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Abu Dhabi, UAEMonday 25 June 2018

Optimism returns to the markets but volatility is far from over

Global equities will remain fragile as they continue to be driven by Trump's policies on trade

Traders Michael Milano, left, and Gregory Rowe work on the floor of the New York Stock Exchange. The Dow dropped 3.68 per cent in March with volatility continuing this month.  Richard Drew / AP
Traders Michael Milano, left, and Gregory Rowe work on the floor of the New York Stock Exchange. The Dow dropped 3.68 per cent in March with volatility continuing this month. Richard Drew / AP

Risk appetite was severely eroded across financial markets as Donald Trump ramped up his tough trade rhetoric, this time targeting China with tariffs on $100 billion worth of Chinese imports. This action follows Trump’s earlier action in March when he introduced aluminum and steel tariffs. If history hasn’t taught us valuable lessons already, trade wars do not work.

Since the announcement, the Dow dropped 3.68 per cent in March and the volatility has continued this month in the US equity markets. The Chicago Board Options Exchange (CBOE) Volatility Index, also known as the VIX, moved above 21 levels for the first time since August 2015. The VIX, commonly referred to as the “fear gauge” is a widely used measure of the stock market’s expectations of upcoming volatility, formed by data compiled by S&P500 index options.

Since the start of this week, optimism has returned as Trump fired a more friendly Tweet towards China, while his treasury secretary Steven Mnuchin reiterated that he doesn’t expect a trade war. This was followed by Chinese President Xi Jinping saying on Tuesday that his government would significantly lower tariffs on vehicle imports. As a result, markets twerked higher with equities and the dollar gaining on the welcome developments.

However, watch for market volatility to continue, driven by these developments, and expect to see US equities and the Dollar Index remain particularly fragile should things escalate further. Neither the index or US equities have sustained a long enough rally and we expect the index to range between 88 and 90.50 levels through the middle of April.

Similarly in US equity markets, the Dow Industrial still looks primed for further downsides. The Index recently hit five-month lows and the daily swings don’t bode well on the daily charts. Watch for 23344 as a key support level on the Dow Jones through the next week or so.

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Read more from Gaurav Kashyap:

US dollar weighed down by trade and interest rate policies

Fed has enough ammunition to fire up interest rates once again

US dollar breaks its three-month losing streak

US dollar weakness to continue due to political gridlock

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US nonfarm payroll data released last week came in with an abysmal 103,000 new jobs added in March - well below the forecast 193,000 new jobs. The sharp losses in jobs were attributed to weather-related causes. Perhaps the diamond in the number was the increasing average hourly earnings, which increased to 0.3 per cent - up from estimates of 0.2 per cent. The news was a bit of a non-factor as markets instead focused on the developing trade war theme.

Looking at how markets will respond to US data in the upcoming weeks, we can expect the data points to drive markets in the immediate short term, however the longer term will be driven by future policy from Washington. Markets are all but pricing in two more rate hikes from Fed chair Jerome Powell, and unless the interest rate picture drastically changes, the Fed theme won’t be a major driver of forex pricing in the months ahead.

My dollar bearish bias continues through this month as I expect to see a move towards 1.25 in Dubai Gold & Commodities Exchange (DGCX) EUR/USD contract. This move could materialise before the European Central Bank rate decision and Mario Draghi conference takes place on April 26. Similarly, look for more upsides in the British pound against the greenback, with DGCX’s GBP/USD contract set to make another test of those 1.43 levels. The Canadian dollar has made up some ground on the US dollar over the past few weeks; I maintain my medium-term short position in USD/CAD with a move towards 1.23 by the summer.

Some of the key numbers due out on the economic calendar include Wednesday's US inflation reading, followed by the Federal Open Market Committee meeting minutes. Inflation data from the UK is due out on April 18, while the Bank of Canada will also be announcing their interest rate decision on the same day.

It may prove prudent to see further developments pan out between the US and China before building any positional trades; instead perhaps the attached volatility would provide good intraday trades.

Gaurav Kashyap is a market strategist at Equiti Global Markets