So what did we learn last week?
Well, we learned that despite what amounts to an institutionalized policy of suppressing vol, there’s only so much markets can take when it comes to political turmoil.
The S&P and the VIX finally met a near-term Waterloo on Wednesday following new revelations regarding what certainly looks like a concerted effort on the part of the Trump administration to obstruct justice. Then on Thursday, yet another corruption scandal rocked Brazil, sending the real plunging and triggering circuit breakers on the Bovespa.
Just when it looked like things had calmed down, a fresh set of headlines hit the tape on Friday afternoon that cast still more doubt on the Trump administration’s ability to remain intact in the face of increasingly aggressive investigations into alleged Russian collusion.
So while it looked, on the surface, like an “all’s well that ends well” type of thing, there was damage. The dollar, for instance, finally gave back all of its post-election gains and the 2s10s slope tells a similar story:
What then, should you expect in the week ahead?
Well, Barclays has some thoughts. Below, find excerpts from the bank’s latest, entitled “Ripples In The Sea Of Tranquility.”
While the scheduled events that carried the highest political risks are behind us, the lurking “sharks” have surfaced, temporarily breaking the calm in the sea of tranquility.
Headlines concerning the controversies of Trump may continue to emerge in the near term, driving bouts of volatility as markets re-evaluate the potential for tax reform and fiscal upside. However, given cyclical outperformance of the US economy, continued hawkish Fed commentary, and lighter USD positioning after the YTD correction, we think falls in the USD and front-end US rates should be limited. In contrast, the market impact of renewed political turmoil in Brazil is likely to be more enduring (at least domestically). Market participants were caught unprepared, and positioning and valuations in BRL assets were stretched following increased optimism on reforms, recovery, disinflation and BCB easing. We see upside risks to our USDBRL forecasts and a re-pricing of the DI curve, given our view of a higher risk of a recession, slower BCB easing cycle and stalled reforms.
In our view, the Brazil issue is idiosyncratic and the drag on other high-carry/high-beta EM will likely be short lived. With sparse known event risks and a lack of compelling themes, a low volatility environment is likely to resume as “political ripples” fade, drawing investors back into high conviction carry trades again.
The OPEC meeting is a key event this week, although EM and oil-linked currencies have been driven more by broader market volatility trends of late and less by oil. Our commodities analysts expect OPEC to extend the deal on production cuts for six months, but make some quota changes, and maintain their bullish view in oil prices over the near term. Oil prices have rallied on expectation of an extension, especially after Russia and Saudi Arabia announced the possibility of a nine-month extension, and could be supported by the confirmation of a finalized agreement, but the upside is likely to be limited. Taking advantage of the recent pull-back in USDRUB owing to poorer risk-sentiment over the past few days, we recommend a relatively oil-hedged FX carry basket of being long RUB and INR vs. SEK and CAD.
Finally, here’s an event calendar from BofAML: