The expectation that the US Federal Reserve could cut interest rates on Wednesday 19 June has seen US bonds yields test multi-year lows while equities have continued to hold near all time highs. This has been driven by recent weaker global economic data which has in part been driven by the ongoing (mostly tense) trade negotiations between the United States and China as well as the raising of tariffs by major economies, specifically the United States, China, Mexico and India to name a few. Currently, the odds of a cut in interest rates, according to the CME suggests a 25% chance of a 25bps cut, down from the previous week’s 20% probability’.
The wide expectation that the Federal Reserve would be “overly dovish” in it’s tone raises the risk of disappointment should the committee remain neutral or even tilt toward a hawkish underlying tone. Whilst economic data has seen a short term negative trend, a resolution on the trade front may be another catalyst that could see the FOMC not bowing to market expectations of a cut. Whilst we have seen the US Dollar recently come under pressure, the long term technical outlook remains positive, with the price continuing to trade within it’s 8 year upward channel as per the US Dollar Index. See Monthly Chart Here:
In terms of US Bonds, the 10 Year Yield currently trades around it’s long term incline support, with a reading of 2.07%. This can be seen on the monthly chart:
The weekly chart shows the yield oversold with the potential for a bullish reversal i.e. higher yields:
Yesterday over in Europe we also saw ECB President Mario Draghi announce plans for fresh stimulus, which may create a divergence between Eurozone and US interest rates, creating further demand for the US Dollar as a higher yielding currency.
Summary: The market’s dovish expectation of the US Federal Reverse Open Market Committee (FOMC) may be overextended/more than discounted, creating a risk where a neutral or even hawkish tilt would see rates tick higher and short term volatility rise.
With the market at a relatively high level of complacency, volatility has remained low. It may however, be an opportune time for traders to position themselves for a potential rise in volatility. A look at the chart of the S&P 500 VIX Futures sees a strong bullish engulfing candle having been printed on 18-June, with the current chart structure being similar to that of January and October 2018.
Traders could look to buy the iPath S&P500 Short Term Vix Futures (VXX) (or alternatively via options) as a way to participate on the potential upside in volatility.
Current Level/Last Close: $26.84
Take Profit Target: $30.40
Please chat to the Unum Capital Trading Desk to take advantage of this trading opportunity.