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Fair weather conditions

A trend of falling volatility and range bound markets continue to prevail, but for how long?

Global markets are little changed over the course of the past week with the most notable development appearing to be the ongoing decline in volatility across an array of indicators, pushing option prices to ever cheaper levels. In the wake of the French elections it seems there is an absence of a strong catalyst to drive price action and where some attention had been focused on falling oil prices, these have rallied in the past few days, suggesting a continuation of a range trading environment.

Data releases remain pretty upbeat and with a number of inflation indicators appearing to suggest that last month's softness was a temporary effect, related to the timing of Easter, we wonder if an upside surprise is also in store with respect to the US CPI data due later today. April eurozone inflation data released last week was stronger than expected and suggests that a modest uptrend in prices continues and in the past few days data in Sweden has painted a similar picture. We see risks to an upside surprise in US CPI today and also in the upcoming UK inflation data due early next week.

We are back in Washington again this week with meetings in the Congress and Senate. Our sense is that Budget Reform remains distant and that Healthcare Reform remains the focus for the foreseeable future. We also continue to be struck by the number of vacant posts for key staff positions and the fact that many individuals we have met have turned positions down. The firing of James Comey from the FBI this week also reaffirms the sense that the circus in the Administration continues to resemble an episode of The Apprentice, yet getting nothing done may not be as bad as it seems. We have met many former policy makers who openly worry that were a fiscal stimulus to be delivered to an economy already at full employment then inflation and rates would almost certainly jump higher - a point which is not well understood by those based in the Capitol. Arguably the economy and financial markets are in very good shape already and nothing much is needed at this particular point.

In DC, it is striking how everyone has stopped following Donald's tweets these days and even at his hotel, his appearance hardly sets pulses racing as was the case just a few months ago.

Mark Dowding, Head of Developed Markets

 

Looking ahead, we do wonder if higher inflation prints for April could push yields higher. It appears to us that risks are in that direction and that a catalyst is needed at the current time to break us into a new range. That said, as things stand, we are very confident that the Federal Reserve (Fed) will hike in June and so the recent uptrend in US yields should remain intact. We also look for similar price action in the U.K and suspect that the Tuesday inflation data could be a lot higher than most market participants are looking for.

Aside from this, a world where we remain in a range and where volatility continues to drop should favour carry trades and lead to further compression in corporate and sovereign credit spreads. We feel that in the coming weeks either 'carry' or 'reflation' will consequently define the broader market theme and that it should be possible to set up to perform well in either situation by running a stance long of spread, short rates and long the US dollar.

We feel fair weather conditions can prevail in markets for now - even if a trend of falling volatility is likely to meet a sticky end at some point in the not-too-distant future. In DC, it is striking how everyone has stopped following Donald's tweets these days and even at his hotel, his appearance hardly sets pulses racing as was the case just a few months ago.

Boring may be good for asset prices and anecdotally it was interesting attending meetings in DC with a medal of 'The Dear Leader, Mr Kim, the Wrong-un of North Korea' applied to one's chest (supplied by a friend who recently visited) without this stirring up hardly any nationalistic sentiment. It seems even events on the Korean Peninsula are being dismissed as a source of risk in markets. In a journalist interview this week it was interesting to sense that for the first time in a long while, there isn't too much worth writing about. That said, at least I got to show Kim the highlights of New York and DC, and although he didn't make it to the White House on this trip, he still got to enjoy The Trump.