The Daily Prophet: Can't Complain About a Lack of Volatility Now

Connecting the dots in global markets.

History will show that stocks ended little changed Tuesday, but, boy, was the ride fun. For the first time in a long time there were some wild intraday swings in stocks, delivering a gift to traders who have done a lot of complaining about of a lack of volatility and complacency.

To be sure, it started out as another sleepy day until just after 11 a.m., New York time, when stocks cratered after the release of e-mails by Donald Trump Jr. that said the Russian government backed his father's presidential campaign and was trying to damage Hillary Clinton. The narrative that the Trump administration's pro-growth agenda was officially dead quickly made the rounds. Or at least it did until just after 1:30 p.m., when Senate Majority Leader Mitch McConnell said he was delaying a planned summer recess by two weeks, giving Republicans more time to pass a health-care bill. Suddenly, the narrative was that just maybe Washington can get something done amid the turmoil.

"Until now, the markets have been ignoring political news," said John Conlon, chief equity strategist at People's United Wealth Management, which oversees more than $7 billion. "It surprises me because we're just beginning earnings season, and in the past that has been a big driver. All this is going to do is push some of this stuff to the background while Congress focuses on Russia." Volatility could be elevated for the rest of the month. Besides the seeming endless revelations surrounding the Trump administration, Federal Reserve Chair Janet Yellen begins her two-day semiannual testimony to Congress Wednesday and the corporate earnings season starts at the end of the week.

Bank of Canada policy makers meet Wednesday and are widely expected to raise interest rates for the first time since 2010. Currency traders have driven the local dollar to a 10-month high in anticipation of a rate hike, but are also piling into options contracts that protect against declines, just in case the central bank decides not to pull the trigger. One-week risk reversals on the loonie, a measure of options positioning, have risen to their highest since January, according to Bloomberg News' Lananh Nguyen and Robert Fullem. Also, investors appear to be fleeing Canadian shares, withdrawing C$358.1 million ($278 million) last week from the iShares S&P/TSX 60 Index ETF, the biggest exchange traded fund tracking Canada's benchmark index, according to Bloomberg News' Kristine Owram. The outflow was the largest since early December. Another C$20.2 million was withdrawn Monday. Canadian equities are the second-worst performers among developed markets this year, battered by a drop in commodities and a looming slowdown in housing. The lag, however, downplays the strength of the economy, which has been growing the fastest among peers. "Our market is unloved by global investors," said Steve Belisle, senior portfolio manager at Manulife Asset Management.  

The Bank of Canada's rate decision may also have big implications for the U.S. bond market, where bearish bets have been piling up. JPMorgan's weekly survey of fixed-income investors released Tuesday showed sentiment has fallen to its lowest of the year, to levels rarely seen since the financial crisis. July is isn't even half over and the Bloomberg Barclays Global Aggregate Index is already having its worst month since November, falling 0.63 percent through Monday. Behind all this is the increasingly hawkish talk from global central bankers, but whether policy makers follow through on their rhetoric may prove make-or-break for some investors, according to Bloomberg News' Brian Chappatta. The Bank of Canada meeting is the first of a flurry of major policy confabs in the next couple of weeks, including the Federal Reserve, European Central Bank, the Bank of Japan and Bank of England. "A hike out of Canada will add to the same type of mentality that's been in markets -- this notion of global central-bank hawkishness," said Timothy High, U.S. strategist at BNP Paribas. "The U.S. Treasury market is trying to find the right level. We've rejected lower yields for now."

The outlook for Europe's single currency is diverging from that of its biggest companies. The change can be seen in the market for three-month options, with traders taking positions on the euro against the U.S. dollar -- the world's most-traded currency pair -- and on the 2.4 trillion-euro ($2.7 trillion) Euro Stoxx 50 Index. Over the past two months, traders have been paying relatively more for calls that bet on the euro advancing against the U.S. dollar, according to Bloomberg News' Todd White. At the same time, they've paid less for bullish options on the 50-member equity index. This has produced the biggest divergence in outlooks of 2017. Why? Traders see the ECB inching toward reducing its quantitative-easing stimulus program. At the same time, delays in the implementation of President Donald Trump's economic policies are also weighing on the dollar. "Sometime after September begins, we're expecting the ECB to announce measures to reduce stimulus, and that will clearly push the euro higher," said Pedro Servet, head of currency trading at Citigroup. "At the same time, there's continuing investor disappointment that President Trump hasn't carried out economic policies he proposed, and that's hurt the dollar."

It's been a horrible year for the U.S. dollar, with the greenback falling against all but four of the 31 major currencies tracked by Bloomberg. Bets that the dollar will drop even further are boosting the appeal of local currency emerging-market bonds, according to Bloomberg News' Isabella Cota, Ben Bartenstein and Maria Jose Valero. The weakening dollar combined with higher interest rates in developing nations has triggered record inflows to emerging-market funds in the first half of 2017. Although most of that has gone into bonds issued in foreign currency, the tide may shift to local currency debt as yields more than four percentage points higher gain appeal, according to Morgan Stanley. "In local currency, technicals look more positive, as cumulative flows into local debt have only recovered around half of the outflows seen since 2013," Morgan Stanley analysts led by Simon Waever said in a recent research note. HSBC is bullish on local currency government bonds in Mexico, South Africa, India, Indonesia, Malaysia and Russia, citing an expected drop in inflation risk premiums that will likely trigger flatter yield curves, or the difference between short- and long-term yields.

Market participants will be closely watching Washington on Wednesday, but maybe not for the reasons you might think. That's when Yellen delivers her semiannual testimony to Congress. If history is any guide, there's the potential for significant market moves. The February testimony headlines caused a noticeable selloff in the bond markets, as the text of her remarks noted that waiting too long to tighten monetary policy "would be unwise." Look for her to take the opportunity to clarify the timing of an announcement regarding the start of the central bank's balance-sheet unwind or signal the outlook for interest-rate hikes, according to the rates strategists at Bloomberg Intelligence. Lawmakers are also likely to ask Yellen about her interest in pursuing another term as Fed chair, an issue she has avoided in the past. Yellen's opening statement will be released at 8:30 a.m. local time and her hearing before the House Financial Services Committee starts at 10 a.m., followed by the Senate Banking Committee on Thursday.

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