A confluence of factors are raising anxiety levels among investors, and it is being expressed in heightened volatility. The S&P 500 was turned back yesterday
from the key 1945 level, and global
equities are falling today. The over-production of oil is set to
continue to Saudi Arabia denies intentions to cut output, and the Iranians scoffed at suggestions of freezing output. API reported another large rise in
US crude stocks, which points to upside risks on the consensus estimate for 2.4
mln barrel build in today's official Department of Defense report.
Sterling's
slide remains the continuing feature in the foreign exchange market. Brexit fears dominate. It has
convincingly broken the $1.40 level and is trading near $1.3915. It has
lost about 3.4% this week already. In
terms of economic impact, sterling's trade-weighted performance is key. The Bank of England, effective exchange rate measure, has fallen 8.7%, of which
5.4% has been recorded this month alone.
UK officials
are likely more concerned about the pace of the move than the direction. The pass-through
to inflation may take several months provided it is sustained. To the extent that there is a trade advantage,
it likely takes even longer to be seen.
Not only is sterling being sold in the spot and forward
market, but some investors seek protection in options market. Implied volatility is rising, which suggest puts
being bought rather the calls being sold.
Three-month implied volatility is near 11.5% today, up from 8.7% at the
end of last year and 8.9% at the end of January. Last April, three-month
implied volatility spiked to 12.5%.
In the options
market, puts and calls equidistant from the forward strike should be similarly
valued. To the extent they are not reflects a market bias. Three-month
sterling calls are selling at a 1.5%
discount to puts (risk-reversal). This is
the biggest discount since last May. Last April the discount was near 3%.
The takeaway from the options market is that the
pace of sterling's decline and the market's anticipation of further declines,
as reflected in the risk-reversal, do not show sterling
at some kind of extreme, even though the
market is stretched. In the spot market, sterling is trading well through
its lower Bollinger Band (~$1.4025), which is
set two standard deviations below its 20-day moving average. Three
standard deviations from the 20-day moving average is near $1.3850.
What Churchill
said about the Americans, that they can be counted on to do the right thing
after exhausting the alternatives might apply to
the UK now. The
event markets and many polls still point to the UK staying in the EU.
However, because of the significant
potential impact of Brexit, sterling exposure is being pared and hedged,
and based on discussion with numerous market participants, we suspect that it
is too early to try to pick a bottom in sterling (against the dollar and crosses).
The euro is
being dragged down by Brexit fears, though to a lesser extent than sterling. The euro is off 1.3% this week.
Today's losses have seen it fall back below $1.10 for the first time
since 3 February. While the UK may suffer on Brexit, there is some
concern about the fallout for the eurozone.
There have been some reports warning that Brexit, which would be the
first departure from the EU, and could be a catalyst for others leaving, or
injecting uncertainty by holding their own
referendum.
The euro area
has challenges outside of the UK and Brexit. The refugee crisis is proving
intractable. The flash PMI warned of weaker output, orders, and prices. While Draghi is
talking a tough game, the scars from the market's disappointment with the move
in December are still fresh. While participants are paring back euro exposure, they do not seem to be piling into shorts as they did last November.
The euro's push
below $1.10 has extended to almost $1.0975. We pegged the initial target near $1.0950
yesterday, but see the risk of a return to the lower end of the previous range
which is found near $1.08.
The yen to
respond to market developments in a asymmetrical fashion. The earlier gains in equities and US yields did not exert
much downside pressure on the yen. However, the weakness in share prices
and the pullback in US yields have given the yen a bid. The dollar eased
to JPY111.65, slipped marginally below the low on February 12, and bringing the
February 11 low, just below JPY111.00, into view. We have suggested initial
scope toward JPY110.50 and recognize the psychological significance of JPY110.
We remain
impressed by the low level of verbal
intervention by Japanese officials and the absence of material intervention. On a trade-weighted basis, the yen has appreciated by
about 7.5% this month, which is a substantial shock. It is tantamount to
some degree of tightening, and when coupled with the 10.3% drop in the Topix,
it is even greater. It would seem to add pressure on the BOJ to cut rates
further as early as next month.
The US economic calendar
features the Markit’s preliminary service and composite readings and new home
sales. The reports are not typically
market-moving. Three Fed officials speak Lacker, Kaplan,
and Bullard. It is widely recognized that a March Fed hike is very unlikely, but
many, including ourselves, think it is premature to rule out a June hike.
The S&P 500 is set to
open lower, following yesterday’s poor
session. We note two downside gaps.
How the S&P 500 trades around these gaps may offer important insight into the technical
condition. The first is the gap created
by Monday (February 22) higher open. The
gap was entered yesterday but not closed.
The lower end of the gap is comes
in near 1918.80. The S&P 500 also
gapped higher on February 17. That gap
is found between roughly 1895.75 and
1898.80. Indeed,
the risk today is a gap lower opening which would a particularly negative development if it is sustained, leaving a two-day island gap in its wake. Yesterday’s low near 1919.45 is as important as the lower levels cited here.
Market Anxiety Heightened, Oil and Stocks Head Lower, Sterling Can't Catch a Bid
Reviewed by Marc Chandler
on
February 24, 2016
Rating:
Reviewed by Marc Chandler
on
February 24, 2016
Rating:
