Stocks End On A High Note, “Volmageddon” Might Have To Wait -

Stocks End On A High Note, “Volmageddon” Might Have To Wait

Jul 26, 2024Jeremy ParkinsonFinance, No picture0

Image Source: PexelsMARKETSUS stocks ended a wild week on a high note, as investors staged a dramatic comeback fueled by some promising inflation data. By the end of the US session, the expectation of imminent interest-rate cuts had crystallized, flipping stocks into the positive after a roller-coaster ride. Earlier in the week, the Nasdaq and S&P 500 were pounded as Big Tech earnings deflated the AI hype, prompting investors to flee from mega-caps to small-cap stocks. It seems the little guys are finally getting their moment in the spotlight, basking in the glow of those long-awaited rate cuts on the horizon.Core PCE, the Fed’s preferred inflation gauge that conveniently ignores the erratic prices of food and energy, came in slightly higher than expected but still rose at its slowest pace in over three years.If you’re the type to crunch numbers and read tea leaves, the U.S. economy looks set to downshift into a lower gear in the year’s second half. A softer labour market, cooling inflation, plummeting consumer and business confidence, and a housing market revisiting its old troubles all point to this. Earnings reports this season have been pretty “meh,” consumers are showing signs of fatigue, and business capital investment seems ready for a long nap. The added uncertainties of election and fiscal policy will likely deepen the gloom until businesses get a clearer picture of future tax and spending policies and the overall shape of the impending economic slowdown. In short, the economic forecast calls for a long, dreary nap with occasional thundershowers of uncertainty.Still, the encouraging inflation reading sets the stage for next week’s Fed policy meeting. Officials are widely expected to keep interest rates unchanged, but many see this gathering as the final showdown before the central bank starts lowering rates in September. By Friday, the market was practically buzzing with rate cut fever, with investors acting like kids who just found out they might get an extra scoop of ice cream.So, the market has already decided about the Fed this year, but that doesn’t mean it’s smooth sailing from here. Investors are getting yanked in every direction. But nothing sways consumer sentiment quite like the political swamp in Washington.Markets had much to chew on this week and struggled with the bite. The S&P 500 slipped 0.8%, dipping nearly 5% from last week’s record high before a Friday rebound saved some face. Investors now have more clarity on the political showdown ahead, with President Biden officially announcing he won’t run again, presumably setting the stage for a Harris vs. Trump election. But in market terms, November is an eternity away, and the outcome remains as murky as ever despite last week’s ‘Trump trade’.Meanwhile, U.S. real GDP topped expectations in Q2, suggesting that the economy continues to chug along despite some softer indicators. Growth clocked in at 2.8% for the quarter, well ahead of the 2.0% consensus, with strength spread across consumer spending, business investment, and government spending. This left final domestic demand up a solid 2.7%. At the same time, core PCE inflation continues to cool off, with prices rising 0.2% in June, 2.3% annualized over the last three months, and 2.6% from a year ago. This progress should give the Fed the green light to start cutting rates—a September move still looks promising.As the FOMC gathers in Washington, D.C., next week to deliberate on the perennial “should they or shouldn’t they” question of rate cuts, some analysts are advocating for a reduction. However, the question remains for a “data-dependent” Fed: Does the data justify a hasty rate cut in July? Unfortunately, the answer is no, even though they really should consider hitting the preemptive button.Aside from the usual policy circus from Japanese policymakers (more on that in a moment), a pure macro spectacle drove the FX market overnight. Global participants are adjusting to the next phase of the policy cycle, which saw the dollar slip as two-year yields shifted lower.

This hasn’t deterred me from my “Volmageddon” trade. In a bold move, I broke my usual last Friday-of-the-month no-trade rule. I aggressively sold USD/JPY between 154.60 and 70 in anticipation of a political implosion in the US and or a tech sell-off creating a massive surge in volatility.I’ve christened the period from August through November as “The Great Deleveraging of 2024,” but it feels more like we’re just watching the movie trailers as of Friday.Despite Friday’s relief rally, the trend for global stocks appears to be on a downward spiral, industrial metals are taking an extended nap, and the Japanese yen is strutting against the US dollar like it’s auditioning for a lead role in a blockbuster. Meanwhile, the ever-popular carry trades unravel faster than a cheaply made sweater.The markets are a hotbed of drama, and if the current trends continue, we’re in for a show that might rival anything Hollywood can produce, except for a Kamala Harris makeover. So, grab your popcorn and hold on tight – it looks like we’re in for a wild ride!FOR THE RECORDBulls are calling the recent correction healthy, noting that major levels are holding strong. Investors had already priced in a bullish trifecta: a Fed rate cut at 100%, a Trump victory at 75%, and a soft landing at 68% (according to trading desk odds). Credit spreads—the “glue” for Wall Street—have remained well-behaved so far.Bears argue that a steeper yield curve is signalling a recession, and bond vigilantes won’t let Fed cuts do their magic, especially with US debt ballooning by $2 trillion over the past 317 days to a staggering $35 trillion. Consumers have lost patience with inflation, meaning lower nominal GDP and consequently lower, not higher, EPS. Commodity prices hint that the global economy is under the weather, and we’re just one bad payroll report away from shattering the soft landing thesis. And don’t even get me started on the possibility of a Harris win.FOREXThe spotlight in the FX world – the USD/JPY pair – took a moment to catch its breath into the end, sparked by stronger-than-expected Q2 GDP growth. The economy strutted with a 2.8% growth rate, outpacing the 2.0% consensus, fueled by robust consumer spending, government splurging, and hefty capital investments. The low-yielding yen, ever the drama queen regarding US yields, felt the tremors from this economic surprise.Despite the cheery GDP report, we doubt it will ruffle the Fed’s feathers. With a softer labour market, mellowing inflation, plummeting consumer and business confidence, and the housing market revisiting its woes, Fed Chair Powell will likely give us a clearer peek at upcoming rate cuts next week. But Friday’s PCE means September is a lock.This situation leaves USD/JPY on shaky ground, making it unlikely this downward spiral will pull off a quick turnaround like its previous stunts. The pair’s ascent was driven by sky-high US front-end yields, which had robbed the yen of its safe-haven cape. The yen’s risk-averse persona will resurface as US front-end yields keep dipping.Here is a better way to look at the VIX( safe-haven) vs JPY trade

Interestingly, the 10-day rolling correlation between USD/JPY and the VIX has gone negative again, marking five straight days of this throwback to 2022’s switch from a negative to a positive correlation. When front-end yields drop (shaded areas), the negative correlation tends to ramp up, signalling a higher VIX and lower USD/JPY.( MUFG)

In another pre-Bank of Japan plot twist, Japan’s Ministry of Finance (MoF) is reportedly urging the Bank of Japan (BoJ) to cut its bond purchases gradually. This unexpected move adds another layer of intrigue to Japan’s complex monetary policy landscape. It’s as if they don’t want the JPY to strengthen too much, but the market initially read this as big trouble in Not-So-Little Tokyo’s bond market and pared rate hike odds. Once again, the Japanese policymakers tried to snatch defeat from the jaws of victory.I’m exhausted from trading JPY and dealing with perpetual flip-flopping. I’ve been burning too much energy and mental bandwidth on a trade that keeps burning fingers. While I’m still committed to the VIX vs. JPY trade, I’m done playing ringmaster in the circus of Japan’s policymakers and holding our views that Fed cuts and BoJ rate hikes are happening soon and that the Fed is the bigger driver of this differential-narrowing trade.We viewed the 154-155 USD/JPY as the market incorrectly shrugging off the likelihood of a 15 basis point hike from the BoJ next week. We are leaning the other way and expect the TONA vs. SOFR spread to narrow fairly aggressively over the next three months. This is worth 152.00 USD/JPY at minimum.Tokyo’s latest consumer price data revealed that headline inflation took a tiny step down to 2.2% YoY in July, a notch below June’s 2.3% and right on target with market expectations. However, the BoJ’s favourite measure, core inflation excluding fresh food, decided to make a cameo, inching up to 2.2% from June’s 2.1%, hitting the consensus bullseye. It seems like inflationary pressure in services is still building up steam.It’s a nail-biter, but we’re standing by our prediction: the BoJ will shake things up with a daring 15-basis-point rate hike and a simultaneous cutback on its bond-buying program.So, I think the catalyst for a bigger JPY rally ( sub 152) will be if the BoJ accelerates its timeframe for reducing bond purchases. The problem is that the Board is concerned about hurting already weak consumer spending, and the JPY has found a new lease on life, driven by expectations of a BoJ rate hike and a Fed rate cut.Sure, I might be swimming against the tide of headlines here, but sometimes you’ve got to play the contrarian card to keep things interesting!A curious twist emerged from the USDCNH pair, which plummeted from 7.26 to 7.20 mid-week before rebounding post-GDP data. The reasons are as clear as mud—perhaps a fat finger trade, stop-loss triggers, or the unwinding of FX hedges and carry trades in CNH/CNY. As we look ahead, China’s economic fundamentals practically beg for more stimulus. While we expect some action, the real drama will unfold at the upcoming Politburo meeting at the end of July.CHART OF THE WEEKNomura Prime Broker data indicates a massive $56.5 billion CTA profit-taking spree over the last two days. That probably explains why, in our Friday note, I mentioned that more prominent sellers were fading intraday rallies. Flow data spilled the beans, and now Nomura confirms it.

This ultimately means that there’s less chance of a market faceplant next week as traders move into Rock, Paper, Scissors mode during a busy macro and central bank policy week.This action came well before what we pegged to be the 5325 SPX implied volatility tipping point, allowing CTA’s to pocket a tidy profit on their wave of selling and bring their average weighted long position way down. I’ll try to work out the calculations over the weekend. But it could be a calmer VIX -JPY trade into the month-end