Having had the benefit of taking some time away from the screens and the constant stream of news flow that can impact one’s psyche and mindset. It instinctively feels an opportune time to come back refreshed as things could get spicy after the US and European summer doldrums.
As things stand though, the strong bid in US equities is still very much intact, and technically it seems the bulls have control, with the S&P 500 breaking through the 27 July highs and closing up 0.4% at 2850 – new highs are not too far away, as is the case in the NASDAQ 100. Many have talked up the concentration in leadership; however, if we look at the market internals from a more holistic standpoint, we can see that recent participation in the S&P 500 rally has been reasonable broad-based, with 66% of companies now above their 50-day moving average and 17% of companies at four-week highs.
S&P 500 Implied volatility is also fairly suppressed, with the US volatility index (or ‘VIX’ index) at 11.27%, suggesting that at this juncture few see a sizeable increase in range expansion (in the S&P 500) and of course this just allows volatility targeting hedge funds to drip feed further capital allocations into a market where money managers are already very much overweight.
Highly impressive US corporate earnings, it seems, are inspiring the bulls at present and with no one prepared to act aggressively on the macro news flow, micro factors are supporting. But for how much longer?
So, all is calm, and the world is a happy place. That said, there are some key macro concerns which are firmly on the radar, and my base case is that they will become volatility events – not just in equities, but should create greater short-term flows into safe-haven currencies such as the JPY and even into US treasuries. The most prominent of these is the trade dispute between the US and China, and this will become a more pressing market issue in the next two months in my opinion.
Donald Trump and his administration are currently coming from a position of relative economic strength, and this is his trump card (excuse the pun). It seems almost bizarre that Donald Trump has been so enthused that Chinese equities have taken a bath of late, with the CSI 300 now 22.9% lower in USD terms year-to-date. On this point, one can also look at the CSI 300/S&P 500 ratio (both priced in the domestic currency) and see this ratio already sitting at multi-year lows. It is certainly hard to see this trend unwinding too aggressively anytime soon.
(China CSI 300/S&P 500 ratio)
(source: Bloomberg)
US Commerce Secretary Wilbur Ross has also come out punching, with comments late last week that “we have to create a situation where it’s more painful for them to continue their bad practices than it is to reform”.  While the US administration don’t look like backing down, at the same time the rebuttal from China and imposition of their own tariffs on US imports have been a fraction of the $200 billion the US have identified in the next round of tariffs. Some have also concluded that the Chinese authorities recent move to reduce speculation in the Chinese yuan (CNH) may even be a small olive branch to the US administration given their disdain for yuan weakness.
The fact that USDCNH and USDCNY have started to move higher again is of clear interest and is supporting the USD more broadly. Today’s China July FX reserve data will be keenly watched although there no set time for the data to be released. Strategists will be eyeing whether the PBoC have drawn down their FX reserves through July to support the CNY to any extent, although it is only in August that Chinese authorities are looking for greater stability in the currency. The probability is we should see a slightly drawdown in reserves and shouldn’t cause any sizeable moves in markets.
Keep an eye on 6.9000 on USDCNH as a break here could have interesting ramifications for G10 FX and notably, AUD/USD could find sellers on this development, although FX traders here will be eyeing the RBA statement at 14:30 aedt.
So, US-China trade is on the radar, and it just feels as though that once earnings are fully behind us traders are going to start to reposition and de-risk portfolios as we head into conclusions of the investigations on tariffs. Price will reveal all and should be respected, but tactically it feels as though as we head into some key announcements on tariffs in September, and with equities lacking a catalyst at this stage, that implied volatility should pick-up here, especially if the US data flow continues to show signs that perhaps we have seen peak US growth. As mentioned, the Trump administration feel they can afford to push tariffs aggressively given the current economic strength. However, should we see greater signs of economic vulnerability then implied volatility in financial markets will increase.
A rising USD will also be in play, and the recent breakdown in EURUSD has given support to the USD index, where the weekly close above 95.0 has garnered much attention from traders. I would also highlight the 29 May low in EUR/USD of $1.1510, which isn’t too far away and a break here would only accelerate USD inflows and cause further headwinds for emerging markets and select commodities. 
(source: Bloomberg)
GBP is also a ‘must-watch’ currency as we head into 18 October EU summit traders and the playbook here is perhaps not as binary as it initially appears. That said, its hard to do much more than respect the downtrend in GBPUSD as there is a buyers strike on sterling right now and GBP bears have firm control despite what is a very crowded short GBP. GBP implied volatility is going higher in the months ahead in my opinion and whether trading EURGBP, GBPUSD or GBPJPY, ranges are going to increase in months ahead. One to watch.
As mentioned the RBA meeting is a highlight today, although today’s RBA statement should be largely unchanged from the prior month and no one is positioned for any kind of move in AUD or Aussie rates today. A quick focus on the interest rates markets has shown that we have to go out to September 2019 to see an above 50% chance of a hike from the Reserve Bank priced in and this feels about right. AUDUSD is tracking sideways and should be traded as such, therefore in the short-term, I would be a buyer into $0.7350 and look to fade rallies into $0.7450. Keep a focus on USDCNH and the PBoC fixing at 11:15 aedt as this could affect price today. 
Published by Chris Weston, Head of Research, Pepperstone