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Risk? No, thanks:
Equities have been slogged on Wall Street, following to a sluggish day in European markets that saw the FTSE 100 drop 0.2 per cent and the DAX shed 0.85 per cent. Here it looks like this is the convergence punters have been calling: US shares are playing a rapid catch-up with their global counterparts. The losses are piling up. The NASDAQ has been hit the worst in the North American session led by falls in FANG stocks. At time of writing, with about half an hour left in the session, the losses for that index are hovering around 3.00 per cent. That’s not to say the picture is any prettier for the other major US indices: The S&P500 is down just-shy of 2 per cent, and the Dow Jones is much the same.
Typically, US Treasuries have maintained their bid. The yield on US 10 Year Treasuries has dipped to 3.05 per cent, while the yield on US 2 Year note has fallen further, down 3 points to 2.77 per cent. The markets are scrambling for safety once more as volatility spikes again: the VIX is up to about 21, and that is ample reason for investors to bail-out of equities. The US Dollar is suffering from the drop-in yields, and the Japanese Yen is accepting the safe-haven bid, along with the EUR, which is eyeing off 115 again, supported by (slightly) diminished anxiety around the Italian fiscal crisis. Of course, the Australian Dollar and New Zealand have pulled back, trading at 0.7290 and 0.6840, respectively, although it must be mentioned that commodity prices are holding well enough.
The US Dollar Index is threatening to break short-term trend line support, and this is clearly helping gold prices: in another example of a flight to safety, the price of the yellow metal has climbed to $US1224 per ounce. Calling a top for the greenback is way too rash, and in time if this level of volatility continues, a return to the almighty Dollar would surely manifest. What is happening here, for now, though, is traders are pricing in a more dovish Fed, against what is being presumed as the start of “slower global growth” narrative leading into 2019. The hostilities between the US and China flowing from the weekend’s APEC summit fanned these fears, as has the deteriorating situation around Brexit. But ultimately, they tie back to the belief that the Fed may have overcooked their tightening regime.
It’s the Fed, stupid!
Markets have reduced their bets the Fed will hike rates next month to 65 per cent, with only a further two priced in for 2019. This is well-off the number flagged by the Fed in their dot plots, which outlines a further 5 hikes by 2020. The divergence between policy makers forecasts and that of market participants opens-up a cavernous divide, and subsequently boosts the chances of high future volatility. Growth aside, inflation risk still exists. Although there are few major signs (for now) that inflation could spiral out of control, building wage pressures, higher prices from tariffs, and the knock-on effects of Trump’s fiscal assertiveness mean that the risk remains non-negligible. If inflation were to emerge, the Fed would have no choice but to react and hike rates, sending markets scrambling to re-price expectations.
Corporate debt bomb?
It's on the chance that this situation will occur that has traders most worried, especially given the hot issue in global markets, presently: the massive US corporate debt burden and the impact tighter financial conditions will have on it. Credit spreads have continued to widen since October’s major share market correction: in fact, on both investment grade debt and junk bonds, the widening has accelerated. The dynamic makes it truly difficult to sustain equity markets gains, as attention becomes fixated on credit risk, and the broader implications of a more expensive debt burden for corporates, as a climb in short term rates translates into higher future refinancing costs. Indeed, it remains early days on this matter, but if it were spiral out of control – in a worst-case scenario – the selling across global equity markets witnessed already would only be the beginning.
Pain for the Asian equities:
It must be said this is one of the more catastrophic scenarios, and it is a long way from assured that it will play-out. Nevertheless, as it stands one day into the trading week, equities are having trouble finding friends. The volatility in US markets has futures pricing-in a generally negative day for Asian equity markets, on the back of day that – granting thinner volume everywhere bar Chinese markets – wasn’t too bad. The ASX 200 certainly suffered, but the Nikkei was able to add 0.65%, the Hang Seng 0.72 per cent, and the CSI300 1.13 per cent. There was very little news flow for the region yesterday, aside from the overhang of the disappointment from the APEC summit, and perhaps the absence of information supported those gains.
It will be another day with a dearth of scheduled economic data, with RBA Minutes this morning the highlight. SPI futures are pointing to a 9-point drop at the open for the ASX200. It was another matter of yesterday’s sell-off simply being an “equity problem”: few sectors were spared from the selling, as investors, trading within thinner volumes, unwound their exposure to equities. The story for the day – and this was represented in trading volumes – was the latest chapter in the Financial Services Royal Commission. The financials sector sucked 15 points from the index on volumes 15% per cent above average. The close for the ASX200 below the psychological-level of 5700 opens-up downside for the ASX200 in the days ahead to key support around 5625, with momentum indicators and the RSI suggesting such declines are more than feasible.