- Broad-based selling across financial markets, with US and European fixed income markets leading the way. The iShares MSCI Emerging Markets (emerging market ETF) -2.5%, while the iShares iBoxx $ High Yield Corporate Bond (NYSE:HYG) (high yield corporate bond ETF) -0.7%. Equity naturally followed, with the S&P 500 -1.5%, with 97% of stocks lower on the day. Volumes were 17% above the 30-day average.
- Many are pointing out that the S&P 500 had seen 43 trading sessions without a 1% move, then we get three in a row. The VIX (US volatility index) +17.7%, however at 17.8 the index is only modestly above the one-year average.
- Importantly, we have seen good selling of longer dated bonds in developed markets. The US 10-year treasury has pushed up six basis points to 1.72%, while the German 10-year bund up seven basis points and the highest since early July. This has taken the German yield curve (2’s vs 10’s) to the steepest level since 24 June.
- All eyes should be on the open of Japanese bond futures at 09:45 aest, as the moves in developed market fixed income, which are largely behind the volatility, have stemmed from Japan and the potential changes in monetary policy. Much focus has been on further news that the Bank of Japan are looking to even take their negative deposit regime even lower, countering this by easing off from buying bonds with maturities of 25 years or more.
- Steeper yield curves in the US should in theory be positive for US financials, but the implied probability of a hike this year has not increased at all; key Fed member Lael Brainard made sure of that yesterday. The pick-up in volatility is not being driven by higher Fed hike expectations and the volatility is more about changes to Japanese central bank policy, and to a lesser extent the ECB.
- In theory, the moves in both the sovereign and corporate bond market and the moves higher in three-month Libor (this has a huge bearing on loans to businesses and consumers) are doing the job of tightening for the Fed. Why raise rates when financial conditions are tightening anyhow?
- Systematic funds (Risk Parity Funds, Commodity Trading Advisors and Managed Volatility Funds) have been max short volatility and at their upper limits of long equities and short USD. These are some of the biggest financial market players in the world. There is much talk on the floors that we seeing a huge position unwind (more below).
- US crude is 2.2% lower from the ASX 200 close. Here we have seen a mix of general risk aversion and the International Energy Agency (IEA) talking about the glut in oil pushing out until 2017.
- We are calling the ASX 200 at 5182 (-0.5%). S&P futures had started to fall through the Asian session yesterday, so some of the falls in the US cash session are priced in, still expect another day of selling. BHP and CBA are likely to open 1.6% and 0.5% lower.
- AUD/USD and NZD/USD have been the big fallers overnight, with AUD/USD hitting a low of $0.7440. The pair looks destined to close below the 31 August low, thus technically one can expect lower levels in the short-term.
Asian markets are starring at a modestly weaker open, however one saving grace is that some of the falls in the US equity markets have already been priced in. It must be said though that price action here in Australia yesterday was terrible and as mentioned in yesterday’s note, we specifically wanted to see if traders and investors would use the opening bounce in the market to offload stocks. Offload they did!
The moves in markets overnight have been caused by three things for me. Firstly, we have seen a further steepening of various yield curves, which in itself is not necessarily bearish if the cause is higher inflation and growth expectations.
However, that is not the case and this move is being caused by the Bank of Japan looking to change the structure of its asset purchases, largely as a result of how poorly its asset purchase program has worked thus far. Throw in recent commentary (or should I say lack of) from the ECB that throws into question the sustainability of the ECB’s asset purchase program and you have a move higher in longer-term bonds, that no one is positioned for.
Secondly, some of the biggest systematic (rule based/computer driven – see point seven) funds have had to alter their portfolios, many which have been at extreme levels. This has caused massive shifts in their portfolio and in turn we have seen markets respond in kind.
The rest of market participants have had to simply react and when volatility increases traders’ absolutely have to alter their strategy if they are to stay in the game. Pure and simple, if volatility increases and we see (price) range expansion one has to look at altering position sizing, while pushing out stop losses to account for greater leverage in the market.
Thirdly, throw in comments from the IEA that have pushed crude price lower and we have a further move out of equities. The concerning situation is the genuine reasoning behind the risk aversion move is very complicated for many to fully understand.
The issues causing a strong correlation between equity and fixed income selling are not the same as, say, the European debt crisis that everyone has an opinion on. This is very different, and many in the retail community seem quite unsure about it.