Friday Focus: Calm confirmed though with a few loose ends

Global equities are on course for the first week of gains out of three, though loose ends in outlook for risky assets are keeping investors vigilant.

VIX falls into line

Amongst the positives: volatility structure turned benign overnight. Backwardation – when front-month VIX futures are higher than the spot – has passed. AKA, short-covering is done. Recall that whilst the vol. squeeze was contained, risks that it could metastasize gave the correction a panicky edge. Still, although panic is now at bay, underpinned gold and yen prices and unabated government bond and dollar selling are making the relief feel incongruous. A balanced view should include Moody’s confirmation last night that declining U.S. corporate default rates continued throughout the turmoil. Defaults are expected to keep heading lower into 2019, partly supported by the firm profit outlook. Only a stock market relapse could throw a spanner in the works, says Moody’s. All told, the best guess about the visible horizon is that stock markets have resumed their upward run—though emergency preparedness kits at the ready.

Stock market calmers

Japan’s Nikkei can also now be scratched off the sick list following a second rising session after belatedly joining the rebound, possibly helped by re-nomination of Haruhiko Kuroda as head of Japan’s central bank. To make the tacit monetary message clearer, a younger deputy was also appointed Masazumi Wakatabe, an even bolder exponent of extraordinarily accommodative policy. Positive calm wafted through South Korean markets, Hong Kong and Australia too, though soft mining earnings trimmed some of the latter’s weekly gain. Earnings disappointment has yet to catch on in Europe, hence a more solid tally for the week is in the offing here. Europe’s STOXX is still down about 6% from its January peak, but has seen its best week since December 2016; that should be worth some additional momentum from Monday.

Yen in spotlight

The yen remains the epicentre of global dollar selling. A new cycle low of 106.015 overnight—keeping up the pattern of speculative attacks in Asian liquidity as per the last several weeks—suggests a test of the 105 handle is on the cards. Perhaps the best way to see the yen’s rally is that it’s more reflective of the spirit of the times—the dollar’s predicament—than the yen wearing its traditional guise of safe-haven (Note the BoJ news was ignored). USD/JPY’s reversal high on Friday was 106.2. The dollar above there could begin a rethink of the sell-off.

Sterling eyes May, euro near ‘Draghi High’

The pound is holding on to most of its 2% weekly gain, though Friday’s reversal at $1.411—near another failure on 5th February—keeps things interesting. Retail sales reaction was immaterial. The focus now is PM Theresa May meeting Chancellor Merkel on Friday. She will probably also have informal contact with EU chief negotiator Michel Barnier. Hence cautious GBP/USD offers are appearing. The hourly low from Thursday at $1.4071 has broken. Thursday’s kickback low of $1.4020 is the target for many. Euro also retraces some of its advance to a new three-year high with over 2% under its belt for the week. The euro’s bugbear remains $1.2569—the ‘Draghi high’ from the last ECB meeting. But the rate is not done with challenging it in the near term, as momentum oscillators have unwound quite a bit whilst the uptrend is unbroken.

Who’s afraid of the Big Bad 3%?

After another week when the dollar/Treasury yield correlation has stayed broken, even relentless selling of U.S. government debt look less sinister. At this point it would be difficult to find market participants who don’t see 3.00% on the 10-year as a dead cert. (The yield is inching ever closer; another new four year high at 2.9134 overnight). Some of the charge from the inevitable has dissipated, helped by economic readings and fiscal intent. We still expect a market flashpoint when 3% arrives but not much sense of crisis.

The rest of Friday

A snapshot of U.S. consumer sentiment so far in February looks like Friday’s sole remaining economic highlight. The University of Michigan’s series is important, but never pivotal. So with markets having withstood this week’s inflation shock, stronger negative surprises would probably be needed to shatter the cross-market calm. Any disappointments in Coca Cola Co. and Kraft Heinz earnings reports will probably be shrugged off, overall.