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Traders have been happy to sell volatility (vols) in equity markets like its 2017 again, with implied vols in the S&P 500 (i.e. the VIX) eyeing a move below the 20-handle – A level we haven’t seen since 4th December. VIX futures have re-opened on a flat note and implied vol is worth watching as it could inspire volatility-targeting funds to increase exposure into risk assets this week. 
With liquidity a hot topic on the floors, one interesting dynamic is the focus on fund flow data, where, according to Lipper, US-based equity funds pulled $98b through December, which, is, of course, a considerable amount of capital. That said, it represents just 0.8% of the $12t invested in mutual funds and ETF’s – of course, there are other flow metrics we can identify, but it’s worth considering whether these funds use strength into 2600 as an opportunity to further reduce positions.
There is still much work to do to feel structurally bullish, but I like the price action in the S&P 500 futures, with the S&P 500 cash market printing a higher high and eyeing a move into 2577 (the 38.2% fibo of the October sell-off). In the oscillator complex, we’ve seen a bullish momentum crossover seen on the weekly chart. That said, it still very much feels as though traders are looking at this short-term move with a high degree of cynicism. 
Traders long on pessimism 
I had been arguing, like many others, that sentiment had become far too pessimistic, and market-pricing, certainly in the rates market had gone too far. On Thursday, I highlighted the fact the fed funds future was pricing a 16% chance of a cut from the Fed at the March meeting, and in my opinion that was far too rich. In the bond market, we had seen US Treasuries out to the 7-year maturity command a yield less than the top of the fed funds range of 2.50%. Well, courtesy of a sensational payrolls report and a pre-prepared speech from Jerome Powell, that went right to the jugular of market concerns, the moves in rates, credit and fixed income were about as punchy as we will see for some time to come.
A 14bp move higher in the 5-year Treasury was as big a move as we have seen since 2016, although, the whole curve was smashed, and with a ton of government issuance this week it will be interesting to see if further selling plays out. We also have Services ISM (tonight at 2 am) and US CPI (Saturday 00:30aedt) to contend with, while we are also treated to speeches from Fed members Bostic, Evans, Rosengren, Powell, Bullard and Clarida throughout the week. From what we heard from Powell, Kaplan and Mester on Friday, the Fed is not hiking the fed funds rate until the issues in the economy are resolved, and the markets are already telling us that’s a big ‘if’. At the same time, balance sheet normalisation will be reviewed if this worrying message portrayed by the market actually plays out. 
Powell came towards the market 
The interesting concept from the Fed chair Powell’s speech was, again, that he used it to clear up another faux pas. That being that the balance sheet was perhaps not on autopilot, and he would not hesitate to adjust the pace of normalisation should it be required. So, Powell effectively coming closer to the market saw risk come alive, especially when it was married with a view that the economy was likely to be ok in the next couple of years. Importantly, high yield credit spreads came in a punchy 29 basis points relative to investment-grade credit, which, as we can see from the Bloomberg chart has been incredibly correlated to equity returns since March 2018. 
Top – Orange – S&P 500 (inverted), white HY/IG credit spread, lower – % change in HY/IG spread on the day 
(Source: Bloomberg)
We even saw the USD index fall 0.1%, marking a run of three consecutive weekly falls, and we can see the USD basket still holding for dear life around the 96-handle. 

It was almost the perfect storm for Asia, made even more significant with the PBoC announcing a 100bp cut to the ratio of reserve’s they must hold on their balance sheet. The cut should see a net injection of RMB 800b into the Chinese banking sector once we adjust for a portion of the liquidity is designed to offset the drain caused by the soon-to-be maturing MLF (Medium-term Lending Facility) program. Either way, good news, albeit even if it was thoroughly expected, has hit a market long on pessimism and traders have bought into the ‘things are perhaps not as bad’ trade. 
Chinese equities have got off to a cautious start, although better buying can be seen in Hong Kong and it seems many see RRR cuts unlikely to stimulate to any great extent, and is a pre-cursor to tougher times ahead. 
Outside of China and Asia has responded, pricing in the new news, but it’s hardly euphoric, and while S&P 500 futures have pushed 0.3% higher, this is a reflection that the Nikkei 225 found additional buyers on the open and is currently 2.8% higher, although coming off the early highs. High-Grade copper is 0.3% lower, after a 3.1% rally on Friday and this could be worth following through the week, with price holding the 2016 uptrend, but for how long?
The ASX 200 has rallied 1.1%, although volumes are again on the light side and the index has failed to hold the 5700 level, despite trading into 5716. If we look at swaps pricing the market has not found any real love from Powell’s speech and price in 12bp of cuts over the coming year. One questions if traders have been looking to see China’s reaction to gain the confidence the support the Aussie index into the figure – indeed, with talks between China and the US trade representatives from tomorrow, Chinese equity markets could represent a gauge on how retail trader sense any potential resolution. 
In FX markets, if we look at USDJPY, we can see the price has rallied to the pre-TRYJPY inspired ‘flash crash’ of 108.70, although sellers have seen this as the natural point at which to fade the rally and the flow today has been net JPY buying. Aside from USDJPY, the USD is lower versus all G10 and most Asian EM currencies. Could this be a precursor for how traders will trade the USD through this week? It feels like that could be the case, but a united Fed is a clear risk positive, and, from what we heard on Friday it seems a broad consensus is being formed that the US central bank will pause, at least until April, and then should the economy play out as most on the board expect then they will re-visit tightening. 
USDJPY Daily – a chart I have pushed of late and remarkably similar moves as Q417

Published by Chris Weston, Head of Research, Pepperstone