Getting Paid To Be In The Market
IG | Mar 02, 2016 11:56PM ET
The theme of the last 12 hours has been lower volatility, and naturally traders and investors have been asking whether we are in for a prolonged period of low volatility.
Looking at the US volatility index (the ‘Vix’) we can see implied volatility in the S&P 500 has fallen 4.6% to 16.88, however this is still in line with the 12-month average. The ASX volatility index has also pulled back in the last few days to 20, but again this is still hovering around the 12-month average and a 17% premium to the 5-year average.
AUD – The perfect storm
One just has to look at the price action in the S&P 500 last night, where we saw the index trade in a 18 point range, while the Dow traded in a lowly 134 point range. Low volatility and positively trending equity markets (the S&P 500 closed on the day’s high) means hunting for yield and being paid to be in a position. That was seen clearly in the Aussie banks yesterday. With such bullish price action front and center in the FX markets, the AUD is now looking really strong.
AUD/USD has drifted to the $0.7300 area, but the real action is in the crosses where EUR/AUD and AUD/JPY are moving far more aggressively on a risk-adjusted basis. Investors can pick up a 1.85% yield in an Australian 2-year bond relative to a negative 55-basis-point yield in the German bund and a negative yield out to 10 years in Japan, so naturally this favors the AUD. In fact, adjust bonds for inflation and one can still get a positive ‘real’ return in Australia if we push further out the maturity curve. The greatest risk for the AUD one senses is renewed CNY weakness.
There are not many economies who can say that, so in times of lower volatility reach for the AUD. If the RBA ever really wanted to get the AUD down, they would need to flatten the yield curve aggressively. This isn’t going to happen!
Australia January trade data is released at 11:30. Expectations are for a modest improvement in the trade deficit (consensus –A$3.2 billion), although I suspect the AUD won’t be hugely sensitive to the print.
When we consider the ongoing rate hold at the RBA and another 2% rally in the iron ore price overnight, you then have the perfect recipe for AUD appreciation. Take a look at the daily chart of high grade copper as well, which often leads the Aussie. The bulls are fully in control of this move and the trend is certainly your friend. It goes hand-in-hand with the steeping of the fixed income curve in Australia and the US – i.e. the world is not such a bad place.
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The ASX 200 to test recent highs again
The ASX 200 will naturally feed off the US lead, but should be supported given the underlying strength – our call is for 5040 . Japanese markets will likely open modestly lower, so if we see traders look to support this index from the initial fall it could support S&P futures, which in turn should be beneficial for Australian equities. I do feel that moves to 5055 on the ASX 200 will be faded, should we get there today, as the trend is still sideways and conditions dictate that two standard deviations from the 20-day moving average could result in mean reversion. A close above the February 23 high of 5037 would be positive though.
Oil has been fairly whippy, but the net effect is a modestly higher price, with US oil currently trading at the top end of its multi-month range. Sizeable conflicting forces were at hand with a sizeable 10.37 million barrel increase to inventories (reported by the EIA), relative to a strong 6 million decline in production. Exxon (NYSE:XOM) reducing output is certainly aiding this bid in oil. Aussie oil plays should do nicely on open, while BHP should open 3% higher based off its ADR’s performance.
China will be a key focus and many will be preparing for this weekend’s National People’s Congress. Traders, economists and investors will be primarily focused on the GDP target for 2016, where all the talk has been that they will set a 6.5% to 7% growth target. Today’s CNY ‘fix’ could be a focal point and will get more attention with the market devoid of a strong lead. In the US we get jobless claims, factory orders, durable goods and the highlight will be services PMI. After a strong ADP payrolls report last night (214,000), keep an eye on the employment sub-component, as this is the best lead for Fridays payrolls report (consensus 195,000).
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