Markets Skip Political Tension, Focus on ECB and QE

It’s been a quiet overnight session as the market contemplates the weekend’s Italian Referendum and Austrian elections results.

Italy’s referendum was strongly defeated, and investor response was ho-hum – the expected volatility was settled within three-minutes, for Trump it took three-hours, for Brexit three-days.

Political risk from Italy has not spread beyond its borders as markets were correctly positioned for the “anti-establishment” sentiment. Also aiding to curb volatility is the fact that the current coalition-backed government may remain in power with a new PM and a cabinet-reshuffle. Nevertheless, there still remains the problem of the Italian banking sector with extremely high non-performing loan ratios.

Net result, the global risk sentiment that roared back after falling prey to the initial Renzi fallout is somewhat subdued ahead of the U.S open.

Expect investors to turn their attention back to the monetary policy front. There are two remaining Tier 1 central banks this week to announce their rate decision – European Central Bank (ECB) and Bank of Canada (BoC).

1. Asia stocks follow the stateside lead, Europe finding traction

It’s a game of two halves over night on the equity front with Asian stocks posting their biggest rise in two-weeks as investors judged the selloff post-Italy referendum to be overdone. While in Europe, the rally could be running out of steam.

MSCI’s broadest index of Asia-Pacific shares ex-Japan jumped +0.7%, its biggest daily rise in a fortnight, ending two-days of declines. Korea climbed +1.4% while Japan rose +0.4%. Hong Kong’s Hang Seng Index added +0.8% as the Vix fell to the lowest level in 18-months.

In Europe, equity indices are trading generally higher in accordance with yesterday’s risk-on sentiment. The FTSE 100 is under-performing, as energy, commodity and mining stocks weigh on the index due to copper prices trading sharply lower intraday. Banking stocks are lending support to the Stoxx 600 ahead of the U.S open.

U.S futures are set to open unchanged.

Indices: Stoxx50 +0.5% at 3,067, FTSE -0.1% at 6,742, DAX +0.1% at 10,697, CAC-40 +0.2% at 4,584, IBEX-35 +1.2% at 8,771, FTSE MIB +1.2% at 17,248, SMI +0.5% at 7,887, S&P 500 Futures flat.

2. Crude prices under pressure, metals mixed

Oil prices are under pressure as data indicates that crude output rose in every major export region despite plans by OPEC and Russia to cut production.

The market does not expect the global supply glut problem to be so easily dealt with by a six-month OPEC agreement.

Brent crude oil futures are trading at +$54.64 per barrel, down -30c from yesterday’s close. West Texas Intermediate crude (WTI) is at +$51.39 a barrel, down -40c.

With most of the position adjustments that last week’s OPEC decision forced upon investors may now have run its course leaves the market exposed to further profit taking.

In commodities, spot gold has rallied +0.1% to +$1,171.52 an ounce following yesterday’s slump of as much as -1.7% to its weakest intraday price since last Feb. Industrial metals are also under pressure, copper and nickel are down -1.2%.

3. Fixed income skips political tension, focuses on ECB and QE

The Euro bond markets reaction to Italy’s rejection of constitutional reform suggests investors are shrugging off political tensions, turning instead to expectations that a ‘dovish’ ECB this Thursday will improve risk appetite. Core-eurozone bonds did not attract “flight-to-safety” after the Italian result; they were sold across the board.

The market is pricing in an extension to their QE program beyond March 2017. Is it too aggressive? The lack of tension in the market certainly reduces some of the pressure for the ECB to act.

In the U.S, with last Friday’s unemployment rate falling to a nine-year low of +4.6% in November makes it almost certain that the Fed will raise interest rates on Dec 14. Fed fund futures are pricing in a +93% probability of a rate hike.

4. Currencies caught in the headlights

The “big” dollar is continuing its consolidation mode in the post Italian referendum environment with the major Euro pairs little changed outright. Investors seem keen to keep it close to home until Thursday’s ECB announcement.

The EUR is holding steady at €1.0770 area, sterling is approaching the mid-£1.2750-60 area, while and USD/CHF is staying above parity at $1.0064. USD/Yen has inched higher, but is still holding below the psychological ¥115 handle where prior export orders where willing to sell the greenback.

Expect many to focus on the pound, the market is very short it, and both dealers and investors are certainly vulnerable to a further squeeze higher – the current sterling bid is being somewhat supported by a softening in the tone of U.K. politicians on Brexit.

5. RBA rate announcement

RBA left its Cash Rate Target unchanged at +1.50% (as expected).

The communiqué was largely unchanged, but cosmetic tweaks did appear. Officials noted some slowing in the annual growth rate was likely, before it picked up again. They acknowledged that global outlook for inflation was more balanced than it has been for some time, but see the global economy growing at slower pace.

Domestically, they accepted that the Aussie labor markets are mixed with strong growth in part-time sector and that inflation is to remain low for some time on subdued labor costs.

Officials recognize likely slowing in growth in Q4 before a pick-up in 2017.

AUD/USD has been trading in a relatively range post decision around AUD$0.7450, while 10-year Aussie yields back up for the fifth time in six-sessions, up +3bps to +2.82%.