Well, this escalated quickly, but the markets have come alive with the sound of volatility and traders reaching out for portfolio hedges. That said, the time to hedge was last week when the VIX was not at 25%, and we see a massive 9.48-volatility premium for S&P 500 1-month put volatility over calls. The old saying, hedge because you can (and it’s cheap) and not because the market forces you to do so rings true here.

Gold has been a great portfolio hedge for a while now, and will remain so notably against the risk of Sanders winning the November US election. The metal hit a high of $1689 but has since come off the boil with price sitting $28 lower here. That said, gold remains supported on dips, especially when we have seen some incredible moves in the US bond market with gains led by the belly of the curve, with 5-year Treasury’s -12bp, and at 1.20% is eyeing a move into 1%. Further out the Treasury curve and UST 10s at 1.36% are eyeing the at-time lows of 1.31% – the bond market has been telling us all we need to know.

Gold remains a play on an expected response from central banks and while we continue to see a solid bid in both nominal and real rates, the market is now pricing a 58% chance of a cut from the Fed on 29 April and a full cut by June. I reiterate the view that we are closing in on a point where we see a re-run, perhaps in a less aggressive manner, of 2018 where the market had a view that the Fed would end its QT program and cut rates, yet the Fed shared a different view – it wasn’t long before the markets forced a re-think from the Fed.

At the heart of this view, we see US 5yr inflation expectations dropping to 1.61% and the lowest levels since July 2016, and the Fed will have noticed this even if we have just heard from Cleveland Fed President Loretta Mester who, among other comments, detailed that the “virus is a risk but I am struck by the US resilience”. It doesn’t sound like the Fed is overly concerned at this stage, although we’ll get a better gauge tomorrow when the Fed general, Jerome Powell speaks at 07:00aedt.

Yield curves continue to flatten and invert, and when we see the VIX at 25%, that combination is generally a toxic mix for risk and we head to safety, looking for a return of our capital rather than on it. When we look at the news flow, there is no clarity that we can be confident on any of the assumptions that feed into earnings models, especially for airlines or travel companies which have been taken to the woodshed. When countries are closing borders, the threat of an outbreak is becoming more pronounced in Europe and the Middle East and supply chains are just going to become more disrupted, how do we model risk when we can’t even model economics with any confidence?

When we don’t have clarity or genuinely understand what is the markets circuit breaker, then we head to cash or buy bonds, gold and the JPY – the holy trinity in this market – although long volatility is also working well as traders sense movement. Indeed, for anyone, including yours truly, who thought the JPY had lost its safe-haven quality, well it was the superstar major currency, notably NOKJPY, which sold off 1.7%, with traders seeing a punchy 4% decline in crude.

Asia equities face a dark and sinister open, with Aussie SPI futures some 2.6% from the official ASX200 close. We can use that as a guide, and while some of the move lower in US equities was already discounted, we see S&P500 futures 1.9% lower from the same time. It takes a brave soul to be buying these markets, but the opening 30 minutes will be key to psychology – it could well be a buyer strike and another day where order book dynamics take hold and the sellers exasperate the move. Expect moves of 2% for the Nikkei 225 and Hang Seng too.

On the European side, it’s the MIB which has been hit the hardest, with a 5.4% drop (a 5.1 Z-score move), which won’t surprise given Italy is at the heart of concerns and it’s a higher beta index anyhow. The DAX needs attention as we see the index right on the 12,900 area, where the index has held in on multiple times since November. The bulls will need this to hold, or the risk of a quick move to 12,660 and then 12,000 is elevated.

I would also add, that when we’re talking levels we should watch the S&P500 (US500). If we see price head through 3200 then it will lead to even higher volatility and risk of a 10% drawdown. The bulls need to defend this level or its goodnight Vienna.

Published by Chris Weston, Head of Research, Pepperstone