A traders market - Omicron trends to drive headline risk

Chris Weston
Head of Research
28 Nov 2021
I'm not sure anyone expected Friday’s volatility shock – the fact the VIX index exploded 10 points (54%) to 28%, crude fell 13% and long volatility strategies lit-up.

This portrays the one-sided skew in positioning - many will claim they expected a move lower in risk and that is fair, but these were huge moves.

Across asset class we saw some of the biggest percentage changes since the pandemic breakout – case in point, the 4.7% close lower in the EU Stoxx 50 index was a 6.4 Z-score move.

Friday was also a classic flow move, where the overriding feeling was that market players went into capital preservation mode and adopted a mindset of a return of one’s equity – Funds de-risked and de-grossed as volatility rose, and over-levered positions caused forced selling – gamma related flows in options land kicked in and again this just exasperated the movement.

One naturally questions if size sellers were met with a lower top of book liquidity, that exasperated price moves – That changes today as trading desks are fully manned through EU and US trade.

Here's a few highlights for the week ahead:

  • US ISM manufacturing (Thursday at 2:00 AEDT) – consensus 61.0 (from 60.8)
  • US non-farm payrolls (Sat 00:30 AEDT) – 535k jobs, participation rate 61.7%, U/R 4.5%
  • Canada employment data (Sat 00:30 AEDT) – no consensus.
  • China manufacturing PMI (Tuesday 12:00 AEDT) – 49.8 (49.2)
  • Aussie Q3 GDP (Wed 11:30 AEDT) - -2.6% QoQ, +3% YoY
  • OPEC meeting (Thursday)
  • Powell and Yellen testify before the Senate and House Panel
  • Eurozone inflation estimate (Tuesday 21:00 AEDT) – 4.3% YoY (4.1%)

Headlines will now dominate and drive price action above all other considerations and while we have some tier one data to focus on this week, such as US non-farm payrolls, we all become scientists again. Choosing which headlines are noise and which ones are genuinely going to move sentiment is where money will be made and that's difficult as emotion can often take over. As always, price is the final arbiter and that will be guided by semantics.

One even questions if data matters that much anyhow – I guess the market will make up its collective mind sooner than later on whether protections offered by current vaccines are effective and we can (hopefully) move back to obsessing over inflation and how many rate hikes are priced in 2022 and beyond. Until we feel assured that Omicron is not going to alter the way we live too intently in high vaccination countries then markets may be less sensitive to the economic data points.

We wait for real colour on the efficacy of current vaccinations against severe cases, hospitalisations and fatalities. If the new variant undermines what we have been vaccinated against then what we’ve seen in markets on Friday is probably not an overreaction. We may not truly know the answers to that for a period of time

For those who however are keen to get amongst the headlines, having a keen eye on movements in Gauteng province in SA seems logical, which is where ground zero seems to be for Omicron. We've seen just how transmissible the virus is, with cases coming to light in a number of countries, resulting in a rapid closing of borders, while some have added fresh restrictions.

Watch guidance from big Pharma

Having an eye on Moderna and Pfizer seems logical too – a 21% rally for Moderna on Friday shows the market sees Pharma (along with Pfizer) having a big role in shaping our understanding and affecting broad sentiment across markets. Tests on whether the current dose of Spikevax has the desired effects on Omicron or whether more needs to be done could be a very useful guide for market participants.

What will cause central banks to pivot?

In a world where central banks are in the process of normalising policy, it leads to a more challenging situation and one where markets will search out what It will take to see them pivot and move to a more dovish stance – the barriers I suspect are high and that could lead to a solid correction in risk as market test out central banks – again that will be dictated by whether the market sees the worst-case scenario as a real threat.

A snapback in risk due near-term?

If I look at the FX markets this morning, I guess the logical place to start is with USDZAR, which is currently -0.7%. I see AUDJPY, one of the go-to proxies of sentiment currently +0.6% and this cross has an 82% 10-day correlation with S&P 500 futures – it suggests equity indices will trade on a positive footing. Most of the talk I’ve seen from other traders is they wanted to buy risk today, guided by comments notably from Barry Schoub, chairman of the Ministerial Advisory Committee on Vaccines, detailing g a news network that cases that have occurred so far have mild cases.

Crude is a must watch

Crude is a must-watch this week – not only has price closed below its 200-day MA for the first time since November 2020 but has moved c.20% since 10 November. This makes Thursday’s OPEC meeting even more interesting. It feels like a halt to its planned output increase is a given, but will there be talk of output cuts? I feel this is a low probability but given crude 13% decline on Friday, I feel SpotCrude and SpotBrent could see real interest this week from traders.

So, a big day ahead and while we may see traders initially push back into long risk positions today – notably in Crude and Equity indices, while covering shorts on AUDUSD shorts – we know the worst-case scenario and markets will continue to work through news flow on transmission, re-production rates and the picture on whether the vaccines hold up. Travel and re-opening stocks should be great sentiment gauges too and worth putting on the radar.

Will any rallies be a one-day affair? This is a fickle market and the risks to me are that until we have clarity there are two-way risks in markets and volatility should remain elevated – a trader’s market.

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