- Volatility has yet to take a breather
- Global record low yields the new norm
- Low yields favor the dollar
- EUR bear itching to sell more
The market has yet to take a breather early in this New Year, basically carrying on where it left off in the fourth quarter of 2014. Traders and dealers are happy that there is strong price movement from all the asset classes — bonds, equities, and FX. It provides market opportunity. Early market signs would suggest that nothing is about to change anytime soon as the market continues to print new intraday record currency highs and lows (mainly driven by central bank rate divergence), while pressuring bond yields further as tumbling oil prices dampen the outlook for inflation, and raise the prospect central banks will extend stimulus measures to boost growth. No one seems concerned with the transfer of wealth from oil producers to the consumer just yet as the price fell below $50 per barrel for the first time since 2009. Interestingly, price and yield moves are ignoring basic fundamentals. For instance, German five-year paper has been trading in and out of negative yield territory.
The CBOT VIX (implied volatility) finished 2014 about +40% higher than where it started the year. Historically, the VIX is usually inversely correlated with equities. Nevertheless, they both ended 2014 up. Last year, the VIX averaged just shy of 15 (currently north of 20 and up +4% in 2015), which is below its historical norm, but well off its lows for the year (10.28). The VIX of the VIX (or VVIX: volatility of volatility measure) has been trading above 97 for the past three months, and is now straying into territory that is leaving some investors nervous. The present equity rout is a good example, reminiscent of last October’s equity shock driven by the possible finality that the Federal Reserve will increase interest rates. As to when that will happen is another question entirely.
Low Yields Spruce up the Buck
Even government bond directions are a coin toss for many. Currently, the market seems unconvinced by the direction of U.S. yields, with lower yields currently winning out. A small percentage of the market is betting that U.S. 10’s could reach new lows in 2015 (+1.388%) despite the possibility that the Fed could raise rates in the second half of this year. Why? Lower global yields should make the U.S. market most attractive and a rising U.S. dollar adds to its appeal. Others point to the possibility of the “slam-dunk” that is the European Central Bank (ECB) beginning to act (rather than just talk) in building its balance sheet to €3T, though it may not happen on cue as expected at the ECB’s January 22 meeting. Note that the ECB’s balance sheet has already been bumped +8% from September’s levels but is still some -€850M from the target.
The currency market is being dominated by the mighty dollar while the EUR faces a three-prong attack: inflation or a lack thereof, a possible “Grexit,” and the dollar itself. The EUR is now trading at levels last seen in late 2005/early 2006, and it is providing more uncertainty to the global equity markets. The market will be looking to tomorrow’s European flash consumer-price index for further evidence of low inflation.
The Eurozone’s Modest Growth Story
This morning’s eurozone composite purchasing managers’ index (PMI) was revised to 51.4 in December (expected 51.7), providing further proof of modest growth despite businesses continuing to cut their prices. The combination of weak economic growth and low inflation maintains pressure on the ECB to provide additional stimulus, and supports market expectations that a government bond purchase plan will be revealed at the ECB’s January meeting. The composite PMI for the fourth quarter was the lowest since the third quarter, 2013, and an indication that eurozone growth has taken another step backward from its already weak pace.
The market is reporting that the ECB is eyeing three possible outcomes for quantitative easing (QE) later this month:
- Buy government bonds on capital keys
- Only buy AAA-rated paper including loans
- National central banks buy their country’s government bonds based on capital keys
If true, then the QE debate can be interpreted as shifting toward QE modalities with the ECB eager to show that it is not adding credit risk by getting member state central banks to hold the risk. Perhaps a greater concern is that QE could be announced ahead of the ECB’s January pow-wow but with few details. The final result for this month’s highly touted ECB meeting could end up being an uneasy compromise on criteria, terms, and magnitude of eurozone government bond purchases. ECB President Mario Draghi will not want to, nor can he afford to disappoint the market. Deflation, low inflation, and the bank’s market reputation are all at stake from his perspective. Many analysts have noted that the president may find himself “over compromising and under delivering.”
EUR Bears Begin to Growl
The EUR (€1.1900) has again turned south. Market consolidation was always expected after the massive break of the psychological €1.2000 on the weekend. So far, the EUR’s solid downtrend has made any recoveries rather weak. The International Monetary Market futures would suggest that there is even more room for EUR speculators to go shorter. Current future EUR shorts are still -15% below last year’s peak and -30% below the 2012 record. The obvious risks from Greece exiting the eurozone, and the ECB meet, should keep rebounds relatively weak. Option and corporate EUR bids below €1.19 will provide some temporary support, but algorithmic or black box stop-losses ahead of yesterday’s Asian low €1.1860 could prove attractive. The market needs to breakthrough this level with conviction for greater bear action. This will certainly open the way for the January and February lows of 2006 (€1.1800 and €1.1826).
U.K. Data Pushes Rate Hike Back
The EUR is not alone on the disappointing PMI front. Business activity in the U.K.’s dominant service sector sputtered in December. It has weakened to 55.8 from 58.6 in November, solidifying the lowest reading in 18 months. The slowdown mirrors a disappointing December for both U.K. construction and manufacturing. The weak headline suggests that economic growth in the U.K. has slowed further in the final three months of 2014 to a quarterly rate of +0.5% from +0.7% in the third quarter. The data should put pressure on Bank of England (BoE) Governor Mark Carney not to hike rates anytime soon. The market has been pricing in a BoE rate hike for later this year. However, the survey shows signs of stronger wage growth, a key component watched closely by the BoE. For Prime Minister David Cameron, the report is not good news, as his Conservative Party will be fighting to win a general election in the second quarter with a focus on growth.
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