with price above the 20-day moving average at 80.56% (yellow histogram). Above 90% concerns.

• Percentage of S&P 500 companies with price above the 50-day moving average at 85.66%. Above 90% concerns.

• Percentage of S&P 500 companies with an RSI above 70 at 12.9% (grey histogram). Above 25% is a concern.

Market internals can offer insights into psychology and sentiment and often when we see extreme readings increase the probability of key turning points. As things stand, we’re not seeing any glaring signs that there is too much love for US equities.

Positioning – There are many ways of looking at positioning, but if we take the weekly Commitment of Traders report, we see net positioning in S&P 500 futures, held by non-commercial accounts, at 17,237 contracts. Despite the strong trend in the index, positioning is clearly not at an extreme.

If we look at the capital flow into mutual funds, we can actually see net outflows from equity-focused mutual funds that specifically invest in developed markets. The flow of capital has moved in emerging markets, which could be seen as a beta play, but also part of the hunt for yield story.

(Source: Morgan Stanley)

The technical set-up and I have looked at the daily chart shows a clear bullish picture. There are few reasons to be short here, and so seems a low probability trade. As I detailed in my Bloomberg cross, the backdrop favors further equity appreciation – https://www.bnnbloomberg.ca/investing/video/pepperstone-s-weston-we-continue-to-stay-in-equities~1723201 .

We can see price at an ATH and is holding above the 5-day average, which is defining the trend. There are no signs of divergence between price and the various oscillators

The wash-up is there is risk, but there are few reasons to feel earnings are likely to be a significant headwind for equities, and the dominant driver remains on how the Fed interacts with markets. Positioning, flow and technicals all point to a market that is seeing no signs of euphoria despite residing at an ATH.

If you have any questions about our equity CFD offering just reach out.

Sign up here for my Daily Fix or Start trading now

Chris Weston, Head of Research at Pepperstone.

 (Read Our Pepperstone Review)

A Day of Event Risk For Traders

I touched on the Jerome Powell’s testimony to the House Services Panel (tonight at midnight) in yesterday’s daily, and that continues to be the dominant event risk.

I will add that Powell speaks on behalf of the Fed and a collective view, rather than his personal thoughts. This is important as there are eight voters, who are yet to be convinced a cut is needed in the near-term, and one could argue that the recent ISM manufacturing and services, and payrolls are no smoking gun.

It’s probably why we continue to see selling in the August fed funds futures contract (the red line), where traders use this tradeable instrument to bet on the probability, and the extent, of a July cut from the Fed. Go back to the 24 June, and the yield here was 2.02%, which given the fed fund effective rate (https://fred.stlouisfed.org/series/FEDFUNDS) sits at 2.38% (green line), it shows we were pricing in 36bp of cuts (if we look at the difference between the two variables). The yield on the August contract has since risen to 2.14%, and we see 24bp of cuts currently priced. So, I would expect this to get some focus over the next 24 hours or so, and importantly we should see the USD, gold and equities keying off this instrument.

On a side note, Pepperstone is planning to roll out interest rates and bonds to clients in the next few months, so I will keep you appraised here. As even if you solely trade equities, FX or gold, they can be useful in understanding what’s priced in, and this can really help with our risk-to-reward assessment. Especially when holding positions over events.

Source: Bloomberg

Fed member Harker offers his thoughts

Philadelphia Fed President Harker was interviewed in the Wall Street Journal, causing a bit of a stir, easing USDJPY above 108.80, a level I mentioned yesterday, and for those who like to trade inverse head and shoulders patterns, then consider the technical target here. Harker’s view that “there’s no immediate need to move rates in either direction at this point in my view though slowing global growth and uncertainty over trade policy have created clear risks to that outlook”, has genuinely resonated here.

It’s also been a key reasoning why AUDUSD has traded through the 20-day MA and looks heavy. A 4.1% decline in the July Westpac consumer confidence (out today at 10:30AEST) has hardly inspired AUD bulls either. 50bp off the cash rate may have helped stabilise sentiment towards the housing market, but consumers seemingly need a bit more encouragement. That said, the probability of a November cut has actually fallen a tad to 52%.

AUDCAD a key play

As I wrote in today’s ‘chart of the day’ (https://pepperstone.com/uk/market-analysis/chart-of-the-day-audcad), AUDCAD is interesting given the cross sits at the lowest levels since 2010 and is one to watch ahead of tonight BoC meeting, which also comes out at 00:00aest. Consider there are actually a few things going right for the Canadian economy, and this could come across in a more balanced statement. With 11bp of cuts priced into Canadian swaps over the coming 12 months, we should consider if the statement goes anyway to justifying this.

For me, diverging paths at a central bank level are the perfect breeding ground for trend traders. Its where we see a blow out in bond yield differentials, with FX coming along for the ride. That’s exactly what we see now, where we see the yield differential between Aussie 2-year and Canadian 2-year bond yields, as highlighted by the red line, getting ever wider. I have overlapped AUDCAD here, to show the influence.

As the event risk rolls on, we also get the FOMC minutes for June at 04:00aest, and it feels like the market is going to focus on the eight members who called for rates to be kept on hold in 2019. We also know that these members were open to a cut, they just wanted more information to compel them to call for a cut – the question is, what exact information would they like to see? Perhaps that comes tomorrow when we get the June CPI print.

Elsewhere in G10 FX, volumes in GBP have ramped up, notably in GBPUSD, which got a lot of attention on the break of 1.2506. Rallies remain an opportunity to sell, although I will say that despite all we hear in the Tory party leadership battle, and measures to make no-deal Brexit a higher hurdle, that traders are still very sanguine on Brexit. If I look at GBPUSD 1-month implied volatility, there are just no concerns here at all that price is going to have a sizeable move. To put into context, the market feels (with a confidence level of 68.2%) that GBPUSD will trade 120-pips either side of the current spot price (1.2452), putting a 240-pip range in play. Still incredibly hard to buy GBP on a timeframe over 4-hours.

DAX and FTSE at a make or break

Aside, from the pre-positioning in FX I’ve mentioned above, we see a better feel to equities again through Asia. The German DAX (GER30) and FTSE 100 (UK100) are two markets on my radar, as the price has come back to test their respective break-out points, and the buyers have supported. A rally tonight off this level is what technical traders would guide as support and could be a clear bullish signal.

Sign up here for my Daily Fix or Start trading now

Chris Weston, Head of Research at Pepperstone.

 (Read Our Pepperstone Review)

Will Powell Cause a Market Tantrum?

That is playing out now, with rates and bond traders two or three steps ahead of central banks.

With that in mind, I wanted to explore tomorrow’s (midnight AEST) testimony from Fed chair Jerome Powell to the House Financial Services Panel, as this is central to markets this week and has the potential to be a volatility event. In theory, we could get the necessary insights that allow us to mark-to-market current pricing, positioning and flow against how the Fed chair sees things.

And, if markets don’t hear what they want to hear, then we have to adjust. And we know markets can adjust violently and if you’re ill-prepared, it can get nasty.

So, what do we want to hear?

Well, if you’re long USD, short bonds and short stocks, then you want Powell to tell us that the US economy is evolving as planned and that the Fed would take a more protracted assessment of the unfolding economics, before doing what could be needed to keep the economic expansion going. Some would argue that after Friday’s US payrolls report this outcome is now in play, especially given the easing of broad financial conditions.

However, I’d argue that financial conditions have been driven largely on the notion that we will see easing and potentially even a 50bp cut in July. So, should Powell hand down a ‘wait and see’ argument in his testimony, then one can easily imagine rates pricing falling to a 50% chance of a cut (now 100%), and this will result in the S&P 500 down by more than 2% on Wednesday, with 2-year Treasury’s pushing higher by over 10bp higher. We’d also likely see the USD index (USDX) gaining by some 1%, with gold likely crashing below the 1 July swing low of $1381, opening up what is effectively a sizeable double-top, and a technical move into $1325.

In this scenario, we’d likely see Asia FX, which I’d throw in the AUD, taken to the woodshed, and Thursday’s equity open would not be a pretty picture. This is our risk, but the thing that makes this a lower probability is that if I see the risk, then obviously Powell understands it too, and he won’t want to see a reaction like this. There’s a reason why implied volatility in FX markets is so low. That being, central banks have almost changed their mandates to support markets and suppress volatility.

On the other side of the coin, if you remain a gold bull, long of bonds and stocks, or holding USD shorts, then you want Powell to guide to either a clearer view that a 50bp is on the cards. Or, at the least indicate a 25bp cut is coming and importantly that they are open to more. As mentioned, the interpretation of the narrative can be quite subjective and central banks often use single words or short phrases as trigger points.

The base-case

I tend to focus on USDJPY (see below) as a key barometer and perhaps one of the cleanest vehicles to assess the market’s reaction to US data or a Fed speaker. USDJPY implied volatility (IV) expiring on Thursday (so incorporating Powell’s speech) sits at 6.36%, which is low. To put into context, it suggests we see a 49-pip move, in either direction from 108.75 (the current spot price), and statistically offers a 68.2% degree of confidence that we see price moves contained in a 98-pip range through that time.

USDJPY set-up looking interesting

It’s interesting to see traders closing shorts in USDJPY today, and adding longs here, with price having pushed through the 108.70 resistance, although my preference is to see if it can close (the day) through this level. We can call this an inverse head and shoulders pattern, but USD longs are working on the day.

With USDJPY IV at these levels, the market feels on balance that Powell, while refraining from actually saying a cut is on the cards in July, will likely portray that the Fed will do what is necessary to keep the economic expansion in place. Powell will then be grilled by the House Panel on precisely what he meant in his recent speech, where he famously quoted, “an ounce of prevention is worth a pound of cure”. A-line, which, almost in isolation, compelled a handful of economists to forecast 50bp of cuts in the July meeting. It seems that ‘prevention’, in this case, is considered codeword for insurance cuts; at this interval, that most likely means 25bp – that outcome seems assured.

Why the Fed still needs to ease

A 50bp cut is certainly what Trump would class as ‘prevention’, and one could argue this is still more likely than no cut, given the tight US labour market is not feeding into higher wages/inflation. US 5-year inflation swaps are not far off their lows at 2.04%, The Fed’s own 5-year inflation sits even lower at 1.80%, and the NY Fed’s recession probability model has risen to 32%.

(NY Fed recession model – the red area represents periods of prior recession)

Of course, the Fed will look at the various parts of the bond yield curve, and when we see the 3-month/10-year spread inverted by some 18bp, so it’s fair to say monetary policy is deemed too tight.

We can even look at the recent economic data trends and see the Citigroup economic surprise index, which effectively measures how US data has fared relative to consensus. So, if the index is going down, the trend has been that the data flow has missed forecasts.

Either way, the Fed seems destined for a cut, and that should be portrayed in Powell’s speech. But if the market hears something that is off script, then we could see fireworks. As mentioned, the market is not expecting big moves, but this because we have a belief, he has our backs. Let’s see, but it is an event risk we should be prepared for.

Sign up here for my Daily Fix or Start trading now

Chris Weston, Head of Research at Pepperstone.

 (Read Our Pepperstone Review)

Asia Proves That Good News is Bad News For Risky Assets

The key risk is a market that genuinely starts to believe the global economy is spiralling out of control, and while we have seen some signs softening economics, we have not yet hit this tipping point.

The other key headwind was a market that questioned if the dovish pricing path and expected easing from the Fed and other global central banks were incorrect. Well, Friday’s headline US payrolls was a surprise, but was it a game changer? I am not so sure, but it did cause a monster 10bp move higher in US 2-year Treasury’s, and some 6.5bp of cuts priced out of July FOMC meeting. With the market having moved from pricing 31bp of cuts for the July meeting (so a 25% chance of 50bp), to now pricing in one cut.

The reaction in the S&P 500 was quite telling, and after an early bath into 2966, we saw the buyers step back in and drive the index higher, despite no real reversal in US rates and bonds. One could argue this is actually a bullish dynamic, but with a clear a hammer candle on the daily chart, a move below 2966/58 (see below) would argue that we may see equity implied volatility pick up a touch, which would just incentives increased profit taking.

The fact we are now pricing exactly one cut from the Fed feels fair, and in-line with recent commentary from Fed members Bullard and Kaplan. However, one questions whether we have genuinely moved from a debate around whether we will see a 25bp or 50bp cut at the July FOMC meeting, to a 25bp or no cut debate. In my opinion, the fact we still have a 100% chance of a cut in July is probably just enough to keep the S&P 500 on track for 3000, but a 50bp cut would almost certainly have pushed us through the figure.

And, we also have to consider US Q2 earnings season, where according to FactSet, we’ve already seen 88 S&P 500 companies issue negative EPS guidance – the second highest since 2006. So, traders are bracing for what could be a poor earnings season.

Global equities are undoubtedly expensive, but valuation has been driven by lower yields and liquidity, and this just makes this Thursday’s (00:00aest) speech from the Fed chair Powell so important. Powell will guide the market here, and his insight will shape the pricing for the July FOMC meeting, and if the Fed is looking more closely at August, as the month to ease, Powell will simply have to guide expectations accordingly. A big beat/miss in this week’s US CPI could influence too.

For those running USD positions, gold or US equities around this point, which is likely most who are reading this, Powell’s testimony is an event risk and one we should consider how any reactions affect our exposures.

Daily chart of USDJPY

The weekend news has mostly centred on the Eurozone, where we have seen a restructuring from Deutsche Bank, as well as the broad EU banking sector, given the woeful technical set-ups on so many EU financial names. There has been broad chatter on EU leadership roles, and this takes on new meaning given the ECB, and EC president may have a tough 12 months on their hands, starting with a change to an explicit easing bias in the July ECB meeting (25 July).

So, EU assets are firmly in focus over the coming 12 hours or so, with EURUSD opening largely unchanged, with little moves seen in the EUR crosses either. As it stands, our call for the German DAX open is down 37p and all eyes on how banks trade. G10 FX markets have opened on a sanguine footing, with Asia FX (KRW, IDR and THB) finding better sellers. These moves have been dwarfed by the TRY which has been smashed 2% lower on the open. USDJPY has been well traded, with sellers seen into the top of the multi-month range and this may be one to watch this week, with momentum starting to roll over a touch, but we have to go into the 4-hour chart or lower.

S&P 500 futures have re-opened the new week and sit lower by 0.2%. Asian equities have been sold fairly well here, with the Hang Seng -1.5%, while the ASX 200, and Nikkei 225 and lower by 1% and 0.8% respectively. If we look across the ASX 200, the selling has been broad-based with all sector ex-ASX tech lower, while 72% of stocks are down, with materials and financials taking 18-points out of the index a piece. Volumes have been poor though, and some 36% below the 30-day average and the selling feels like a healthy sell-off in a bullish market.

Sign up here for my Daily Fix or Start trading now

Chris Weston, Head of Research at Pepperstone (Read Our Review)

Crazy Time in Bond Land – Buy Everything Part 2

For those who didn’t see this yesterday, it feels like this chart remains central to the markets thought process:
•    Pink – global money supply
•    Red line – G3 central banks’ balance sheet and expected future trajectory
•    White line – MSCI World index
•    Orange line – Fed fund rate and future trajectory (as priced by rates pricing)

Source: Bloomberg

It’s the equity trade that has caught everyone’s attention though, as the trend seen so clearly in so many charts are a thing of beauty, and the “buy everything” mantra rolls on in earnest. How can we be short of equities with any conviction when the weight of capital is only going one way, and whether I look at market internals or positioning, there are no signs of euphoric conditions. Take the weekly Commitment of Traders report. Here, we see CFTC data showing net long positions (non-commercials accounts) of S&P 500 futures at 86,000 contracts, and even at these levels, we can see it is certainly not stretched by any means.

We have the S&P 500 making its third consecutive record high and yet only 8.5% of companies have a 14-day RSI above 70, with a mere 14% of the index closing at a 4-week high. I can look at the percentage of companies above their 50- and 200-day MA and see these sit at 76% and 73% respectively. Not at levels where the hypothetical elastic band has been pulled too far.

The fixed income juggernaut

But we have to look at the global bond market to understand why equities and high yield credit are grinding ever higher.

There is so much chatter about the pool (USD value) of bonds that command a negative yield. To put this into context, if the corresponding government were to issue bonds at these levels, they would effectively be paid by investors to do so. It is like me going to ANZ and borrowing $1m to buy a house and ANZ paying me to borrow this principle. Mad times indeed and there are no issues with buying a negative bond, as a trade, if you feel yields will go further into negative territory (price higher) and you can make a capital return. Well, as you can see, this pool has reached record levels at $13.4t.