So an extra dose of medicine from the Fed on Wednesday helps smother global market volatility further into the yearend — even though naming an explicit 6.5% unemployment rate could well send Treasury bond volatility soaring as the current 7.7% rate likely approaches that level in 2014 just as the Fed low-rate pledge expires. Not a story for early next year maybe, but…
Even though US cliff talks remain unresolved, many of the edges have been taken off seasonal yearend jitters elsewhere. Euro pressures have been kept under wraps since the Greek deal, the possibility of yet another Fed QE manoeuvre next Wednesday is back in play and a significant pulse has been recorded in the global economy via the latest PMIs – thanks in large part to China and the US service sector.US payrolls loom again tomorrow, but the picture is one of stabilisation if not full-scale recovery.
Any hope of figuring out a new market trend before next week’s U.S. election were well and truly parked by the onset of Hurricane Sandy. Friday’s payrolls may add some impetus, but Tuesday’s Presidential poll is now front and centre of everyone’s minds. With the protracted process of Chinese leadership change starting next Thursday as well, then there are some significant long-term political issues at stake in the world’s two biggest economies. Not only is the political horizon as clear as mud then, but Sandy will only add to the macro data fog for next few months as U.S. east coast demand will take an inevitable if temporary hit — something oil prices are already building in.
Easy come, easy go. A choppy October prepares to exit on a downer – just like it arrived. World equities lost about 3 percent over the past seven, mostly on Tuesday, and reversed the previous week’s surge to slither back to early September levels. Just for the record, Tuesday was a poor imitation of the lunge this week 25 years ago – it only the worst single-day percentage loss since July and only the 10th biggest drop of the past year alone. But it was a reminder how fragile sentiment remains despite an unusually bullish, if policy-driven year.
Have fears of global shortage of high-grade collateral been exaggerated?
As the world braces for several more years of painful deleveraging from the pre-2007 credit excesses, one big fear has been that a shrinking pool of top-rated or AAA assets — due varioulsy to sovereign credit rating downgrades, deteriorating mortgage quality, Basel III banking regulations, central bank reserve accumulation and central clearing of OTC derivatives — has exaggerated the ongoing credit crunch. Along with interbank mistrust, the resulting shortage of high-quality collateral available to be pledged and re-pledged between banks and asset managers, it has been argued, meant the overall amount of credit being generating in the system has been shrinking, pushing up the cost and lowering the availability of borrowing in the real economy. Quantitative easing and bond buying by the world’s major central banks, some economists warned, was only exaggerating that shortage by removing the highest quality collateral from the banking system.
The currency war is back.
Since last week when the Fed started its third round of money-printing (QE3), policymakers in emerging markets have been busily talking down their own currencies or acting to curb their rise. These efforts may gather pace now that Japan has also increased its asset-buying programme, with expectations that the extra liquidity unleashed by developed central banks will eventually find its way into the developing world.
Central bankers as carry traders? Why not.
As we wrote here yesterday, FX reserves at global central banks may be starting to rise again. That’s a consequence of a pick up in portfolio investment flows in recent weeks and is likely to continue after the U.S. Fed’s announcement of its QE3 money-printing programme.
Following are notes from our weekly editorial planner:
Oh the irony. Perhaps the best illustration of how things have changed over the past few weeks is that risk markets now fall when Spain is NOT seeking a sovereign bailout rather than when it is! The 180 degree turn in logic in just two weeks is of course thanks to the “Draghi put” – which, if you believe the ECB chief last week, means open-ended, spread-squeezing bond-buying/QE will be unleashed as soon as countries request support and sign up to a budget monitoring programme. The fact that both Italy and Spain are to a large extent implementing these plans already means the request is more about political humble pie – in Spain’s case at least. In Italy, Monti most likely would like to bind Italy formally into the current stance. So the upshot is that – assuming the ECB is true to Draghi’s word – any deterioration will be met by unsterilized bond buying – or effectively QE in the euro zone for the first time. That’s not to mention the likelihood of another ECB rate cut and possibility of further LTROs etc. With the FOMC also effectively offering QE3 last week on a further deterioration of economic data stateside, the twin Draghi/Bernanke “put” has placed a safety net under risk markets for now. And it was badly needed as the traditional August political vacuum threatened to leave equally seasonal thin market in sporadic paroxysms. There are dozens of questions and issues and things that can go bump in the night as we get into September, but that’s been the basic cue taken for now. The backup in Treasury and bund yields shows this was not all day trading by the number jockeys. The 5 year bund yield has almost doubled in a fortnight – ok, ok, so it’s still only 0.45%, but the damage that does to you total returns can be huge.
Ok, it’s a big policy week and of course it could either way for markets. An awful lot of ECB and Fed easing expectations may well be in the price already, so some delivery would appear to be important especially now that ECB chief Mario Draghi has set everyone up for fireworks in Frankfurt.