During the last two weeks, we’ve witnessed a dramatic fall in equity market volatility compared to that which we experienced during the first two months of 2016. However, we don’t expect the lower levels of volatility to continue.
The drop in volatility has been driven by a number of factors including expectations the US Federal Reserve will be slower to cut rates than was originally thought in December 2015. Also coming into play is easing announcements from the European Central Bank, the weaker US Dollar and stabilisation of the Renminbi.
Stability in the Renminbi has reduced fears that China may devalue and hopefully indicates that foreign investors are less bearish on China.
The US Dollar, whilst weaker overall, did experience a rally to recoup some ground against the Euro, Yen and Renminbi. The rally has put pressure on commodities prices again, bringing an end to the recent rally in oil, for example.
Prices for oil appear to have bottomed out as the collapse in the number of active drilling rigs in the US has begun to be reflected in sustained declines in actual production. And whilst it will take some time for caps on oil supply and improved demand to take full effect – it is coming.
The US earnings season begins in earnest next week, which is why I don’t think volatility will remain low. Earnings have already been revised significantly lower and priced into the market in late January and early February. However, markets could still respond negatively.
There is a lot of data due out of the US this week, which will be closely watched to see if it supports the Fed’s recently dovish stance.
One of the key pieces of data is the March employment figures. Average earnings will be closely watched in this report not only as a sign of strength in the labour market but also its inflationary impact.
Global PMIs will also be out this week. Flash PMIs for major advanced economies suggest that manufacturing growth remained weak in March – with a slight rise for the euro-zone and US, and a fall in Japan.