For those who have traded the overnight move it almost feels like something big is brewing, similar to 24 August and the quasi-flash crash capitulation move we saw. These markets need a strong shake up and sharp downside move, followed by a wave of buying to settle things down. But until that comes there will be no clarity, absolutely no confidence and a bucket load of concern. There’s concern the volatility will feed through into real economics and central banks will be pretty much powerless to stop it.
It almost feels as though the markets are pushing central banks into some kind of action, but they don’t know exactly what it is they want. Deeper negative rates could have untold, dire consequences. Further balance sheet expansion through QE could only lead to more disappointment and an even deeper credibility issue, not to mention dislocations in markets. What we are seeing is a ferocious destruction of wealth and confidence, with some rather powerful bearish trends developing. Traders and investors need to adapt, if they haven’t done so already.
Being long US treasuries has been a brilliant trade, as has gold which has touched $1200, although it rejected this level with buyers emerging in late US trade. The US volatility index (the ‘Vix’) pushed up 11% to 25% and this has sent overall financial conditions even lower, although this would have been worse had the USD not fallen very modestly. At the heart of the selling has been banking stocks and traders have been hedging exposure by being long credit-default swaps (CDS). It’s now front page news that banks’ CDS have spiked of late and the moves lower in their equity have been amazing, but certainly warranted. Take a name like Deutsche; they have €54 billion in bonds maturing over the next two years (much of this in the next two months) and have a market capitalisation of €21 billion. Much of their existing funds are tied up as regularity capital and, as we have seen in recent numbers, earnings are going backwards. This isn’t sustainable.
US banks are reacting to the US yield curve, which again flattened with strong buying in the 10 year treasury. Even if you look US high yield ex-energy, current spreads are thematic with a recession and this is killing the banks. There has also been a further unwind of the high momentum names such as Netflix, Amazon, Alphabet and Facebook and the Nasdaq is down close to 20% from last year’s high. It’s no wonder that short interest (as a percentage of total market cap) is near record levels.
In the FX space the JPY has pushed firmly higher and it has to be disconcerting when we hear that the Bank of Japan (BoJ) are now warning about an interest rate war. This is an issue I have been talking openly about since the BoJ announced it would penalise new reserves held on the BoJ’s balance sheet, and this can’t end well. The Nikkei is going to get absolutely destroyed when the cash market opens and we are currently calling the market to open 3% lower. Short GBP/JPY has been the trade of the day, falling nearly 2%.
The ASX 200 looks set to open below 4920, although we were seeing an open at 4876 when the S&P and Nasdaq were at their low points. Interestingly, 4920 is five points below yesterday’s cash market swing low, so a break above this level could be a modest positive. BHP’s American Depository Receipt suggests the stocks will open 2% lower, with CBA -1.5%. NCM will likely do the opposite and rally over 3%, with energy reacting to another near 5% decline from yesterday’s ASX close, although the S&P 500 energy space closed in positive territory.
Overall, I expect short sellers to be far more active as these is the perfect conditions for profits. That means lots of uncertainty keeping the buyers at bay, a rampant move higher in hedging activity (CDS) and many of the systematic trend-following funds starting to see trades pop up on their radar.