Volatility remains elevated, as markets turn to a week of Central Bank events

Risk appetite lifts on Friday, but markets still nervous

Global stock-markets rallied on Friday, while bond markets sold-off, safe-haven currencies dipped at the expense of risk-sensitive ones, and growth-tied commodities edged higher, as some level of fear abated in the market about the consequences of a looming, global economic slowdown. The moves overall did little to unwind the price action of last week as a whole. Overall, investors and traders still find themselves operating in an environment where the global growth outlook is dimming, and sentiment is very bearish. Central bank related news dominates the week ahead, with hopes now that they’ll be able to soothe some of these concerns by promises of extraordinary policy intervention.

Interest rate cuts a-coming

Of course, as it always happens to be in some way, market action is being dictated by the interplay between what’s happening in the global economy right now, and how central bankers will adjust policy to address that. A continued slowdown in economic growth is all but assumed, at present. However, the ambiguity, and as such fear and uncertainty, in the market is what central bankers are able to do to tackle this. Wherever you look, market participants are betting on imminent policy support. Interest rate cuts have been priced-in the next two months from the Fed, ECB, RBA, BOC and RBNZ, to list but a few.

Bond markets suggest slow-down – and money printing

Not only that, but it looks increasingly so that, given the lack of ammunition these central banks possess when it comes to traditional interest rate cuts, they will have to dust-off the old-money printing machines, and resort to a fresh round of quantitative easing. Just as much as a search for safe yield, it’s this expectation – unfounded or otherwise – that’s pushing global bond yields to extraordinary lows. US Treasuries are yielding less than the overnight cash rate all the way out for 30 years. While the 10 Year German Bund, and 10 Year Japanese Government Bond, is yielding -0.69% and -0.25%, respectively.

Search for safety hurting AUD, heating the USD

That’s driving some reasonably funky behaviour in currency markets, as a search for yield gives way to a search for safety. The Australian Dollar is trading around 67 cents consequently, and the Japanese Yen is benefitting from the flight out of growth-sensitive currencies. But the burgeoning dynamic, and one that could fan market volatility going forward, is a pulsating USD. It’s attracting capital both because of safety and yield, as holding safe German Bunds and Japanese Government Bonds become less appealing. A rapid break-out in the greenback could cause another shake-out in global risk assets – in stock markets, emerging markets and commodity markets.

Commodity markets still speaking the truth

As it applies to commodity markets, there is a curious and uncomfortable marriage between the USD and gold prices now, with both rallying on the anti-risk sentiment. It’s looking like a relationship that may continue to defy conventional wisdom too, as the swelling pool of negative yielding debt keep traders bullish on both. In other commodities though, the essential, tangible fear of slowing global economy can be seen. Oil prices are still drifting lower, even despite OPEC members providing explicit assurances to control prices. And Dr. Copper is still trending lower, portending weaker economic activity in the months to come.

Global stock markets remain vulnerable

Stock markets themselves, as the unreliable barometers, in the short-term, of real-world fundamentals, are behaving in very erratic ways. A piece of folksy wisdom that’s thrown around in the market a lot: the biggest rallies can be found in the most bearish of markets. Such is the dynamic still in global equities right now, with the S&P 500, DAX and FTSE all rallying close to, or greater, than 1% on Friday. Sentiment ought to be closely watched to get a proper feel on how sustainable these sorts of rallies are. The VIX is currently elevated, at 18, suggesting an anti-risk, downside-bias in stock markets still.

The week’s key question: can central bankers bring the goods?

Barring random Tweets, or any other unwelcomed surprises, this week will be focused on the release of monetary policy minutes from the Fed, ECB and RBA, as well as a big meeting between central bankers in the US. The most essential issue for markets in these events is: will central bankers finally deliver to the market the forward guidance already being implied by traders in market pricing? If they bring the goods, then that could go some way to easing the fear plaguing the market right now. If they don’t, then that fear could be compound further, opening up the possibility of greater volatility.