Draining the Punch Bowl

Draining the Punch Bowl

Tuesday’s session was all about the cross-asset selling of equities, oil, and bonds as bear “steepener” returned in vogue. The USD dollar remained tethered to a yo-yo string putting in a very mixed performance.

Stocks and Bonds

Stock markets are being pulverised recording their most significant two-day wobble since Jun 24, 2016, when Brexit rocked markets.

Highflying equity markets are falling back to earth as the reality sets in that global central banks are preparing to trim their bloated balance sheets and will finally begin to drain the party’s punch bowl.

Rising bond yields head investors fear as the possibility of interest rates rising quicker than expected has stoked concerns of an extended equities market purge. Compounding the issues is that hedging becomes much more costly because of those very same interest rate expectations.

Unlike episodic bond sell-offs in 2017 that were little more than a series for a false start. The latest bond market fire sale is more than “false dawn” as the defining move on 10y UST’s above 2.70 roiled markets and has many bracing for more volatility ahead. Especially with a burdening supply of US debt issues set to hit the markets in 2018 and beyond.

Few traders expected this sudden shift in Bond curve sentiment. Also, for the most part,  they were planning to sleepwalk through this week’s FOMC. To a degree, this may have contributed to a panicky move as markets adjust to a bearish bond market sentiment after spending years riding the bull thanks to central bank largesse.

Nevertheless, investors will be watching closely for any subtle change in Dr Yellen’s language in language as any hawkish shift could cause another repricing on the rate curve and further squeeze equity markets.

Oil Markets
Oil prices slipped lower in early Asia trade after a more significant increase in US inventories than expected, according to the American Petroleum Institute.

While still holding on to fundamental positives from a crash in Venezuelan supply and OPEC compliance. The Elephant in the room is shale oil producers as their unlikely to sit idly hoping for higher prices. However, until that wave of tight oil materialises long-term speculators are unlikely to give up the plot as in the absence of a shale ramp, WTI could head north to $70.00 per barrel plus.

Gold Markets

There is no escaping this week FOMC folly, which will be the most significant driver of near-term sentiment. The Feds will keep its monetary policy unchanged. However, the makeup of the FOMC is changing so Yellen my deliver a hawkish surprise setting the stage for a possible policy pivot while trumpeting in the Powell era. Gold bears may take advantage of this move, as USD will strengthen unthinkingly. With the Central Banks taking centre stage, uncertainty around this crucial interest policy decisions will have more Gold investors taking to the sidelines until clearer signals develop.

March hike will not come as a surprise, but a quicker pace of Fed normalisation or even a shift in terminal rate thinking, possess the most significant risk to this nascent Gold rally.
Currency Markets 

G-10 traders have a terrible case of the heebie-jeebies ahead of the FOMC, and Friday’s payrolls data as the uptick in inflation rhetoric has traders thinking something will snap, or at a minimum, there will be a rapid unwinding of 2018 consensus currency trades ( short dollar vs everything ). Either way, it could be a case of picking your poison carefully and minimum getting some optionality in place regardless of the premiums.

With so much noise in the markets, it’s becoming deafening, and there is no sign of let up as we now pivot the most significant noisemaker of them all, President Trump and the State of the Union. Address
The Australian Dollar

Without wasting ink, much is riding on today’s CPI print, but with a measly five bps priced in the May RBA decision, it is too cheap relative to the current stream of economic data. Hence, the reason the Aussie is holding up well despite the shaky risk sentiments.

Malaysian Ringgit

The sudden aggressive shift higher in USD bond yields has caught more than a few investors off guard, but clarity will be a forthcoming post tomorrow mornings FOMC. If Dr Yellen indicates the Feds see an uptick in inflation pressure, this could pressure US interest rates higher and strengthen the USD over the short term.

However, since BNM is also moving on a path of interest rate normalisation, the MYR might be less sensitive to US yield than regional peers.

If that scenario plays out, then it will become a contest of economic data, and if the Malaysian economy counties to outperform, then the Ringgit should remain, stable to stronger.

Interest rates are only one part of the equation the other is equity inflow, and if the global economic environment remains risk friendly, then that will support regional sentiment.

Finally, higher oil prices remain supportive for the MYR, but with today’s drop in price, it offered little support for the Ringgit but does not weigh negative at these higher levels.

Oil prices are moving lower this after the more significant increase in US inventories than expected, according to the American Petroleum Institute (API) said on Tuesday.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Stephen Innes

Stephen Innes

Head of Trading APAC at OANDA
Stephen has over 25 years of experience in the financial markets and currently based in Singapore as the Head of Trading Asia Pacific with OANDA. Stephen's market views focus on the movement of G-10 and ASEAN Currencies. His views appear in Bloomberg, CNBC.Reuters, New York Times WSJ and the Economist. His media appearances include Bloomberg TV & Radio, BBC International, Sky TV, Channel News Asia, ASTRO AWANI and BFM Malaysia. Stephen has an extensive trading experience in Spot and Forward FX, Currency and Interest Rate Futures, Money Market Derivatives and Precious Metals. Before joining OANDA, he worked with organisations like Nat West, Chemical Bank, Garvin Guy Butler, and Sumitomo Mitsui Banking Corporation. Stephen was born in Glasgow, Scotland, and holds a Degree in Economics from the University of Western Ontario.
Stephen Innes