Investors are having some trouble
Determining if the stock bubble
Is ready to pop
Or if Jay will prop
It up, ere it all turns to rubble
So, volatile markets are here
Most likely the rest of this year
Then, add to this fact
A Russian attack
On Ukraine. I’d forecast more fear
One has to be impressed with yesterday’s equity markets in the US, where the morning appeared to be Armageddon, while the afternoon evolved into euphoria. Did anything actually change with respect to information during the day? I would argue, no, there was nothing new of note. The proximate cause of the stock market’s decline appeared to be fear over escalating tensions in the Ukraine. Certainly, that has not changed. Russia continues to mass troops on its border and is proceeding with live fire drills off the coast of Ireland. The Pentagon issued an order for troops to be ready for rapid deployment, which Russia claimed was fanning the flames of this issue. While the key protagonists continue to talk, as of yet, there has been no indication that a negotiated solution is imminent. With that in mind, though, today’s market reactions indicate somewhat less concern over a kinetic war. European equity markets are all nicely higher (DAX +0.6%, CAC +0.8%, FTSE 100 +0.75%) and NatGas in Europe (-2.4%) has retraced a bit of yesterday’s surge. Granted, these reversals are only a fraction of yesterday’s movement, but at least markets are calmer this morning.
However, one day of calm is not nearly enough to claim that the worst is behind us. And, of course, none of this even considers the FOMC meeting which begins this morning and from which we will learn the Fed’s latest views tomorrow afternoon. The punditry is virtually unanimous in their view that the first Fed funds hike will come in March and there will be one each quarter thereafter. In fact, if there are any outliers, they expect a faster pace of rate hikes with five or more this year as the Fed makes a more concerted effort to temper rising prices.
Now, we have not heard from a Fed speaker since January 13th, nearly two weeks ago, although at that time there was a growing consensus that tighter policy needed to come sooner and via both rate hikes and balance sheet reduction. But let’s take a look at the data we have seen since then. Retail Sales were awful, -1.9%; IP -0.1% and Capacity Utilization (76.5%) both disappointed as did the Michigan Sentiment indicator at 68.8, its lowest print since 2011. While the housing market continues to perform well, Claims data was much higher than anticipated and the Chicago Fed Activity Index fell sharply to -0.15, where any negative reading is seen as a harbinger of future economic weakness. Finally, the Atlanta Fed’s GDPNow indicator has fallen to 5.14%, down from nearly 10% in December. The point is, the data story is not one of unadulterated growth, but rather of an economy that is struggling somewhat. It is this issue that informs my decision that the Fed is likely to sound far more dovish than market expectations tomorrow, The policy error that has been discussed by the punditry is the Fed tightening policy into an economic slowdown and exacerbating the situation. I think they are keenly aware of this and will move far more slowly to tackle inflation, especially given their underlying view that inflation is going to return to its previous trend on its own once supply chains are rebuilt.
For now, barring live fire in Ukraine, it seems the market is quite likely to remain rangebound until we hear from Mr Powell tomorrow afternoon. As such, it is reasonable to expect a bit less market volatility than we saw yesterday. But, do not discount the fact that markets remain highly leveraged in all spaces and that the reduction of high leverage has been a key driver of every market correction in history. Add that to the fact that a Fed that is tightening policy may push rates to a point where levered accounts are forced to respond, and you have the makings of increased market volatility going forward. While greed remains a powerful emotion, nothing trumps fear as a driver of market activity. Yesterday was just an inkling of how things may play out. Keep that in mind as we go forward.
Touring the markets this morning, while Europe is bouncing from yesterday’s movement as mentioned above, Asia saw no respite with sharp declines across the board (Nikkei -1.7%, Hang Seng -1.7%, Shanghai -2.6%). US futures, too, are under pressure at this hour with NASDAQ (-1.7%) leading the way, but the other main indices much lower as well.
Looking at bond markets, European sovereigns are all softer with yields backing up as risk is re-embraced (Bunds +2.1bps, OATs +1.4bps, Gilts +4.4bps) as are Treasury markets (+0.7bps), despite the weakness in equity futures. Bond investors are having a hard time determining if they should respond to ongoing high inflation prints or risk reduction metrics. In the end, I continue to believe the latter will be the driving force and yields will not rise very high despite rising inflation. The Fed, and most central banks, are willing to live with rising prices if it means they can stabilize bond yields at relatively low levels.
In the commodity markets, oil (+0.1%), after falling sharply from its recent highs yesterday has rebounded slightly. NatGas (-1.4%) in the US is also dipping although remains right around $4/mmBTU in the US and $30/mmBTU in Europe. Gold (-0.25%) and Copper (-0.3%) continue to consolidate as prospects for weaker growth hamper gains of the latter while uncertainty over inflation continue to bedevil the former.
As to the dollar, it is stronger for a second day in a row today, with substantial gains against both G10 (NOK -0.7%, CHF -0.7%, SEK -0.6%) and EMG (PLN -0.75%, RON -0.5%, MXN -0.45%) currencies. Clearly, the Ukraine situation remains a problem for those countries in proximity to the geography, while Mexico responds to slightly disappointing GDP growth data just released. But in the end, the dollar remains the haven of choice during this crisis and is likely to remain well bid for now. However, if, as I suspect, the Fed comes across as less hawkish tomorrow, look for the greenback to give up some of its recent gains.
This morning brings only second tier data; Case Shiller Home Prices (exp 18.0%) and Consumer Confidence (111.1). So, odds are that the FX market will continue to take its cues from equities, and if the sell-off resumes in stocks, I would expect the dollar to remain firm. For payables hedgers, consider taking advantage of this strong dollar as I foresee weakness in its future as the year progresses.
Good luck and stay safe