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Risk-Taking Rebounds as Rates Volatility Falls

As month-end flows begin to dominate price action in the financial markets, equity futures are preparing for a modest rally at the open, with bank shares and technology indices poised for the biggest gains. Treasury yields are little changed, the dollar is 0.3 percent higher, and other majors are turning in a mixed performance.

Implied volatility levels remain relatively elevated as participants hedge themselves against another scare, but term structures are looking interesting: pricing suggests traders expect next week’s US data releases to trigger market movement, but ranges are then expected to tighten in the period preceding decisions from the Bank of Japan, European Central Bank, and Federal Reserve in late April and early May. If the “dollar smile” framework remains applicable today (we think it does), a sustained decline in currency and interest rate volatility should favour risk-sensitive currencies – like the Australian and Canadian dollars – against the greenback and yen.

The euro is modestly stronger after European Central Bank’s Peter Kazimr suggested that a “slower pace” of rate hikes might be appropriate in months to come, with core inflation levels remaining the most important variable in determining policy changes. Traders are overwhelmingly convinced rates will climb by a quarter point in May, with at least one more increase coming before the cycle ends in coming months.

The Canadian dollar continues to grind higher as global risk sentiment improves, but doesn’t appear to have reacted to yesterday’s budget from the governing Liberal Party. The plan, delivered by Finance Minister Freeland, is expected to add another $43 billion in spending over the next six years, with deficits widening as the economy slows and borrowing costs climb. Canada’s federal debt remains among the lowest in the G7, but the country’s financing position looks far less favourable once provincial obligations are added in, and the corporate and household sectors are included.

Chinese shares are climbing after Alibaba said it would split its business into six independent companies. Markets are looking forward to the value creation that could accompany multiple new listings, but we also can’t help but think the episode is reminiscent of the trust-busting effort that broke the Bell System into a number of regional entities in the early eighties – one that ultimately help foster greater innovation in the telecommunications sector (with a critical caveat being that Chinese authorities appear to have executed the process far from prying public eyes).

A thin economic data calendar beckons. Federal Reserve Vice Chair for Supervision Michael Barr, Federal Deposit Insurance Corporation Chair Martin Gruenberg and Treasury Undersecretary Nellie Liang will deliver Congressional testimony for a second day, appearing before the House Financial Services Committee this morning. In yesterday’s session, the three downplayed systemic risks related to the downfall of several regional lenders in recent weeks, with Mr. Barr suggesting that Silicon Valley Bank “failed because its management failed to appropriately address clear interest-rate risk and clear liquidity risk.”

The Energy Information Agency is expected to confirm a 6.1-million barrel drawdown in American crude inventories last week, helping support prices in markets that have had a tumultuous month. Barrels of West Texas Intermediate are trading for almost $74 this morning, down from more than $80 in early March, and up from $64 at the height of the regional bank seize-up. With supply disruptions in Iraq intersecting with growing demand from China, few expect the OPEC+ group of exporting nations to adjust production targets at its next meeting, and the Biden administration seems reluctant to begin refilling the Strategic Petroleum Reserve at these levels.

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Higher for (even) longer