US claims Mexico trade deal closer, claims EU offering better deal. Markets unimpressed. But market volatility shifts lower. Local rates shift lower

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By Nick Smyth

It was another quiet night across markets with volatility remaining very subdued.  There wasn’t much new from Fed Chair Powell’s testimony to Congress but US equities and the 10 year US bond yield are slightly higher. 

Fed Chair Powell delivered his testimony to Congress overnight but didn’t add much to his comments from the previous day.  While core inflation had converged to the Fed’s 2% target he noted that the Fed was still “slightly more worried about lower inflation”.  In another slightly dovish remark, Powell said “we’re close to full employment, maybe not quite there”, which seems a little surprising given the US unemployment rate is 4%.   There was little reaction to his comments and the consensus is that the Fed will, barring a shock, hike rates twice more this year and adopt a more data-dependent rate policy in 2019.  The US 10 year bond yield is up 1bp to 2.87%. 

US equities are a touch higher overnight (S&P500 +0.2%), led by the Financials sector after a better than expected earnings report from Morgan Stanley.  The S&P500 is now less than 2% from its record high reached earlier this year.  

On trade, President Trump said a US-Mexico trade deal was “getting closer” and the US administration may seek a deal with Canada at a later date (the Mexican peso is the strongest major currency on the day).  Elsewhere, European Commission President Junker will meet Trump next week to discuss potential reductions in car tariffs, with Economic Advisor Larry Kudlow saying Junker “is bringing a very important free-trade offer.”  There was little reaction to the US Commerce Department’s announcement that it had opened an investigation into whether uranium imports threaten national security. 

One of the features of the past few months has been very subdued volatility across asset classes (perhaps with the exception of commodities).  The VIX is now below 12, while measures of implied volatility across bonds and currencies are at or near multi-year lows.  To an extent, measure of low implied volatility probably reflect the modest moves seen across assets – for instance, the US 10 year Treasury yield has traded an exceptionally narrow 7 basis point range over the past three weeks.   While trade tariffs are a clear and obvious threat to the global economy and markets, the broader economic backdrop is one in which global growth is strong, core inflation is slowly edging higher, and central banks are either hiking gradually (like the Fed) or not at all (like the ECB) – i.e. macroeconomic volatility is also low at present.  While market volatility can always change abruptly (like we saw earlier this year), for the moment the low volatility environment is helping to support risk assets like equities.  

Local rates markets reversed some of the moves seen after the core inflation upside surprise, with the 2 year swap rate down 2bps and the 10 year rate 4bps lower yesterday. 


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