Where will further volatility come from?
We have once again entered into a period characterised by data-driven market moves. Markets until only recently seemed comfortable with how future dated contracts had been priced. This was true of most assets from FX forwards, volatility indices including the VIX, equities and treasuries. Despite most developed economies having deeply inverted yield curves signalling enduring recession risks, market pricing at least had stabilised, albeit within a pessimistic equilibrium. Since data surprises in the United States and the Eurozone, that equilibrium has been disturbed.
The catalyst provided to US data was to challenge the market’s view that US yields were due to peak. The June pause widely expected by the Fed had allowed further hikes to be priced out of the curve once again. However, particularly strong economic data from the USA forced investors to question whether robust US fundamentals would sustain still above-target inflation levels. Rising front-end rates translated within FX into stronger long-USD forward points and in the case of some currency pairs it has delayed the point at which forward curve inversion takes place. This will change forecasts for H2 and beyond as investors adjust to the costs of relative currency plays.
The opposite disturbance has undermined the terminal rate in the Eurozone. Weak data, beginning with PMIs within core eurozone economies forced investors to question whether the ECB could afford, and from a more optimistic lens would even need, to raise rates to the degree previously expected. The disturbances created within market pricing by even low-salience data readings has left investors looking more closely than ever at data release dates. As recently as yesterday, ISM manufacturing, construction and services data brought volatility within USD. Yesterday’s price action confirms that the major source of risk and volatility for the short term outlook will be within data.
Discussion and Analysis by Charles Porter
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