Increased volatility from market and political risk

The horrific events in Paris on Friday are likely to have a short sharp effect in markets but in the long-term, real effects are more likely to influence political risk than the markets themselves.

Paris
Source: Bloomberg

What might be affected from the Paris attacks could be a change in spending from the consumer over the coming quarter and a possible shift in confidence. However, in the main markets, the fallout from the terror attacks are likely to short-lived.

Since the Twin Towers attacks, there have been four major attacks across the global. The initial reaction in all jurisdictions were short, sharp sell-offs, but within ten days of the events, the markets or local currency returned to the level of before the events. I would expect the same reaction for the Paris events.

What is likely to have a bigger effect on the markets over the coming period is the market risk that has ramping up rapidly over the past two weeks.

Last week was the worst week in the US since August – it fell 3.6% over the five days and is back below the 100-day moving average. The CBOE VIX index is back above 20 for the first time since August and jumped over 40% in the five trading days. All point to the impeding rate rises as the issue, but from my perspective, it’s more than just that.

The catch is if the market can force the Fed to delay the expected December lift-off date.

There is talk that the October non-farm payrolls (NFP) is actually a seasonality read as firms ramp up hiring after the summer holidays. What would happen if the November read reverted back to the developing trend seen in August and September?

The market pricing of a Fed rate rise in the US has been impacted by US equity market volatility, the strength of the USD and the issues facing the likes of China and Europe. Now, if the November NFPs were 150,000 or less, the Fed funds futures December would likely fall below 50% probability.

Would that force the Fed to postpone the lift-off date? The reaction in the currency market and the equity market would be strong, as credibility of the Fed is questioned. Flight to risk-off assets would only strengthen further and the ‘limbo’ effect would make trading very tricky.

Ahead of the Australian Open  

I am continuing to watch the Toronto Stock Exchange (TSX) for ASX leads. The correlation remains rock solid and considering the TSX just has its worst stretch since before the GFC with eight consecutive declines and a 4.6% decline over that period (the worst period on the TSX since June 2002), it is definitely something to be aware of.

We are currently call the ASX down 1.4% to 4981 and it could even cross the 29 September low this week if the risk issues ramp up further. That would see the ASX back in lock step with the TSX.

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