Markets mixed despite VIX hitting a decade low

2 May, 2017

After returning from a long weekend, equity investors seem undecided on whether to be bullish or bearish. Stocks across Asian markets were mixed on Tuesday despite the CBOE Volatility Index hitting its lowest levels in a decade. However the low volatility was reflected in currency markets with the Euro, Pound, and the Yen stuck in tight trading against the U.S. dollar.

The Reserve Bank of Australia kept interest rates steady at 1.5% as widely anticipated, but the positive tone on the labor market outlook pushed the Aussie 0.2% higher against the dollar. Australia’s central bank now expects unemployment to decline gradually over time, and inflation to increase as the economy continues to strengthen. The biggest concern going forward is likely to remain the overheated housing market despite price growth slowing slightly in April. For traders who like high yielding currencies, it will be critical to monitor the differentials in government bond yields. Spreads between U.S. and Australian 10-year bond yields are currently below 30 basis points, and without sufficient premium, it will be hard for AUDUSD to resume its rally. It will require somewhere around 50-60 basis points premium for AUDUSD to break above 2017 highs.

The Fed is next as it kicks off its two-day monetary policy meeting today with an announcement due on Wednesday. While no one expects any changes to policy, the 500-word statement will probably provide some direction to the US Dollar. Economic data released has not been encouraging lately. Friday’s GDP didn’t reflect the upbeat PMI reports with the economy growing 0.7% in the first three months of 2017. Consumers pulled back on spending, and U.S. employers added far fewer jobs than expected in March.

Will the Fed acknowledge a slowdown in growth and thus send rate hike expectations lower for 2017? Or are these factors only a temporary drag affected by the Easter bank holiday weekend and a delay in tax refunds, which is likely to be reversed in Q2? The Fed’s statement should be answering these questions, and based on that, traders will act.

In Europe, investors will take cue from the final PMI numbers from Spain, Italy, France, Germany.

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