• Edward Ballsdon

Less oversold prices = more volatility?



Many risk assets across different markets that got hammered in March have subsequently rebounded off very "over sold" levels. As an example, this can be clearly seen by the recent price action of AUDJPY, one of the highest correlated assets to the S&P. The fx cross reached very over sold levels with the price very distant from the 50 and 200 day moving averages and its' RSI sub 30. The rise in price has corrected these oversold indicators, but the price now seems to be rejecting breaking through the 50 day moving average resistance. After being heavily oversold, AUDJPY looks more balanced.



Despite production cuts, the oil price is back at the lows (although the forward curve remains steep). Oil is now testing the psychological $20 support level. The similarity to the chart above is that the RSI is no longer as oversold and the price is no longer as distant to the 50day ma. as the latter has declined markedly.



10 year Inflation breakevens have rallied hard from very oversold levels (RSI touched an exceeding low 11) - the price has now reached the 50 day ma, which should be an initial resistance. I wonder if inflation breakevens will be able to continue their rally as weak inflation data gets published (see post on US CPI) and if oil does not bounce, let alone should it break below $20.



Thanks to the Fed's outsized buying of USTs under its' QE program, 10 year Real Yields have recovered most of the losses that occurred during the sizeable sell off when the government announced its' huge fiscal policy. However there are subtle differences between the chart below of 10 yr Real Yields and those above of "risk assets" (i.e. those positively correlated to the S&P).

  • First the moving averages of the charts above have changed directions and started declining - they have not for 10 year real yields.

  • Secondly, the RY price pierced the moving averages on the way up and again on the way down.

In other words, the trends in "risk assets" seem to have changed, it has not for 10 year US yields.



Similar price and momentum trends to AUDJPY and inflation breakevens can be seen in EM currencies, the 5 yr Eur ITRX Credit Index and the Btps/Bund spread (although to varying degrees). Given the high correlations between asset classes, I could add many more charts to show similar behaviours.



The rebound of risk assets from oversold levels, which has now perhaps come to a market pause at key resistance levels, raises the question about market volatility in the immediate future. Naturally both the VIX and FX implied volatility levels have declined markedly in this risk asset rally from very overbought levels.



Markets tend to "buy the rumour and sell the fact". The recent rebounds in risk assets have puzzled a lot of fundamental value asset managers, but the bounce looks very much like the "buying the rumour" that everything would be saved by fiscal policy.


But yesterday's market reaction to the 1Q results of JPM and Wells Fargo's might be an example that shows the market is now beginning to "sell the fact". (NB the announced provisions and losses were pretty much in line with the recent post that explained how Covid19 would impact the outlook for banks).


The banks' results were "ok" and not too far from expectations at all. However, whilst the S&P 500 closed UP 3% on the day, the S5BANKX (sub index of banking stocks) closed the day DOWN 4.1%.



CONCLUSION


  • After reaching very oversold levels on the 23rd March, risk assets have rebounded and in may cases reached the first major resistance levels of the 50 day moving averages.

  • Correlations between risk assets remain very high (with the exception of oil which cannot find a bid at all).

  • Implied volatility has declined substantially in this risk asset price rebound.

  • Real yields have not changed trend and are completely uncorrelated to risk assets. This is easily explained away by the Fed's balance sheet expansion.

  • Yesterday's market reaction to half decent bank earnings could be a signal that the rebound is over and volatility will increase.

  • With poor economic data being released on a daily basis, the risk reward of holding risk assets could look very poor if volatility starts rising ahead. This is especially the case for EM countries, who remain outside the "circle of trust" when it comes to money printing.

  • Short AUDJPY and inflation breakevens are a very good hedge for risk asset declines.




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