The Fed black-out period effect

US markets

With Fed officials in their communications blackout period ahead of next Wednesday's FOMC meeting, the economic data this week will do most of the talking. So markets are likely opening up in a wait-and-see mode.

Still, counterbalancing forces in the global economy are helping to keep the ship sailing on an even keel even in the face of a highly challenging environment. A remarkably resilient US labour market, robust China data, and the lack of other crises from regional banks have all helped to keep stocks range-bound. Not that there has been evenly good news, far from it, but investors top of mind fears around deposit flight and credit crunches were generally viewed as better than feared in the bank's latest earnings results.

With the Vix falling, much is getting made about the systematic footprint on US markets. As expressed by the VIX, equity volatility is back in its historically normal range. Implied and realized equity vols measured over the last 2 to 4 weeks are at their lowest since Dec 2021. But, notably, they have declined from very elevated levels last year to historically normal ranges. Indeed, the VIX is right in line with its 20-year median. So, there is no question a steady decline in equity vol has driven the increase in systematic strategy positioning this year. But, these strategies are typically closely tied to realized vol measured over longer windows, such as over 3 months. Three-month vol is still above its normal range, implying additional room for a decline and, in turn, for systematic strategies to raise exposure further in the S&P 500. 

Asia

In China, the fastest part of the post-reopening rebound is done. Continued consumption recovery will increasingly require higher income growth and improved consumer sentiment as we advance. So the easy part is done; now, the consumer will need to do the bulk of the heavy lifting. 

On the policy front, better-than-expected Q1 GDP took some pressure off policymakers to conduct broad-based easing, but the divergences underlying the economy call for targeted support. Most investors expect the broad monetary and fiscal stance to be unchanged, some industry-level policies (e.g., property and internet) to loosen further, and policymakers to continue their pro-growth rhetoric and to focus mainly on boosting confidence, encouraging consumption, and creating jobs for young workers. The April Politburo is the following key event to watch.

Forex

The Fed is counting on tighter credit conditions to help "finish the job," The ECB seems unlikely to have much assistance bringing potentially even more persistent inflation pressures back to target. A strong inflation report for April could tip the scales for another 50bp increase at the next meeting. This raises the probability of more divergence than currently priced, which would lift the current cap on EUR/USD targets this year. The big worry for the Euro bulls is that the ECB could face credit concerns at some point, with sovereign spreads still a potential risk as policymakers work to slow the nominal growth that has mitigated spread widening. For the Euro to progress further in this environment, it must attract portfolio inflows, requiring more investor confidence that longer-run capital return prospects have improved. With these constraints still lurking, we are skeptical that the EURUSD will move above 1.1200 this year. 

Speculation on BoJ policy normalization has picked up once again ahead of the April 27-28 meeting (Governor Ueda's first at the helm), mainly as wage growth looks set to be firm and new core CPI inflation has reached fresh multi-decade highs at 3.8% yoy as of March. However, with the risk of a US recession appearing somewhat more prominent, the BoJ might be reluctant to change policy at this stage.

The US debt ceiling deadline is approaching and could fall in early June. Most believe that the probability of a "no deal" outcome is higher than at any point since at least 2011. But, the direct impact on spot FX markets is uncertain. In more severe outcomes, safe-haven demand could temporarily boost the Dollar. But, in most scenarios, the Dollar responds negatively to this as a potential weight on growth via a hit to sentiment or related business spending and through possible fiscal reduction that could be part of a deal. 

Oil

The recent stress in the US banking sector has heightened concerns around the growth trajectory, triggering a shift from a market heavily focused on inflation last year to growth concerns.

 Oil markets have particularly suffered from growth worries and slowing inflation, with areas of the economy showing signs of reset, such as housing and wages. These direct wealth effects will trigger consumer rethinks around current travel and future trends throughout the US driving season, typically a boon for oil bulls.

From the policy perspective, the main risk to growth and oil markets is if the Fed signals a rate hike beyond May.