Risk-assets climb on easing US-Mexico tensions, and the prospect of Fed-cuts

Markets’ sentiment reversal

A noteworthy shift in sentiment has occurred in financial markets. The short-term trend has reversed, and the tide, it seems, has turned, for now. After what was a long weekend for Australian financial markets, there is substantial and meaningful news flow to catch-up on for Aussie traders and investors. First of all, the US-Mexico stand-off over trade and illegal migration was ostensibly resolved, avoiding the risk of higher trade-barriers between those two economies. Second of all, US Non-Farm Payrolls data missed expectations on Friday night, with markets now discounting greatly a high chance of monetary support from the US Fed in the near future.

Easing US-Mexico tensions dulls volatility

It’s difficult to judge which story held greater weight. But if one looks at the markets, and the areas within those markets, that have benefited most from the de-escalation of US-Mexico trade tensions, then one might infer it was this issue that had market participants most-spooked. It was a sea of green across global equities yesterday, as traders pared back their fears of an economic slowdown in North America induced by the imposition of US tariffs on the Mexican economy. The VIX has pulled back well from its highs now, currently sitting around the 16 mark, as fear manifestly wanes in global markets.

Risk-assets rally, as investors revise growth outlook

As such: the S&P 500 added around 0.5%, the Eurostoxx 50 gained 0.24%, the FTSE100 rallied 0.59% per cent, the DAX leapt 0.77%, the Nikkei climbed 1.20% and the CSI300 was up 1.29% in the last 24 hours. Looking deeper into the price action, and the underlying dynamics of stock markets are heartening for market bulls right now. Cyclical sectors and others tied to the fortunes of fundamental economic growth have out-performed. On Wall Street, stocks in the IT sector added most to the S&P 500, while consumer discretionary stocks performed best in relative-terms.

Cyclicals climb, while safe-havens retrace

Furthermore, there has been a tangible bounce in commodity sensitive sectors, and an observable rotation out of defensives. The energy sector and materials sector gained on Wall Street, despite a pullback in oil prices and industrial commodities; and utilities and real estate sector assets were the only laggards for the market last night, in large part due to significant rallies in sovereign bond yields. The sell-off in government debt speaks loudest of the shift in market-sentiment. The yield on the benchmark 10 Year US Treasury note, for one, leapt 6.4 points, on the general shift in the long-term global growth outlook.

Greenback recovers some of its losses

The jump in US Treasury yields has supported flows into the USD. The Dollar remains well-off its highs, however the easing of US-Mexico tensions, and the subsequent revision of the US growth outlook, has resulted in seemingly counterintuitive price action. That is: the US Dollar has rallied, pushing growth currencies like the AUD and NZD down. To be fair the Dollar has shifted the entire G10 currency-space around its gravity. The Euro is in the low 1.13s, the Yen is in the mid-108s, and the GBP is back in the 1.26 handle (which also suffered from very disappointing UK GDP figures overnight).

Markets betting-big on Fed cuts

Somewhat illustrating the significance traders were placing on a potential deterioration in US-Mexico relations, the rally in US Treasury Yields and the US Dollar comes despite what is an aggressive repricing of US rate expectations. This dynamic was born on Friday night from much softer than expected US Non-Farm Payroll numbers, which revealed the US economy only added 75k jobs last month (against an estimate 177k), and annualized wage growth declined to 3.1%. Markets are now pricing in a 77% probability that the US Federal Reserve will cut interest rates in July, with 2-and-a-half cuts priced-in by year end.

ASX to play a little catch-up

After the 3-day weekend for the ASX, SPI Futures are suggesting that the ASX 200 ought to add around 26 basis points at today’s open. The data docket is looking relatively light for Australian markets today, with limited corporate and/or economic event risk. NAB Business Confidence data will be released, and will be watched for any sign of a post-election bounce in business sentiment in the Australian economy. The day’s trade may well be dictated by pure catch-up to the weekend’s events, before focus turns to a litany of global economic data as the week unfolds, as well as Thursday’s highly anticipated Australian employment data.