Market Takes The Path To Pain

It was always going to get ugly yesterday, once the market realised that the era of cheap money from the Fed is nearing the end. What was interesting about yesterday’s move lower was the sheer inclusivity of it all. Stocks regardless of sector, bonds regardless of credit rating and commodities regardless of scientific formula were all taken lower.

The winners on the day were few, with USD the major beneficiary. Going forward, as we said yesterday, the relationships between asset classes and data have only shifted slightly – but very importantly.

We are great fans of acronyms in financial markets. Readers will have heard me talk about RORO in the past - the dynamic that the market finds itself either Risk-On (happy to invest in riskier assets on the back of increasing global economic confidence) or Risk-Off (safer assets are desirable as confidence slips). This used to govern the markets and now doesn’t. The new acronym is POPO – Path On/Path Off.

The “path” is not to enlightenment but is instead the path that the Fed currently envisages the US economy coming down in order to meet its timeline for the reduction of asset purchases. This was clearly laid out by Fed Chair Ben Bernanke on Wednesday evening. Data that supports the jobs market, indicates solid growth or points to an improving inflation outlook will be viewed as “Path On” and markets will behave like they did yesterday – although without the magnitude of the losses.

Likewise, “Path-Off” should see these losses retraced as investors bet that the world is not ready for a Fed to step away from the printing presses.

That being said the mixture of noise and signal from the Fed statement and recent pressures out of China have meant that some data has been lost. Sterling was one of the better performers against the dollar yesterday following a surprise increase in retail sales in May. Sales rose by 2.1% compared to a 1.0% expectation, which helpfully erased the past 2 months of declines. One caveat to the increase in sentiment is that it’ll be interesting to see if retail sales in a climate of falling real wages is driven by an uptick in consumer credit demand i.e. are people loading up the credit cards to afford life now?

The European open is looking like we could be in for a classic ‘dead-cat bounce’ kind of session. Investors will be happy to swoop in on assets at these levels and run them a little higher, plus those of us who were backing the USD are more than likely going to reduce positions and bank some profit.

Pressure could be seen on the single currency following the news overnight that the IMF has warned Eurozone creditors of gaps in the financing of Greece’s bailout. Greece is due another round of funding from the troika in July – we could be heading down this track again unfortunately.

In the meantime, have a great day and a cracking weekend.