08/01/2015: Can we trust the risk rally?

Risk appetite has begun to improve in the past couple of days. This follows on a three day period at the beginning of the year where investors were hit with a significant flight into safe haven assets. However the question is whether this rebound can be trusted and whether the improvement in sentiment will last.

Bull Bear

After a relatively quiet end to the year, the renewed decline in the price of oil has really spooked financial markets. The glut of oil supplies (the primary driver of the lower oil price) show no sign of falling. Furthermore, disappointing PMI data across the world at the turn of the year shows that demand is also unlikely to pick up any time soon either, and this then drove further downside in the oil price. However, there has been an element of support for oil which has returned in the past 24 hours. This support has enabled investor sentiment through financial markets to improve once more.

Safe haven trades which had performed so well in the early part of the week are now retracing their gains. The gold price is falling (off $16 since the $1222.40 rally high), the yen is weakening again and US Treasury yields have bottomed (the 10 year yield is up over 100 basis points in the past 2 days and is once more testing 2.00% again).

The VIX Index which had spiked significantly higher just a matter of days ago fell 8.5% yesterday allowing the S&P 500 to rally strongly. The movement in the S&P 500 options volatility and the equity market have a strong negative correlation and if the VIX continues to pull lower then equity investors can expect a nice rebound after 5 straight days of losses had been record (until yesterday’s rebound).

However, the oil price has the capacity to scupper this rebound once more. There has been no significant fundamental event that has been seen in the past couple of days which has helped to generate the support. However, technical indicators have been pointing towards an oversold position recently which may be the cause of the consolidation. However, technical rallies in oil have tended to be near term phenomena since the huge sell-off began. It is my belief that until there is some concrete fundamental evidence that shows a fall in the glut of oil supply or evidence of a pick up in demand, the oil price will struggle.

If this is the case and there is no fundamentally supportive event, then volatility can be expected to remain a feature of financial markets. This would certainly not be the ideal conditions to generate sustainable gains in the equity markets, whilst also maintaining demand for safe haven assets in due course.

There is a lot more that needs to be done to suggest this is a sustainable rally. Market conditions are likely to remain volatile and this would suggest active traders will be the ones that benefit from the noise.

Oh and don’t worry, there is only the small matter of Non-farm Payrolls to worry about tomorrow…

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