For the 3rd day in a row, traders in credit and equity markets bid for protection. VIX rose 1 vol to 13.5% (diverging notably from stocks) and High-yield and investment-grade credit protection is back at 1-week wides (again diverging notably from stocks). USD weakened back to pre-FOMC levels (-0.4% on the day) led by EUR liquidity needs by the look of it, was ignored by the commodity markets which saw silver and gold tank (gold < $1200) and WTI crude back under $100. Treasuries rallied modestly (yields -3bps) as stocks wriggled sideways on super-low volumes (with NASDAQ underperforming and Dow outperforming to break the new record-high 16,500 level). Homebuilders outperformed even after the dismal home sales data with Energy worst on the day.
With equity markets reacting enthusiastically to the Fed’s historic policy change announced last week, PIMCO's Mohamed El-Erian notes many have rushed to declare victory. Whether in asserting investor comfort with the policy regime shift or in declaring the definitive end of dependence on quantitative easing (“QE”), they believe that the markets’ short-term reaction can indeed be extrapolated into the longer-term. While most Fed officials will welcome the markets’ favourable reaction – and especially so after the May-June shock – El-Erian suspects that they are much more cautious. Indeed, in this FT Op-Ed, he lays out four reasons why such caution is understandable.
The world economy has experienced another year of subdued growth, having failed to meet even the most modest projections for 2013. Most developed economies continued trudging along toward recovery, struggling to identify and implement the right policies. Meanwhile, many emerging economies encountered new internal and external headwinds, impeding their ability to sustain previous years’ economic performance. Nonetheless, some positive developments in the latter part of the year are expected to gain momentum through the coming year. But the global economy is still subject to significant downside risks. In short, while the global economic outlook for 2014 has improved, policymakers worldwide must remain vigilant about downside risks and strengthen international cooperation. Developments in 2013 provide strong incentive for policymakers to do so.
While some individual stocks (cough TWTR cough) may have reached irrational bubble territory, the US equity market is undergoing a seemingly 'rational' bubble. However, as John Hussman illustrates in the following chart, the probability of a stock market crash is growing extremely rapidly.
We are happy to announce that the job market is officially improving. It was almost exactly a year ago when we reported that Delta Airlines received 22,000 applications for about 300 flight attendant jobs in the first week after posting the positions outside the company. The applications arrived at a rate of two per minute. Said otherwise, the precious few lucky hires had overcome an acceptance ratio of 1.3%. Putting this into perspective, the acceptance ratio at Harvard, the lowest of any university, is 5.9%. Fast forward to today and once can clearly see an improvement: over the weekend, Southwest Airlines Co. which last hired flight attendants from outside the company in 2011, received applications at a rate of only 80 a minute, getting a paltry 10,000 resumes for 750 openings.
The US economy is stabilizing, but it's not truly recovering. That's the view of Saxo Bank's Chief Investment Officer, Steen Jakobsen. Following the Fed's tapering news, Steen says the risk is that we trade on perception and not reality... "We're at the end of asset inflation," he says, and that "will dawn on the market very soon."
While shortened Christmas Eve trading is traditionally the lowest volume day of the year, based on recent trends it may be difficult for today's action to stand out from the landscape thanks to an ongoing volume collapse, which however should make the even more traditional low-volume melt up that much easier. Sure enough, futures are modestly higher driven by their favorite signal, the EURJPY. Not surprisingly there has been particularly light newsflow with market closures in Germany, Italy and Switzerland in addition to early market closures for UK, France, Netherlands and Spain. Those markets that are open are trading in positive territory with the FTSE 100 being supported by BSkyB following an upbeat pre-market report for the company and their customer base, whilst the IBEX 35 is being supported by the financial sector. Overnight in China there was news of an injection of CNY 29bln via a 7-day reverse repo, although market commentators have said that this is more of a gesture than any meaningful intervention given the size of the country's banking market. Fixed income markets are particularly light with there being no trade in the bund future given the Eurex closure, with other trading products relatively flat given the lack of newsflow. However, the short-sterling curve has bear-steepened and thus continuing the trend seen since the end of last week as a result of both UK unemployment and UK GDP coming in better than expected.
With all eyes squarely focused on US equity markets daily impersonation of the Caracas Stock Index, BofAML is growing increasingly concerned about China. Since the start of December, Chinese equities have been under significant pressure with the Shanghai Composite on the edge of completing a 3-month Double Top. A break of 2079 would confirm this move, exposing considerable downside in the weeks ahead. This could also prove to be the catalyst that ends the 17-month downtrend for USDCNY.
With both current conditions and future expectations indices jumping higher, the UMich consumer confidence headline final print rose at its equal fastest pace since Sept 2009. The surge in current conditions - the largest since Dec 2008 - has lifted it back to the highest level since July 2007. If there was anything to note that took the shine off such an exuberant surge it's the fact that the headline number did actually miss expectations (3rd miss of last 4) and the final outlook data dropped from the preliminary print. As we have noted before, it is confidence that 'inspires' the multiple-expanding hope as fundamental reality fades - bulls better hope it's different this time as we hit the year's highs in confidence.
Just shy of the new year, financial markets continue to be dominated by the extent of monetary accommodation. Especially in major advanced economies, bonds and stocks have shrugged off the summer sell-off and posted gains on the view that low policy rates and large-scale asset purchases would persist longer. Much attention has been given to the hope of a strengthening in the U.S. economy. In Abe Gulkowitz' latest The PunchLine letter, he highlights the key elements from a very slowly improving labor market to the amazing moves in asset markets with 'all the charts you can eat' in between. The unnatural easing stance, though necessary, spurred an aberrant demand for assets in the riskier end of the spectrum. By and large, such assets have so far lived up to their promise. The new year may again challenge that assumption as the likelihood of unlikely events rises.
Thanks to Bob "I don't get out of bed unless it's over 20" Pisani's daily diatribes about VIX (the so-called 'fear' index), we are supposed to rest assured that all is well in the ever-decreasing horizon world of equity markets. However, while VIX measures the expectations of 'normal' day to day moves in stocks, it does not offer any insight into market participants' perspectives on tail risks (or 'the big one'). CBOE's SKEW index does just that, based on the pricing differences between normal and fat-tail risk pricing in the options market, it provides a measure of the market's belief in extreme events... and for only the 4th time in history, it's flashing a big red warning signal of volatility ahead.
This past week the Federal Reserve began tapering their current large scale asset purchase (LSAP) program, more commonly referred to as Quantitative Easing (QE), by trimming $10 billion in bond purchases from the previous monthly totals. This week's "Things To Ponder" is a diverse set of views on the potential effect of the taper on the financial markets and the impact to investors. Regardless of your personal expectations as to the impact of the reduction of liquidity in the months ahead, it is always a good mental exercise to consider opposing viewpoints to balance your own views by eliminating confirmation bias. Here are 5 disparate views on the effect, and potential outcome, of the Federal Reserve's latest move.
Overnight one of the main stories is that the European Union has been downgraded to AA+ from AAA by S&P. While the market digests the impact of the downgrade, all eyes remain on the US treasury market. As Deutsche Bank notes, treasuries are increasingly being viewed as a potential sign of the success or not of the Fed taper in early 2014. From the lows in the immediate aftermath of Wednesday’s FOMC, 10yr UST yields have added more than 10bp. Yields continue to leak this morning (-2bp to 2.95%) though we’re still hovering at levels last seen in early September just before the Fed surprised markets with its non-taper. Despite this, US equities and credit were both reasonably well supported yesterday. However the combination of higher UST yields and a stronger dollar resulted in a fairly difficult day for EM. In EMFX, the Brazilian Real fell 1.1% against the USD, underperforming most other EM currencies. The move was exacerbated by the announcement from the BCB that it would wind back its intervention in the currency market, following the initial positive reaction to tapering on Wednesday. Other EM currencies also struggled including the TRY (-0.7%), MXN (-0.7%) and IDR (-0.3%). A number of EM equity markets struggled including in Poland (-0.7%) and Turkey (-3.5%).
US equity markets were the first to move yesterday on the news of the tapering which is a loosening and not a tightening move by the Fed. Overnight and today has seen stocks stabilize as the rest of the world wakes up to what this slowing of flow actually means... From EM FX to precious metals to colossal flattening in the US Treasury term structure, things are making major moves...
As equity markets around the world try valiantly to hold on to yesterday's manufactured gains that 'proved' the Taper is a good thing, few have commented on the consequences that are already being felt. Emerging Market currencies were broadly pummeled overnight with Indonesia's Rupiah tumbling to 5 years lows and the Turkish Lira collapsing 1.9% in the last 2 days (its biggest drop in 4 months) to an all-time low.
*LIRA AT LOWEST VS USD ON CLOSING BASIS SINCE AT LEAST 1981
*TURKEY CENTRAL BANK TO SELL MINIMUM $50M FOR LIRAS TOMORROW
The Istanbul stock exchange is down 7.3% in the last 3 days (biggest drop in 6 months).