There were wild market moves on Monday night and Tuesday with US stocks down sharply and erasing the gains for 2018. At one point yesterday, S&P500 futures were down more than 8% from where they closed last week, although they have bounced back somewhat over the past few hours and are starting to show some signs of stabilising (for now at least). The VIX rose to 50. Bond yields have fallen sharply in response to the stock market meltdown but FX has been surprisingly stable. The NZD is close to 0.73, similar to where it closed last week.
US stocks had finished last week on a soft note, down around 2% on Friday in response to the higher than expected US wages data and rising bond yields. The losses accelerated on Monday afternoon in New York, with the S&P500 and Dow closing down more than 4% (the Dow had been down more than 6% at one point), and then continued in Asian hours yesterday. At one point yesterday, S&P500 index futures were over 8% lower than their close last week and more than 12% off their intraday record highs set in late January. Market measures of volatility have unsurprisingly ratcheted higher amid these extreme moves; the VIX rose from below 15 last week to 50 yesterday, its highest level since the Chinese currency devaluation in 2015.
Markets have shown some signs of stabilising since the European market opened last night; S&P500 futures are 4% off their lows. The VIX is down to 35, but remains at very elevated levels compared to the past few years.
There was no obvious catalyst for the market moves this week. On Monday, the US ISM non-manufacturing index rose to its highest level since 2005 with the important sub-components all doing well. Dallas Fed President Kashkari softened his comments in the wake of US non-farm payrolls, saying US wage growth was “not yet” enough and “it could be a blip, but let’s not ignore it”.
The fall in stock markets likely reflected a combination of factors. First, the wages data on Friday added to the growing sense that US inflation was starting to pick up which will probably lead to faster Fed tightening (and higher bond yields). To date, stock markets have benefited from a ‘goldilocks’ environment marked by reasonably strong growth and earnings yet low inflation and low interest rates (and hence low recession risk). Equity funds saw their largest monthly inflows on record in January amid growing investor optimism, and this positive market sentiment was arguably vulnerable to a correction. Second, the starting point for stock market valuations (at least on conventional metrics like P/E ratios) was already very high. Lastly, the increase in market volatility likely triggered selling from investors who had calibrated their position sizes to the previous low volatility environment.
We’re still inclined to view the move lower in stocks as a correction (from record highs) rather than the start of a bear market. The global growth outlook remains very strong and US inflation, while gradually rising, doesn’t appear likely to increase sharply, at least according to most economists. In that environment, recession risk should remain reasonably low for the immediate future. That said, we suspect there will be more volatility in the coming days.
Bond yields moved sharply lower in response to the sharp declines in stock markets. The 10 year US Treasury yield, which had reached a 3 year high of 2.88% on Monday, fell more than 20bps at one point yesterday. As stock markets have stabilised overnight, bond yields have bounced back, and the 10 year yield is back above 2.75% (albeit below where it was before the US wages release). The decline in US bond yields was probably exacerbated by short covering from speculative investors.
Strangely, FX markets have been reasonably stable despite the very large moves seen in stock and bond markets; most major currencies have moved by less than a percent against the USD since the end of last week. The JPY has appreciated, as one would expect during such a period of risk aversion, but it is only up around 0.75% since the end of last week.
The NZD is actually higher than the end of last week, just above 0.73, which is unusual given it historically has tended to underperform during such ‘risk-off’ episodes. The Global Dairy Trade auction overnight, which showed a 7.6% rise in whole milk powder, probably helped the NZD at the margin. NZ labour market data are released today and we are looking for a decline in the unemployment rate to 4.5% against market expectations of a rise to 4.7%.
The RBA left its cash rate at 1.50% at its meeting yesterday and expressed greater confidence that unemployment and inflation will move gradually back to target. There was little market reaction and the market now awaits Governor Lowe’s speech tomorrow and the Statement of Monetary Policy on Friday. The NZD/AUD has risen to 0.9275, its highest level in almost 6 months.
Overnight, NY Fed President Dudley’s is speaking and the market will be especially focused on what he has to say about recent market volatility.
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