Markets welcome the return of volatility

​​​​​​Today's news headlines:

  • ‘No-Deal Brexit becomes battlefront in UK Tory leadership race’. Leadership candidate Dominic Raab has threatened to bypass parliament and take Britain out of the EU without a deal if necessary to achieve Brexit by October 31st. All four candidates speaking at Tory hustings yesterday have ruled out bringing Brexit Party leader Nigel Farage into their negotiating team; however, Raab would consider working with him. (Bloomberg)
  • ‘US and Mexico fail to agree deal to avoid tariffs’. The US and Mexico have been unable to agree a deal to avoid tariffs on Mexican exports despite concurring on the need to curb illegal migration flows. Donald Trump tweeted that not enough progress had been made to stop tariffs coming into play on Monday. Meanwhile, senior Republicans and Democrats may come together to try and veto the move. (Financial Times)

Gyrations

After months of very little change in markets, the past week has been unexpectedly volatile. Each new provocation has caused gyrations across assets classes that are not simple to explain. Given this series of sometimes contradictory moves, we think it is worthwhile reflecting on the lay of the land now that things seem to be moving in a more consistent direction.  

  • The first day of June proved to be a low for most equities, which have rebounded to varying degrees throughout the week. The S&P 500 is up 4.0% from those lows. The dovish tone which promises fundamental support has certainly been of help to bolster confidence. The exception to this trend is Asian—excluding Japan—which has remained flat or continued to decline partly due to increasing trade tensions and partly due to holiday closures of markets. 
  • The sovereign bond markets are a more nuanced picture. US Treasury yields have rebounded from lows, mostly due to trade fears, but the risk-off tone remains strong. Japanese Government bonds—the alternative safe-haven asset—have gained from the US Treasury retreat. 
  • Oil demand might be waning as well, introducing supply glut worries. Gold, the barometer for market tension, has been steadily increasing towards five-year highs.   

It’s a muddled picture with flights to safety alongside gains in risk assets. We sense that one of these will give way to the other, and only the news flow and Donald Trump’s Twitter feed can determine the outcome. 

Bottom line: The currency picture is confused, but the risk-off tone which seems to dominate overall tends to favour Dollar appreciation, despite the US being at the centre of geopolitical tensions and likely loosening of monetary policy. What appears to be clear is that volatility has returned to markets.

How will the ECB follow suit?

Central banks across the globe have shifted guidance away from interest rate hikes as downside risks to global growth linger. Earlier this week, three key Federal Reserve officials signalled a willingness to cut interest rates, while Australia cut its interest rate for the first time in three years. Today, the focus is on the European Central Bank (ECB) as it announces its latest interest rate decision followed by the all-important ECB Press Conference with Chief Mario Draghi. The ECB has limited tools to provide monetary stimulus since its interest rate has been stuck at 0.0% since 2016, and it has already undergone a massive quantitative easing (QE) operation. There probably isn’t scope to change interest rate policy, but the long-anticipated lending program may get some fresh airing. So far this week, the Dollar index has pulled away from year-to-date highs, and the Euro has climbed on news of this global shift in monetary policy guidance. Today, the ECB may provide a key reason for the risk-on trend to continue as markets anticipate future monetary stimulus.

Bottom line: Central banks all over the world are showing signs of favouring monetary stimulus in the current economic climate, this shift may gain traction as the ECB announces its interest rate decision today, and may provide more light on its already announced upcoming batch of cheap lending.

GBP/USD

Pessimism around the poor US ADP Employment Change figure was short-lived as the pair broke below its recent upward trajectory in late trading yesterday. The Pound index traded relatively flat yesterday into this morning ahead of Bank of England (BoE) Governor Mark Carney speaking later.

GBP/EUR

The pair moved higher yesterday as recent support for the trade-weighted Euro index fell away following the EU’s disciplinary proceedings regarding Italy’s spiralling public debt. The Euro continued its decline into early trading today ahead of the ECB policy statement and press conference later.

EUR/USD

A combination of US Dollar selling bias and strong Eurozone Purchasing Managers’ Index (PMI) prints moved the pair higher in early trading yesterday. The Dollar then found some support following a good ISM non-manufacturing reading pushing the pair 80 pips lower than the high of the day.