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However, disconnected trading in the currency, credit, equity and commodities markets have seen gaps being created and led to the gap close sell-offs on Friday in Europe and the US.
What catching my attention
The S&P has not had back-to-back gains for 27 sessions now – the most since 1970. Volatility was up over 60% last week, the S&P had its worst week in two months, yet the dollar index is still at a 12-year high. It’s a big disconnected trade; this will annoy the Fed but there is nothing they can do about it and nor will it change their rate rise this week.
Credit spreads have been widening all year and the steepening of corporate credit has been developing for the past nine months, but this came to a head Friday. Commentary is pointing to the fact that a major junk bond froze redemptions on Friday and the flow-on effect this will have on high yielding counterparts. The US$778 million fund, however, has been illiquid for a month and the fact that most investors were rushing towards the exit forced it to slow the outflows.
The issue in the credit market (particularly corporate bonds) is the fact that US$3.3 billion in capital outflows has occurred from high yield funds in the last four weeks alone – this liquidity issue will mean credit markets are in for a rough ride.
Hedge fund managers now have a record level of shorts in oil; WTI has been trading in the US$35 a barrel handle, which is the lowest level since 2008 in weekend end trade, and the downward trend has continued unabated.
This positioning on a structural level makes complete sense (supply/demand thematics). However, the level of short interest makes me wary that a very sharp short squeeze is coming. The Fed could be the catalyst here if the USD eases as long USD positions close out. I am still short overall on oil, but this narrow trade is at the point of bursting higher on the cover trade.
I am cognisant of the fact that equities are currently ‘testing’ the strength of investors resolve. Over the past two weeks, markets have been looking for cues and reactions to certain permutations of how the Fed press conference and statement could transpire.
You only have to look at trade last Thursday and the fall out to Janet Yellen’s speech to an economic forum in Washington, and the following day in her testimony to Congress where she stated that the Fed is still on course. Equity volatility spiked and trading was violent, which suggests equities are not positioned for a hike – I see it more as liquidity testing and which equities will be structurally affected by higher rates.
However, the equity dilemma is more than just possible negative reactions to the Fed. The disconnect with commodity prices, sluggish global growth and the fact other central banks are signalling further stimulus is unlikely (which, from my perspective, signals that their capacity is empty) means equities are facing real pressure on three major fronts in the coming period.
Ahead of the Australian Open
We are calling the ASX down 89 points to 4927. This would be only 12 points from the intraday year low and the seventh major test of the 5000 point mark. What’s making this even harder is that value is not materialising. BHP and RIO lost 5.3% and 4.3% in London on Friday; its ADR is suggesting it will fall into the low $16 handle on the open this morning.
China data over the weekend was positive. It’s unlikely to save the ASX from the carnage likely to be seen on the open today, but may moderate it.