S&P 500, EURUSD, Yield Curve, Fed, Dollar and AUDUSD Talking Points
- The Trade Perspective: USDJPY Bearish Below 121; AUDUSD Break from 0.7550 to 0.7450 Range; Crude Oil Bullish Above $100
- Data from Russia and energy prices offer important insight into the effects of the 39 day assault on Ukraine, but monetary policy may be a more pressing theme
- While the RBA decision is most prominent, key dovish Fed speakers and US ISM service sector report may be the most important update amid yield curve inversion
Plenty of Threats but a Market Running with a ‘Low Risk’ Reading
We have kicked off the first full week of the month of April and the second quarter with a broad yet uninspired boost in risk assets. With so many active headwinds confronting this market – inflation, interest rates, growth forecasts, Russia, etc – it is difficult to envision a systemic bull trend truly taking over. Nevertheless, the S&P 500 advanced 0.8 percent while the Nasdaq 100 charged 2.0 percent higher through Monday’s close. That move was supported by similar drift from global indices, emerging market benchmarks (eg EEM), junk bond measures (eg HYG) and carry trade. Speculative conviction doesn’t always arise from a singular or convincing catalyst, but we don’t seem to be on the technical cusp of a bigger market run from the likes of the S&P 500. We are trading comfortably within last week’s range while the SPDR ETF – one of the most heavily traded derivatives in the world – notched is lowest volume of the year.
Chart of SPDR S&P 500 ETF with 20-Day SMA, Volume and 1-Day Rate of Change (Daily)
Chart Created on Tradingview Platform
Another point of serious disparity for me in market-based confidence comes from the implied measure of risk from the VIX. The volatility index derived from S&P 500 options (download our intro to options guide here) has been dubbed the ‘fear index’ for its inverse correlation to the underlying index – in other words, it tends to rally when capital markets are seen experiencing – or are expected to face – risks. While the stock market has advanced the past three weeks, numerous fundamental threats are very close at hand. That said, the lowest reading from the volatility index since January 12th seems more the performance of a lagging rather than a leading measure. Such discord doesn’t mean we have to reverse imminently, but it does suggest the market is poorly positioned for fresh shocks.
Chart of VIX Volatility Index with 20 and 200-Day SMAs (Daily)
Chart Created on Tradingview Platform
Fundamental Updates: Russia; Monetary Policy and Growth
In assessing the market activity level and direction moving forward, we need to take stock of the biggest, unresolved risks in the system. The Russian invasion of Ukraine has passed its 39th day and the human toll continues to grow. The amoral markets, however, are responding more to the economic and financial implications. It may seem that we have moved past this theme as an ongoing threat with the this past month’s recovery, but there are more abstract risks that have not been fully registered. Commodity price inflation as a result of the war and sanctions continues to play out with WTI crude oil bouncing back above $100/barrel before reaching the midpoint of its December 2021 to March 2022 run. Gasoline, liquid natural gas and grain futures are even less relenting. The broader financial toll Russia’s disconnect from the global system carries serious risk itself and is not at all clear. The country paid off three quarters of a $2.2 billion bond payment, but there wasn’t ready word of the balance being cleared – something that risks default. Then there was JPMorgan’s CEO warning that the conflict could cost the world’s largest bank as much as $1 billion. These are the more macro concerns I have, but I will nevertheless watch for the release of the country’s own March PMIs from Markit.
Chart of Major Macroeconomic Events
Calendar Created by John Kicklighter
If you are looking for a fundamental theme that can generate more consistent traction in the markets, I believe monetary policy will continue to press both relative valuations of regional assets as well as collectively influence the view of risk/reward across the entire financial system. In monetary policy, the rise in costs for commodities is passing through to consumers and prompting major policy authorities to respond with benchmark rates and adjustments to their stimulus programs. The markets have been very efficient at pricing the former, but the plans and implications of quantitative tightening seems nebulous to how the market is assessing risk. On that front, meeting minutes from the Fed, ECB and a few other central banks this week can offer some critical insight. Over the weekend, even members from the notoriously dovish ECB were discussing the end of the QE program and rate hikes thereafter around Q3 – though Chief Economist Lane hedged his bets owing to uncertainties.
Chart of Central Bank Monetary Policy Stance with Rate Forecasts
Chart Created by John Kicklighter
The Markets With the Most Potential and the Sleeper Theme
Putting themes to function, there are specific markets that I will be looking to in order to reflect the fundamental themes. In general, there doesn’t seem an urgency to resolve the general tension in sentiment; so I don’t hold explicit expectations for the likes of the S&P 500. That said, there is distinct potential from event risk like the RBA rate decision. The market has fully priced in no change at its Tuesday meeting but is also certain of a move in June. Such conviction on both sides presents opportunity to surprise in either direction. For AUDUSD, that looks like a break from a narrow range, but EURAUD is stretched to the downside, helped along by the Euro’s own tumble. EURUSD slid this past session back below 1.1000, but a true break is still ahead of us. That said, I am also keeping tabs on the Fed speakers scheduled Tuesday afternoon (in particular Lael Brainard who is perhaps now the most dovish member) as well as an eye on the headlines from the BOJ and Japanese Ministry of Finance. The potential for intervention on behalf of the Yen seems high.
Chart of EURAUD with 20-Day SMA (Daily)
Chart Created on Tradingview Platform
While monetary policy is a comprehensive enough fundamental theme ahead, I will also be watching very closely the headlines and trade room chatter around growth. A slowdown in economic outlook has not been enough to shake this market lately, but the word ‘recession’ has been floating around more aggressively as of late. That is in part due to the inversion of the 2-10 yield curve (the difference between the 10-year and 2-year US Treasury yields). When that particular part of the curve flips, many investors interpret as an advance recession warning. The track record of the signal is pretty good over the past half century. The negative reading through Friday surpassed the September 2019 slip and is comparable to 2007. If the US ISM service sector activity report for March due Tuesday in the New York session extends the rapid drop of the past few months; this backdrop can put a match to considerable fundamental fuel.
Chart of the US 10-Year to 2-Year Treasury Yield Spread, Services and Mfg ISM Activity (Monthly)
Chart Created by John Kicklighter with Data from FRED and ISM
