Market Update: Volatility Slumps, US-China Talks Extend, CPI in Focus

The reduction in the volatility (vol) space gets increasing focus, as volatility is a core input for investment managers capital allocation to equity and for traders it is a key input when considering position sizing. On a cross-asset basis, we observe the lower vol regime in US Treasuries, with the MOVE index at 92% and a discount to the 12-month average of 102%, or in US equity, with the VIX now set at 16.89% - the 11th percentile of its 12-month range and a solid discount to the 12-month average of 18.77%.

With SPX500 20-day vol realising at just 12%, implied levels of equity vol have limits even if we are set to navigate US inflation and the possibility that perhaps US-China talks won’t result in the positive outcome that markets seem to have discounted.

In FX vols, USDJPY side, G10 FX 1-week and 1-month implied vols have pulled below the 20 percentiles of their respective 12-month ranges - in the case of AUDUSD and NZDUSD implied vol is not far off 12-month range lows – perhaps influenced by the fact USDCNH vols are the 5th percentile. Some will feel there is a worrying level of complacency expressed in market pricing and the minimal level of portfolio hedges currently in place, even if it is now relatively cheap to build protection. Naturally, many have spent time building a list of potential catalysts for what could go wrong, and result in higher volatility and drawdown in risky markets, but few are seemingly prepared to front run these, preferring to act dynamically as and when the news reveals itself.

One could argue that the level of cross-asset volatility and the grind higher in US equity portrays a view that the US needs China’s rare earth enough to cut some sort of agreement which would allow some degree of freedom for US chip exports. One suspects it also suggests the tariff deadlines for China and the ROW will be extended, that US hard data economic data points continue to hold up, with the soft data metrics further improving. While the noise in Congress will start to build, pricing suggests the ‘One Big, Beautiful Bill Act’ (OBBBA) should pass the Senate with minimal tweaks and unlikely to set off a renewed selloff/buyers strike in US long-end Treasuries and Section 899 (as part of the OBBBA) failing to really stir things up.

All factors to potentially react to and while markets may be pricing in a lot going right, it’s the flows that drive markets at these levels (not fundamentals) - subsequently, we have to be open-minded to where the market wants to go, and markets gravitate to key levels:

• NAS100 futures (now 21,962) eye an upside break of 22k and the ATH of 22,319
• SPX500 futures printed a higher high on the day with price just 2% from its ATH Nvidia remains front and centre with a potential upside break of $145 putting the ATH of $153.13 in play.
• US small caps continue to grind higher, with the Russell 2k building on its recent technical breakout – with the index still some 12% away from the prior highs, this laggard remains a tactical long.
• The FTSE100 hit a high of 8856 in cash trade, and falling just shy of its ATH of 8908.
• In Australia, SPI futures are now firmly at new all-time highs, and the move in the futures through overnight (sycom) trade suggests the ASX200 cash index should open just shy of its all-time high of 8615.
• The HK50 holds the 21 May breakout high of 23,917 and 24k but needs to find 3% to print new cycle highs.
• The German Dax has recently seen a small unwind of extended longs and looks to the 2 June low of 23,740 – however, the index is still just 2% off the ATH of 24,479 and if the buyers can wrestle back control this is the obvious target.
• Bitcoin is 1% off its recent ATH, although on the day Ethereum is leading the charge higher and eyes a break of 2800 – the best level since February.
• In FX, AUDUSD and NZDUD still interests (despite the very low vol), where we’ve seen the highest YTD close in both pairs.
• USDJPY longs target a daily close above 145.08 to get the pair pumping higher.
• US 10yr Treasuries hold a range of 4.60% to 4.30% - a break on either side may increase cross-asset volatility.

Let’s see if the US CPI print kicks some life into the markets - with the consensus position that US core CPI will come in at 0.3% m/m, we may need to see an outlier print to really get markets moving – a number that rounds to 0.5% or 0.2% would certainly get some talking, and while seemingly unlikely, the market needs to see news that surprises. Poor demand in the 10-year Treasury auction may also spur increased vol in USTs and the USD, and we look for any further colour on US-China trade talks with the market building a view that the outcome will be a positive affair.

Good luck to all.