Rates Volatility Goldilocks Continues

Bond

Forex

Summary:

Eurozone consumer inflation expectations will be the main data point to look out for today. Markets have become numb to central banks' hawkish comments.

Range trades are a near-term catalyst to our USD-EUR rates tightening view

The Saudi oil production cut and calm market conditions paving the way to another flurry of debt issuance are the two most salient bearish risks for core government bonds this week. That said, the Fed went into its pre-meeting quiet period with the probability of a 25bp hike on 14 June well below 50%, and we think there is little the European Central Bank (ECB) can say to really cause a hawkish rethink of its rates trajectory. We take as evidence the lack of market reaction to various officials – including Christine Lagarde and Joachim Nagel – stating that inflation remains too high. The main reasons, we think, are that markets are already pricing two 25bp ECB hikes by the end of the summer and that central banks have been explicit that economic data will determine the path for monetary policy.

We see this as a recipe for rates to remain within their range. Core bonds erased their early sell-off in the U.S. session yesterday thanks to signs of a cooling service sector displayed in the ISM services reading. Is this enough to change the prevailing narrative? It isn't, but Treasuries went into the release very close to the top of their recent range in yields which we suspect made short-term investors all the more enthusiastic about buying the morning dip. The same cannot be said of Bund yields, which started the week close to the bottom of their range, making them less appealing to range traders.

This state of play, high dollar and low euro rates, happens to contradict our expectation of narrowing rates differentials and we expect this dynamic to reverse. In the short term because the lack of market direction should limit further U.S. Treasury sell-off and further Bund rallies, and later because tangible signs of a decline in core inflation occurring in the U.S. are so far lacking in Europe. This should allow a fall in USD rates later this year, even as their EUR peers remain elevated for a while longer.

High but stable rates volatility is a boon for risk appetite

The implication for markets outside of rates is positive. After a year of being tormented by the relentless rise in borrowing costs in 2022, few investors are sorry to see yields lacking in direction. Realised and implied volatility remain high compared to their 2021 levels, but well below their late 2022 peak. Until rates make a decisive break lower on a dovish pivot by central banks, current levels of volatility can be thought of as the new normal. This stabilisation has been enough to boost risk appetite in other markets. Whether lower rates volatility is the cause or another symptom of lower macro uncertainty, it has come with valuations in some risk assets that belie recession calls.

This is visible in many corners of financial markets. Eurozone sovereign spreads, much like some measures of swaption implied volatility, are approaching their lowest levels in a year. Similarly, although the factors may also include money market dynamics, swap spreads are shedding their risk premium acquired during the latest bout of U.S. regional banking stress. At the front-end of the curve, the credit premium received by investors is painting an upbeat picture. We will stop short of extrapolating this to other markets, but a continuation of the current rates volatility status quo seems to suit most markets.

Today's events and market view

The release most likely to move euro markets today is the ECB's consumer expectations survey and more specifically the questions on their inflation outlook. Eurozone retail sales are expected to edge modestly up after their slump in March. There will also be construction PMIs to look out for from Germany and the UK.

Bond supply takes the form of a 30Y gilt sale from the UK, to which Germany and Austria will add respectively 10Y/23Y linker and 10Y/13Y bond auctions. The EU has also mandated banks for the sale of 7Y and 19Y debt via syndication.

Klass Knot, Mario Centeno, and Boris Vujcic are on the list of ECB speakers for today.

Weak factory orders in Germany released this morning add to the sense of anemic growth. We think this is more likely to result in an even more inverted yield curve in the near term rather than significantly lower rates overall as the ECB is laser-focused on its inflation fight.

Source: ING

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Samantha Luan

Forex

USD: RBA hike questions whether the Fed could do something similar

The dollar opens Europe a little weaker and is about 0.5% off yesterday's highs. The sharp drop from those highs came on the back of the softer May ISM services data, where both activity and price levels supported the US recessionary narrative and further questioned the quality of Friday's strong NFP jobs report. However, the US data calendar is now pretty quiet for the rest of this week and the market may well hold positions into next week's May CPI data and the June 14th FOMC meeting.

Delivering some food for thought ahead of that FOMC meeting was last night's surprise hike by the Reserve Bank of Australia (RBA). Having paused its aggressive hiking cycle in April, the RBA hiked another 25bp, citing increased upside inflation risks and – like many central banks around the world – frustrated that core inflation was not falling more quickly. The RBA's move to restart its tightening cycle may throw extra focus on tomorrow's Bank of Canada (BoC) meeting after paused rate hikes at its March and April meetings. A 25bp BoC rate hike tomorrow (now priced with a 43% probability) would probably cause ripples across core bond markets around the world and could keep the dollar bid on the view that the Fed might be closer to hiking than first thought. Let's see.

So while the dollar is slightly offered today, we think investors may be reluctant to rebuild dollar shorts until next week's double event risk of CPI/FOMC has been overcome. In the meantime, FX volatility levels continue to sink and the high yielders – especially the EM high yielders – are in demand. It is no doubt a crowded trade, but there is still a lot to like about the Mexican peso which offers 12.5% implied yields through the three-month forwards.

DXY should trade well within a 103.50-104.50 range today.

EUR: Volatility sinks

Both traded and realised volatility levels in EUR/USD are dipping back to pre-invasion levels in February 2022. Despite tight liquidity conditions, FX markets are taking their cue from the rates market. Here, measures like the MOVE index – a yield curve weighted index of 1-month US Treasury implied volatility –- have fallen to the lowest levels of the year, presumably on the view that the Federal Reserve will not be doing a lot with the policy rate over the coming months.

In other times, low volatility might have seen the dollar used as a funding currency for pro-cyclical trades. However, 5% overnight deposit rates make the dollar far too expensive to be a funding currency. This serves as a reminder that we need to see genuinely soft US data – particularly price data – and for the Fed to respond to it in order to see the dollar embark on a major cyclical bear trend. The steeply inverted US yield curve tells us that we are not at that point yet.

With US two-year yields holding onto around three-quarters of their rise since Friday's jobs report, it may be too early to expect EUR/USD to add to yesterday's gains. EUR/USD may trade well within a 1.0680-1.0780 range into tomorrow's Bank of Canada meeting. It may also take its cue from this week's China data, including May trade data released tomorrow and aggregate financing data later in the week.

GBP: A lot more focus on the mortgage time bomb

The UK press is spending a lot more time focusing on the UK mortgage time bomb, where 600,000+ mortgage holders are due to refinance in the next six months and could find themselves paying 400bp more in interest on their mortgages. So far, this threat to the UK consumer has yet to show up in the pricing of the Bank of England cycle, where the Bank Rate is still priced some 90bp higher at 5.40% by year-end.

In EUR/GBP, 0.8550 has been the best level of the last year for sterling (EUR/GBP bounced off 0.8565 last week) and we doubt investors want to chase sterling through those levels anytime soon. GBP/USD is consolidating in a 1.2350-1.2550 range and should stay there if we are correct with our EUR/USD call.

CEE: NBP starts thinking about rate cuts again

Today, we have a number of hard data on the calendar in Romania, Hungary and the Czech Republic. Industrial data in the Czech Republic should be the main focus, confirming the weakness of the economy. Later today, we will see a decision from the National Bank of Poland. We expect, in line with the market, that rates will remain unchanged, so the statement released later may be more interesting.

However, we will get the main portion tomorrow during Governor Adam Glapinski's press conference. The May inflation number fell from 14.7% to 13.0% year-on-year, below market expectations, and even the outlook for further disinflation is better than previously thought. The governor can therefore be expected to raise the topic of rate cuts later this year again. Although this is not our baseline scenario, our economists see an increasing likelihood of such a move. The market at the moment is pricing in roughly 80bp of cutting this year and roughly 150bp by the May meeting next year. That is more than we expect, but markets can be expected to accept the governor's dovish narrative and be open to pricing in even more easing for now.

Despite our expectations yesterday, the whole region strengthened and the positive mood after the US payroll numbers seem to have prevailed over the decline in interest rate differentials. We can expect this direction along with higher EUR/USD to support CEE FX today as well. On the other hand, as we mentioned yesterday, the Polish zloty and Hungarian forint should run into overcrowded market positioning. Therefore, we expect that the Czech koruna should benefit the most from this situation, as it can offer a more balanced market position and, moreover, has already demonstrated the highest beta against EUR/USD within the region in recent weeks, heading below 23.50 EUR/CZK for the first time since mid-May. On the other hand, a dovish NBP narrative may be seen in the Polish zloty market rather after the press conference on Wednesday only.

Source: ING

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Warren Takunda

Traders' Opinions

The Swiss franc, often regarded as a safe haven currency, experienced a depreciation against the US dollar in early June, reaching its lowest level in two months. This decline can be attributed to slowing inflation in the Swiss economy, which has dampened expectations of further monetary tightening by the Swiss National Bank (SNB). In this article, we will delve into the recent inflation figures, their implications for monetary policy, and the potential challenges facing the SNB.

Cooling Inflation Figures

During the month of May, Swiss consumer prices registered an annual increase of 2.2%, marking the slowest pace of growth in 15 months. These figures fell well below the expectations set by the central bank. Moreover, core inflation, which excludes volatile components, decelerated to 1.9%, dipping below the SNB's upper limit of 2% for the first time in 11 months. These indicators reflect a broader moderation in price pressures and contribute to a more dovish outlook for the SNB.

Policy Implications

The recent inflation data presents a conundrum for the SNB. On one hand, the central bank acknowledges that the current interest rate of 1.5% remains low, indicating room for potential tightening measures. On the other hand, the deceleration in inflation and the dip in core inflation below the upper limit pose challenges to the bank's previous expectations of further tightening.

SNB Chairman's Perspective

Chairman Jordan of the SNB has provided insight into the central bank's stance on the matter. He stated that the risks of overtightening the monetary policy are low, aligning with market expectations of a 25-basis-point hike this month. However, Jordan emphasized that inflationary risks remain on the upside, suggesting that the bank will need to strike a delicate balance between addressing inflation concerns and maintaining accommodative policies.

Market Reactions

The Swiss franc's depreciation against the US dollar following the release of the inflation data reflects investors' perception of the SNB's dovish outlook. Traders are adjusting their expectations for future monetary policy decisions, which, in turn, influences the currency's value. The recent depreciation serves as a reminder of the impact that economic indicators can have on currency markets.

Conclusion

The recent cooling of inflation in Switzerland has introduced a new dynamic to the policy landscape for the Swiss National Bank. While the current data supports a more cautious approach to tightening, policymakers believe that the interest rate remains low and that inflationary risks are still present. Balancing these factors will be crucial for the SNB in the coming months as they determine the appropriate course of action. Market participants will closely monitor any hints or announcements from the central bank to gauge the future trajectory of the Swiss franc and the broader Swiss economy.

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Cohen

Bond

Hedge funds' relentless selling of Treasuries shows no sign of abating, with the latest U.S. futures market data showing new record short positions across the curve.

Commodity Futures Trading Commission (CFTC) data show that funds amassed new record short positions in two-, five- and 10-year Treasuries futures in the week through May 30, as uncertainty around the U.S. debt limit standoff reached fever pitch.

A short position is essentially a wager that an asset's price will fall, and a long position is a bet it will rise. In bonds, yields rise when prices fall, and move lower when prices increase.

Hedge funds take positions in bonds futures for hedging purposes and relative value trades, so the CFTC data is not always a reflection of purely directional bets.

Analysts say the huge buildup in short Treasuries futures positions in recent months may be rooted more in "basis" trading strategies between cash and futures contracts rather than an outright bet on higher yields.

Whatever is driving it, the selling momentum is remarkable.

The latest CFTC data show that in the week through May 30 speculative accounts grew their net short position in two-year Treasuries by 79,661 contracts to 969,863 contracts, raised their net short position in five-year bonds by 49,768 contracts to 983,837, and expanded their net short position in the 10-year space by 78,783 contracts to 850,421 contracts. Funds Go Deeper into Record Short U.S. Bond Territory_1

Funds Go Deeper into Record Short U.S. Bond Territory_1

Funds Go Deeper into Record Short U.S. Bond Territory_2

Funds Go Deeper into Record Short U.S. Bond Territory_3

All are the largest net short positions since CFTC Treasuries futures were launched over 30 years ago, and amount to a combined net short position across the two-, five- and 10-year parts of the curve of around 2.8 million contracts.

That's significantly larger than the previous record net short total position in late 2018 of just over 2 million contracts, almost entirely down to the current extreme bearishness in the two-year space.

If hedge funds are selling, asset managers are buying. The latest CFTC data show asset managers are net long two-, five- and 10-year Treasuries futures to the tune of 1.0 million, 1.7 million and 1.3 million contracts, respectively.

This fits with fund flows data that show U.S. bond funds have accumulated net inflows of around $100 billion so far this year, according to Barclays. In the first five months of last year, these funds had posted net outflows of around $50 billion.

Bank of America's monthly fund manager survey in May showed that investors' allocation to bonds rose to a net 14% overweight, the largest allocation to bonds since March 2009.

There's a tug of war between speculators and asset managers, and neither side appears to have the advantage - the two-year yield is up a bit this year, while the 10-year yield is down a bit.

Anyone betting on a flatter yield curve this year will be in the money, but with curve inversions having reached historical levels recently, for how much longer? Strategists at Citi and Deutsche reckon the bias from here is for the curve to steepen.

Source: Reuters

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Devin

Commodity

The Organization of the Petroleum Exporting Countries and allies including Russia, a group known as OPEC+ which pumps around 40% of the world's crude, agreed on a new oil output deal on Sunday.

Saudi Arabia, the group's biggest producer, will make a deep cut to its output in July on top of a broader OPEC+ deal to limit supply into 2024 as the group faces flagging oil prices.

A surprise announcement by OPEC+ in April to deepen production cuts helped to raise prices by about $9 a barrel to above $87 per barrel in the days followed.

Yet benchmark crude prices have shed those gains since, with Brent futures on Monday trading at just under $78 a barrel.

On Sunday, in addition to extending the existing OPEC+ cuts of 3.66 million barrels per day (bpd), the group agreed to reduce overall production targets from January 2024 by a further 1.4 million bpd to a combined output of 40.46 million bpd.

The changes, however, included lowered targets for Russia, Nigeria and Angola simply to bring them into line with current production levels.

Here are the main reasons why OPEC+ cut output:

Concerns About Weak Global Demand

Data from China has aroused fears that the economic recovery after coronavirus lockdowns by world's second-largest oil consumer is losing steam.

Russian Deputy Prime Minister Alexander Novak has also pointed to "interference with market dynamics", a Russian expression to describe a Western price cap on Russian oil.

Fears of another banking crisis in recent months have led investors to sell out of riskier assets such as commodities with oil prices falling to near $70 per barrel from a peak of $139 in March 2022.

A global recession could lead to lower oil prices.

Oil prices also recently came under pressure from concerns about U.S. debt ceiling negotiations, though fears of a debt default by the world's biggest oil consumer have abated since a bipartisan deal was sealed last week.

Punishing Speculators

The planned cuts will also punish oil short sellers betting on oil price declines.

In 2020, Saudi Energy Minister Prince Abdulaziz bin Salman warned traders against betting heavily in the oil market, saying that those who gamble on the oil price would be "ouching like hell".

He repeated his warning ahead of Sunday's meeting, telling speculators to "watch out" which many market watchers and investors interpreted as a signal that OPEC+ could consider further output cuts.

US Output Rising

U.S. crude oil production is set to rise by 5.1% to 12.53 million barrels per day (bpd) in 2023 and by 1.3% to 12.69 million bpd in 2024, according to government forecasts.

This compares with around 10 million bpd as recently as 2018.

Meanwhile, Saudi's energy ministry said the country's output, the biggest chunk of OPEC+ production, would drop to 9 million barrels per day (bpd) in July from around 10 million bpd in May, in its biggest reduction in years.

Saudi output is set to rebound to around 10 million bpd from August, unless market conditions prompt the kingdom to extend cuts.

Russia, the world's third-biggest oil producer, is targeting production of around 9.5 million bpd until the end of the year and 9.3 million bpd next year.

Tensions With Washington

Additional cuts from OPEC+ could drive tensions with leading consuming nations that are trying to fight inflation.

Washington called OPEC+'s action in April inadvisable.

The West has repeatedly criticised OPEC for manipulating prices and siding with Russia despite the war in Ukraine.

The United States is considering passing legislation known as NOPEC, which would allow the seizure of OPEC's assets on U.S. territory if market collusion is proven.

OPEC+ has criticised the International Energy Agency, the West's energy watchdog for which the United States is the biggest financial donor, for advocating oil stocks releases last year. The IEA had argued these were necessary to bring down prices given concerns that sanctions would disrupt Russian supply.

The IEA's predictions of price strength never materialised, prompting OPEC+ sources to say it was politically driven and designed to help boost U.S. President Joe Biden's ratings.

The United States, which released most stocks, said it would buy back some oil in 2023, but later ruled that out.

OPEC observers also say the group needs nominal oil prices to be higher because money printing by the West in recent years has lowered the value of the U.S. dollar, the currency in which oil is traded.

Source: The Globe and Mail

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Warren Takunda

Traders' Opinions

Stocks

Recent economic data releases from the United States have raised concerns among investors and analysts, highlighting a potential slowdown in the country's economic growth. The latest reports indicate a moderation in the services sector, factory orders falling short of expectations, and a reversal in the dollar's gains. These developments suggest a need for caution as market participants evaluate the health of the US economy and anticipate the Federal Reserve's next policy moves.

Slower Expansion in Services Sector

The Institute for Supply Management (ISM) reported that the US services sector experienced a significant slowdown in May, with the Services Purchasing Managers' Index (PMI) falling to 50.3 from April's 51.9. Although this reading indicates the fifth consecutive month of expansion, it represents the slowest rate in the current sequence. Key contributing factors to this deceleration include a decline in business activity, new orders, and employment, coupled with faster supplier deliveries. The drop in new export orders further underscores the challenges faced by the sector.

Factory Orders Miss Expectations

In April, US factory orders grew by 0.4%, falling short of market expectations of a 0.8% increase. While defense spending provided some support, overall growth was slower than the previous month. Notably, demand for transportation equipment, particularly defense aircraft and parts, remained robust. However, orders for fabricated metal products, primary metals, and computer and electronic products experienced contractions, highlighting the impact of higher interest rates. These figures suggest that certain segments of the manufacturing industry are facing headwinds.

Dollar's Retreat Reflects Concerns

Following the release of disappointing economic data, the US dollar relinquished its earlier gains and traded relatively unchanged. The ISM Services PMI decline and the below-forecast factory orders contributed to investor uncertainty about the future trajectory of the US economy. With the Federal Reserve's next policy decisions in focus, market participants are evaluating the likelihood of interest rate adjustments. Currently, opinions among traders are divided, with expectations of a rate increase in July decreasing since the ISM Services release.

Fresh data further extends Dow's losses

The Dow Jones Industrial Average experienced losses on the back of the economic data, declining over 150 points. The underperformance was driven by cyclical stocks, such as Caterpillar, Boeing, and 3M, which are sensitive to economic performance. In contrast, the S&P 500 and Nasdaq reached new highs, buoyed by gains in technology shares. Apple's stock, in particular, hit a record high as the company prepared to unveil a "mixed reality" headset at the Worldwide Developers Conference. Other technology giants, including Netflix, Alphabet, Oracle, Amazon, and Microsoft, also saw positive trading activity.

Gold Prices Respond to Weaker Economic Outlook

Gold prices experienced a modest increase, surpassing $1,950 per ounce. The minor decline in US Treasury yields and a weakening US dollar contributed to this uptick. The lackluster economic data reinforced expectations that the Federal Reserve may pause its tightening cycle in the near future. Despite the recent uptick, gold prices remain below the near-record high reached in early May, as traders anticipate prolonged elevated interest rates globally to counter persistent inflationary pressures.

The recent economic indicators from the United States paint a cautionary picture, suggesting a potential slowdown in the country's economic growth. The services sector's expansion has moderated, factory orders have fallen short of expectations, and the dollar's gains have reversed. These developments have prompted market participants to reassess the health of the US economy and speculate on the Federal Reserve's upcoming policy decisions. As investors navigate the uncertainties ahead, monitoring key economic indicators will be crucial in gaining insights into the trajectory of the US economy and its potential impact on financial markets.

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Kevin Du

Cryptocurrency

The capricious cryptocurrency's been uncommonly quiet over the past four weeks, bound in the range of $28,452 and $25,800. Even the end of the U.S. debt ceiling saga did little to whet risk appetite.

Bitcoin's volatility index is near 64, well below the 2023 peak of 116.5 touched in January, according to CryptoCompare. Overall daily cryptocurrency spot trading volumes - above $20 billion for most of the year - have languished at around $10.6-$12 billion in the last two weeks, data from The Block shows.

The data signals a reluctance of investors and traders to take positions in either spot or derivatives, said Noelle Acheson, an economist who has tracked the crypto sector for seven years.

This was echoed by Matthew Weller, global head of research at financial services group StoneX. "Looking at bitcoin's chart, traders are waiting for a definitive break away from the $27,000 level that has magnetically pulled prices back consistently," he said.

The world's biggest cryptocurrency is still the best-performing asset of 2023, with gains of about 62%. Yet it has slid nearly 14% from a peak of $31,035 in April, keeping nervy traders guessing about its next move.

Still waters run deep?

"The lack of anything interesting is also interesting," said Luuk Strijers, chief commercial officer at derivatives exchange Deribit.

Bitcoin's 7-day and 30-day implied volatility - options traders' expectation of future price turbulence - have slid to January lows of under 40%, after peaking at 76% and 67% in March, according to The Block.

"If implied volatility falls to rock-bottom levels, it can't go much lower," Strijers added. "Trading volatility, buying options in the absence of a price move, that's what people might do in this market."

Market positioning indicates the maximum pain level for the June 2023 options expiry for bitcoin is at around $24,000, which could act as a support or resistance level, according to analysts at Bitfinex.

"Traders should be prepared for potential market turbulence and short-term price fluctuations in the second half of the month," they said.

Longer term, in 2024, they expect bitcoin's halving - a technical adjustment that reduces the rate at which new coins are created - and the U.S. elections to ratchet up volatility.

The Bulls Are Hiding

Funding rates, which measure the cost of holding bitcoin via futures, have edged lower, indicating investors are less willing to pay to be long. It was last trading at 0.0098%, way below the 0.0302% seen in March.

"A bull market is easy, when everything is going up," said Thomas Kralow, a crypto hedge fund manager at Kralow Capital. "But it's markets like these where people lose money - because of false beliefs that we are finally turning the corner, which is incredibly hard to predict."

He added: "Right now with the drop in volatility, we have a few trades that we are open to hedge in case bitcoin drops down to $20,000."