Wake Up! A Big Wednesday Awaits for Macro Traders

(Bloomberg) -- Traders who enjoy chaos should love Wednesday. It’s as if the biggest geopolitical, economic and monetary-policy risks of the moment have fused and are hurtling our way.

There are four big events. The European Central Bank releases its policy decision amid growing concern it’s doing more harm than good. British Prime Minister Theresa May holds Brexit talks in Brussels. On the other side of the Atlantic, the U.S. inflation report comes out to a crowd eager to learn more about the health of the economy. And the Fed releases the minutes from its surprisingly dovish March meeting.

Any jolt of energy could raise cheers. Currency traders across the largest developed markets are operating in the quietest conditions since 2014, and rates volatility is headed back to the record low levels seen in March, when the strongest quarter for government bonds in years was closing out.

For Sydney-based Stephen Miller, going long the dollar is the best trade for this week’s balance of risks, particularly versus the euro. “Europe’s malaise is much more manifest than anything else that’s going on in the U.S., Australia or China,” said Miller, an adviser at Grant Samuel Funds Management Pty and a former head of fixed income at BlackRock Inc.

This view is widely shared, as events in Europe are top of mind for many investors concerned about the knock-on effects for global growth.

ECB Shudders

“The ECB does manage to generate volatility, so on the day itself I’d put that pretty high on the list of things that could actually inspire the market to trade more actively,” said Alan Ruskin, the New York-based chief international strategist at Deutsche Bank AG.

However, a surprise from the central bank is unlikely to trigger more than knee-jerk reactions, in his view. “The market just doesn’t believe the ECB has much latitude to do anything,” said Ruskin, who sees the euro sticking to a range of $1.1177 to $1.1330. Options positioning shows bets the euro will weaken, but traders are refraining from adding structures that would benefit from a wider trading range.

While the ECB is clearly getting concerned about weaker credit growth, it’s not about to leap into action. Policy makers will probably set generous terms on their new long-term loans for banks by June, and possibly introduce a tiering system for the deposit rate after the summer, according to Michel Martinez, chief economist for Europe at Societe Generale SA.

Shaky Brexit

Nomura International Plc analyst Jordan Rochester will be monitoring headlines Wednesday as EU leaders meet in Brussels. They’re considering May’s request to delay Brexit until June 30, which must be approved by leaders of all 27 remaining member states.

The market expects a one-year extension to the Brexit deadline, according to Rochester, who doesn’t expect much reaction. But attention will soon shift to the fate of the beleaguered U.K. prime minister, he said, and if she survives politically, the pound could rally in the second half of the year.

The U.K.’s wretched divorce is keeping New York-based UBS Group AG strategist Vassili Serebriakov tactical on the dollar for now, but he’s looking to short the U.S. currency in the second half of the year if global growth improves as he expects. “When we get to the second half of the year I think you’re going to see broad dollar weakness.”

Inflation Gauge

Tame U.S. price data occupy a lower rung in the rankings of tradable news, but this week’s report on the consumer price index could prompt more aggressive bets on a Fed rate cut, according to Chirag Mirani, head of U.S. rates strategy at UBS.

If core inflation only grows 0.1 percent from February, that would cause the yield curve to steepen, with the front-end outperforming 10- and 30-year maturities, Mirani said. Conversely, he said a rate exceeding the median economist estimate of 0.2 percent might allow yields to climb, but not far. He recommends exposure to 10-year inflation breakevens because “the Fed really can’t get hawkish until market-based inflation expectations at least start to drift higher and show some confidence in their direction.” But it’ll be a gradual move, in his view.

“You’ll need a quarter’s worth of data, in my opinion, for the market to guide itself to a more normalized level.”

Eugene Leow, fixed-income strategist at DBS Bank Ltd., is cautious of investors adding U.S. duration to their portfolios unless they are confident a recession is imminent. “It can be argued that the market has become too complacent on inflation risks -- especially with the bounce in oil prices -- and the upcoming sizeable Treasury bond issuance,” Singapore-based Leow said in a report.

Fed’s Agenda

Investors will seek clarity from the Federal Open Market Committee’s March deliberations on why policy makers lowered their projections for rates so sharply last month. That move provided a cue for traders to bet aggressively on a U.S. rate cut, and the Fed’s unlikely to endorse that positioning, according to UBS’s Mirani. “The bar for a cut with the labor market adding jobs is very high, to say the least,” he said.

Mona Mahajan, a U.S. investment strategist at Allianz Global Investors, said the minutes will provide key additional color on the Fed’s view of the economy. Investors will also need to look to earnings season beginning later this week, she said.

“Clearly everyone was already thinking about a Q1 that was seasonally weak, but perhaps this Q1 was even softer given the government shutdown, what’s been happening globally and global growth slowing,” she said. “Between earnings and the Fed minutes, we’ll be getting a pretty good sense of how Q2 will play out.”

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