Is the market calm here to stay?

What a difference a week makes. This time last week the markets were reeling from the escalation in the Ukraine/ Russia conflict, however, the markets were able to shrug off any fears and instead concentrate on the positives, most notably the better than expected NFP report for February, which helped risk to claw back earlier losses.

The limited impact from the Ukraine crisis was expected by some who had noted that Ukraine is not a member of NATO, thus any Russian invasion of Crimea would not have triggered an automatic international response. Added to that the crisis is starting to look a lot more complicated than the media portrayed it a week ago, and with the threat of violence out of the way for now, it could take a long time before it reaches a definitive conclusion. The market tends to shrug off on-going geopolitical issues, and the Vix index, also known as the Wall Street fear gauge, was back below its 200-day sma by the end of last week and the S&P 500 had made a fresh record high.

Are the markets too complacent?

Although it is a relatively quiet week for G10 data there are some key event risks that are worth watching out for:

1, RBNZ meeting on Thursday: the New Zealand central bank could be the first of the major central banks to start normalising monetary policy. The market expects a rate hike, which may remind the market that central bank largesse is on its way out. As this is fully expected by the market it could be good news for risk as it may drive more interest in the carry trade as NZ yields start to rise.

2, China data: Markets in Europe and the US have been remarkably sanguine in the face of weak Chinese economic data. Monday saw another bout of weak data including an 18% drop in exports for February and a decline in the money supply. Although the export data could have been impacted by the late Lunar New Year celebrations, recent economic news still points to a slowdown in the world’s second largest economy, which is weighing on commodity prices at the start of this week including crude oil and copper, which fell to its lowest level since 2010. This has weighed heavily on Chinese stocks; the Shanghai Composite index dipped below 2,000 and is back at mid-January lows (see the chart below). Although global markets have so far managed to avoid the same fate, surely a deteriorating economic picture for China could get some people thinking that S&P valuations look rich at these levels?

3, Ukraine crisis: Although the market has been fairly sanguine about events in Crimea, as we mentioned above, in our view this is unfinished business and risks emanating from this conflict could dent market sentiment. The latest reports suggest that the US could propose setting up a military base close to Ukraine, a plan that was originally abandoned by President Obama when he took office. This would likely invoke the ire of Russia and could lead to some retaliation, for example Russia blocking nuclear weapons inspectors from entering its territory, which could ignite Cold War fears.

4, US economic outlook: Although the payroll report was good and suggested that recent weakness in job growth could be down to the cold weather, we need more evidence that the US is picking up. Stocks could start to look expensive if the fundamentals are not there to back them up, especially since corporate profits haven’t exactly been record breaking of late and the S&P 500 has seen a decline in positive sales surprises after the index peaked in 2013.

A limit to risk tolerance

At the end of last week we started to see some nervousness come back into the markets. For example, although the S&P 500 made fresh record highs, the Dow started to falter at the end of the US session on Friday and US Treasury yields failed to push through 2.8%, as a mixture of relief and renewed fears keep investors on their toes. With so many conflicting macro themes, and continued geopolitical fears, it is hard to know exactly how price action will play out, which could trigger some profit taking in the coming days. For now though, the problems in China seem fairly localised (see the chart below), although time will tell if weakness in the Shanghai Composite index, which fell below the psychologically important 2,000 level earlier, could limit upside in developed markets.

Can the EUR sustain gains?

EURUSD made a fresh 2.5 year high on Thursday after the ECB was less dovish than expected; however, the failure to close the week above 1.39 was disappointing. Although a period of consolidation is normal at this stage, it is worth watching price action closely in the coming days. At the same time as the EUR broke out of its recent range, AUD and GBP have come under pressure, we will be watching to see if EUR follows their lead, and if 1.3915 is a temporary top for this pair.