North Korea rattles markets but central banks more important

The market is waking up to confirmation that North Korea tested an ICBM long-range missile that could reach Alaska. In response the US and South Korea conducted a joint military exercise. Gold rallied along with the yen, however, the rally in safe havens has essentially been mild, and stock market futures are predicting a flat to slightly higher open for European and US stocks later today.

While North Korea’s military ambitions are a background threat for markets, we don’t think that this particular geopolitical event is at the stage yet where it will cause a spike in volatility. Far more important at this stage of the economic cycle is what global central bankers will do next. For the rest of this week we have some key central bank announcements including FOMC and ECB minutes and some speeches from key bankers including the ECB’s noted hawk Jens Weidmann. The question now for investors’ is will there be more hawkish rhetoric that could unnerve appetite for risk?

Markets holding out for balanced minutes

Interestingly, the market seems to be focusing on the more hawkish rhetoric. On balance, central bank speak, which has been a key driver of market volatility of late, was on the dovish side on Tuesday. The Swedish Riksbank held rates steady and argued now wasn’t the time to hike rates or cut its QE programme, although Sweden is one of the fastest growing economies in the EU. ECB member Preat, a noted dove, argued for “patience and persistence” when it comes to QE, and said that the Bank needs more time to see where inflation is heading before it can raise rates. The title of hawk of the day should go to fellow ECB member Yves Mersche said that the ECB will have a “compositional discussion” on its QE programme, potentially at its next meeting on July 20^th. He didn’t elaborate on what that means, however, one could assume it could suggest talk of tapering could be on the cards in Frankfurt later this month.

The market appears to be putting more weight on the Mersche comments, the euro was higher during early trading today with EURUSD stabilising around 1.1350 after selling off earlier this week. This move is also supported by another run higher in German bond yields at the start of this week, 10-year German yields rose nearly 1 basis point on Tuesday. Considering there has been a near 200 point move higher in the euro since Draghi uttered the now infamous word “reflation” last week, the FX market is clearly not expecting another about-turn in the minutes from the ECB meeting, which will be released on Thursday. However, if the ECB minutes suggest that the jury is very much out about the prospect of ending QE early and hiking rates as early as mid-2018, which is what the market now expects, then we could see a sharp sell off in the single currency, and a potential rebound in European stocks.

UK service sector PMI critical for sterling

Stock markets seem much more sanguine about the hawkish central bank environment compared with last week, perhaps they expect the minutes form the FOMC and ECB to tone down recent hawkish rhetoric from some members.  The futures markets are pricing a higher open for the Dow and S&P 500 and a flat open for European indices. European indices may be given a lift if key economic data releases, including the service sector PMI in the UK and retail sales data in the Eurozone, are stronger than expected. A weaker than expected services sector PMI could see GBP/USD lose more momentum, which ironically may be good for the FTSE 100. This pair fell sharply on Monday after the worse than expected manufacturing PMI report for June, since the services report is more relevant for the UK economy then the pound reaction could be bigger if we get another data miss. A key level of support includes 1.2875 – the 50-day moving average. A move below here could see further losses for this pair.

The FTSE 100 closed down 0.27% on Tuesday, and the futures market predicts another small loss at today’s open. However, the top performers on Tuesday included Rangold, Fresnillo and other miners. Since mining is an important sector in the FTSE 100, if these companies can continue to move higher in a block, then this could limit further FTSE 100 downside.

The tech sector not out of the woods yet

The focus is also likely to be on the US markets when they open. Can the current economic environment sustain a record high for the Dow? How the Nasdaq will react post Monday’s data glitch is also worth watching. Will it play catch up with the Dow, or is Monday’s technical problem another reason to ditch this sector for good? Ultimately we expect tech stocks to remain relatively range bound as we wait for the all-important earnings season in a few weeks’ time. There is a lot resting on earnings season, and as such we expect it to be a trigger for volatility in the tech sector later this month. Interestingly, the divergence between Nasdaq 100 volatility and the Vix is at its widest level for many years, suggesting that tech is not out of the woods yet.

Waiting for the Big Kahuna…

Overall, economic data and the performance of the tech sector are worth watching. Also, can the FOMC minutes lift the dollar out of the doldrums? Although the dollar index has picked up from last week’s lows, the buck has turned a blind eye to increasingly hawkish rhetoric coming from the Fed, thus we doubt that these minutes will have any bearing on the US currency. Instead hard economic data such as factory orders and durable goods data released this afternoon are far more important for the dollar, and are good precursors of US economic strength before the big kahuna data releases arrive later this week, culminating in the NFP report on Friday.