The Trade Week Ahead – Volatility

The macro-economic mêlée between Atlantic nations ramps up again this week – Europe is releasing CPI data and a raft of PMI pieces – the US releases is January CPI and final quarter GDP.

EURUSD has fallen back from the $1.25 handle as questions build about the impact the strong EUR is having on the European economy in the immediate term. However this week is likely to see price action centre on the USD and its possible weakness so watch for a second test of $1.25.

Chart: EURUSD

USDJPY is even more interesting having fallen to ¥106. it has bounced – however the question the market asked was: are Japanese institutional investors questioning the future of US fiscal policy? Approximately US$300 billion in additional funding will flood the US bond market at a time when the Fed is methodically reducing its balance sheet and nations such as China and Japan reassess their foreign reserves. There is a suggestion that come 2027 for the first time since WWII debt-to-GDP in the US will hit 105% suggesting a US$2 trillion shortfall. It certainly an interesting point and could explain the JPY buying at the expense of USD.

Chart USDJPY

However, the biggest macro point of the week is the first major testimony by new Fed Chair Jerome Powell.

Markets will be glued to his every word – What is his view on US growth, how will he interpret the growth in wages and the state of US employment and what is his view on rate increases over the coming quarters (or even months)?

These three questions have to be asked by the committee to give clarity and a framework for his tenure as Chair. He will need have to navigate his testimony with great skill as each question has the ability to severely impact money markets and currency markets DXY being the best overall gauge here along with the US 10 year.

We are entering a ‘twilight zone’ in the bond market – the US 10-year is itching to hit 3% for the first time since December 2013 (on a closing basis).

Crossing the magical 3% threshold will test the mantle of investors and the attraction of the risk-free rate.

(Source: Bloomberg)

The flow on effect is also likely to be in focus – how will equity markets view the risk-free rate at or above 3%?

The volatility in indices seen three weeks ago was partly triggered by the US 10 year breaking through 2.85% to 2.89%. Volatility in equity markets has since calmed as the US reporting season produced its best quarter in over 10 years which allowed stock fundamentals to drown out the macro noise – US reporting season is now over. If Powell highlights US inflation and the possible rate rises in 2018 the fundamentals of stock that suppressed volatility are likely to be shoved aside putting indices under pressure.

Watch for reactions in the currency markets and the bond markets for leads and confirmation of trends – it’s going to be an interesting week and it will certainly set up the month ahead.

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