Potent event risk portends volatility

The re-emergence of economic fundamentals helped the US Dollar find a lifeline last week, as expected. The currency had been battered by political instability fears as the Trump administration looked increasingly mired in a scandal about senior members’ contact with Russian officials.

Minutes from May’s FOMC meeting struck a cautiously hawkish tone and a revised set of first-quarter GDP figures reinforced policymakers’ argument for continued tightening, relieving pressure on the benchmark unit. Priced-in expectations implied in Fed Funds futures put a June rate hike as a near-certainty.

The week ahead will offer plenty of top-tier economic data to fuel further speculation. The Fed’s favored PCE inflation gauge and its Beige Book survey of regional economic conditions as well as the ISM manufacturing-sector survey and official labor-market statistics are all due to cross the wires.

The latest GDP revision notwithstanding, US economic news-flow has increasingly underperformed relative to consensus forecasts over the past two months. This warns that analysts’ models may be overestimating the economy’s vigor, opening the door for downside surprises.

Absent a major dislocation in financial markets, a June hike is probably a foregone conclusion at this point. However, the Fed’s updated forecast for the rates path thereafter has market-moving potential. A soft round of data outcomes may be seen as reducing scope for a third increase, hurting the greenback.

Another busy week of scheduled Fed commentary will likewise inform traders’ disposition. Comments from typically dovish or neutral officials like Governor Lael Brainard and Jerome Powell as well as San Francisco Fed President John Williams will probably be of greatest interest.

Political risk continues to be an important wild card. Rancor at the G7 leaders’ meeting over the weekend and a steady stream of news-flow on the investigation into the Trump camp’s Russian connection may keep markets on edge. In turn, that may hurt demand for USD-based assets and pressure the currency.

In a week that was relatively light of high-impact European data, EUR/USD perched up to yet another fresh sixmonth high. This furthered the move that started from the lows on April 10th when the pair found support around 1.0600; and since then we’ve had two rounds of French elections along with an ECB meeting, and the net result of that outlay has been a continued run of strength that’s now comprised six big figures in EUR/USD over the span of seven weeks as investors continue to prod the pair-higher.

The elephant in the room for the Euro at the moment is the prospect of QE taper. Various members from the European Central Bank and Mario Draghi himself have directly spoken against this, on multiple occasions, yet markets are apparently continuing to try to get in-front of any inevitable announcement of QE coming to an end before rate hikes move on the table. In March, we wrote that this was an issue that the ECB would likely have to contend with as the ‘green shoots’ of recovery continued to show. At the time, we had some very large political hurdles for that theme to pass with both Dutch and French elections in the immediate future; but as both of those have been resolved in a rather marketfriendly fashion, and as European data has continued to show signs of improvement, investors have continued to bid the Euro-higher under the presumption that the ECB would not likely move-forward with another yet another round of QE as the European economy shows signs of promise.

This would be the first step away from the ‘ultra-loose’ monetary policy of the European Central Bank, with the next logical step being a tightening of policy with higher rates. At the most recent European Central Bank meeting, ECB President Mario Draghi spoke directly to this subject when he said that the bank hadn’t even discussed the prospect of exiting from their current stimulus outlay. Mr. Draghi went on to cite a continued lag in inflation, specifically on the topic of wage growth, as a deterrent from looking at tighter policy options in the near-term.

Next week brings European inflation into the spotlight: We get German inflation on Tuesday morning, just after a long holiday weekend in the United States, and on Wednesday morning we get the release of Euro-Zone inflation figures for the month of May. Given the fact that the Euro has continued to trend-higher despite Mario Draghi’s numerous comments against the prospect of QE taper, fully expect the Euro currency to trade with a direct relationship to these data points, with beats producing additional gains while misses bring on pullbacks and retracements. The bigger question is whether those pullbacks or retracements might turn into something larger after EUR/USD has tacked on over 600 pips in less than two months; and given the extremely weak state of the U.S. Dollar combined with the fact that many are looking for a rate hike from the Federal Reserve in the middle of June, we could be looking at a recipe of a deeper retracement before the longer-term bullish move might be ready for resumption.

It was a major surprise on Friday when a YouGov opinion poll put the ruling Conservative Party just five percentage points ahead of the Labour Party in the run up to the UK General Election on June 8. That was a drop from 20 percentage points a mere 11 days ago and the Pound duly tumbled.

It could have been an aberration but YouGov is a respected polling organization and it’s now clear that the Pound’s direction will be determined short-term by the further polls that will be released over the next few days. The markets prefer the Conservatives to Labour so a rising poll lead will benefit the Pound while a narrowing lead or a complete reversal will hit it hard.

While Brexit remains a key election issue, talks between the UK and the EU won’t start until it’s over so for the moment the divorce is on the back burner. Moreover, Monday is a public holiday in the UK as well as the US so trading is likely to be subdued but quite possibly erratic at the start of the week, meaning taking a position right now is particularly risky.

Note, though, that the YouGov poll was conducted after the horrific Manchester Arena bombing and that GBP/USD is now technically weak, with the pair having dropped through a falling channel support line that had been in place since the start of European trading Thursday.

However last week was a relatively light one for economic numbers. That left the US Dollar, interestrate differentials and oil prices very much in charge of AUD/USD.

As far as markets can tell US rates are very likely to go up again next month. Australian rates are stuck at record lows and, while the next move is thought likely to be a rise, it is not expected this year and possibly not until well into the next.

That means further erosion of the Australian Dollar’s yield advantage over its big US brother, but probably no more than is already in the AUD/ USD price.

This week there are a lot more data for investors to chew over. They’ll get a look at Australia’s Performance of Manufacturing index for one thing. This is analogous to the Purchasing Managers Indexes released elsewhere.

Perhaps more importantly there is also plenty of housing-market information. This will be big news for investors because they know it is also big news for policymakers at the Reserve Bank of Australia. Building approval levels for April will see daylight on Tuesday, with new home sales levels for the same month coming out on Friday.

If these manage to buck the frankly awful trend suggested by March building permits’ horrible collapse, then there could be some relief and upside for the Aussie. However, if they don’t then the slip could be nasty.

By the same token, China’s official and private manufacturing PMI snapshots could unsettle the Aussie if they suggest that the decelerating pace now clear in both series is still with us. Moody’s hack at its China credit rating last week has put the world’s secondlargest economy in an unwelcome spotlight, even if the agency’s worries about both debt and growth are focused some time ahead.

Of course, all these numbers might surprise markets to the upside, in which case next week may contain many happy days for Aussie bulls. However, the balance of past data and probability suggests that they may not, in which case an Australian Dollar already knocked by interest-rate differentials could struggle to gain.

Oil slumped nearly 5% Thursday after OPEC announced that it would extend production cuts of 1.8 million barrels a day for another nine months, ending in June 2018. And while this would normally be taken as a bullish cue for the market, this extension had been mooted around the market since early May, taking the price of oil from a low of $46.72/barrel to a pre-release high of $54.87, a 17%+ rally in just over three weeks. With such a price rise already baked-in to market assumptions, it is no surprise to see the market falling back. And with US shale production hitting just under 10 million barrels a day, according to the latest US EIA data, upside movement in the oil complex may be capped.

And the technical set-up looks slightly worrying as well. As the daily chart below shows, Brent has broken out of its sharp up channel that started on May 5, while the current price is also now below the 20-, 50and 100-day moving averages, a potentially bearish set-up. To return to the up channel, Brent would need to move back above the 100-dma, currently around $53.70, while continued weakness could see the March 22 low of $49.92 the first target.

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