Thursday, October 11, 2018

Capital Markets: "Equity Swoon Takes Spotlight, Pushes Dollar to Backfoot"

From Marc to Market:
Overview:  There is one story today, and that is the sell-off in global equities.  Although the narratives put the US at the center, the fact of the matter is that US equities have been among the best performers this year, despite the rise of interest rates and a President that is not above criticizing the central bank.  Other benchmarks, like the MSCI Emerging Markets and its Asia Pacific Index and the Dow Jones Stoxx 600 in Europe were all well below 200-day moving averages.  It has taken today's follow-through decline in the S&P 500 to test its 200-day moving average (~2765) for the first time in five months.  The rout in Asia took markets down 3.5%-6.5%, with the tech-heavy Taiwan hit among the hardest (-6.3%).  European bourses are around 1.5% lower in late-morning activity, matching yesterday's loss and bring the Dow Jones Stoxx 600 loss to date to about 7.25%.  The equity slide is giving bonds a bond and yields are lower in Asia and core Europe.  Yields in the periphery are higher, led by a five basis point increase in Italy, which is trying to raise 6.5 bln euros in bond sales.    In the foreign exchange markets, the dollar is softer and ironically the yen, which often strengthens during risk-off periods, is underperforming, while the dollar-bloc is firm, and in emerging markets, the typically volatile Turkish lira and South African rand are leading, the advance.  The usually lower volatile Asian currencies like the Korean won (~-0.9%) and Taiwanese dollar (~-0.45%) are among the poorest performers today.

Causes and Effects:  There does not seem to be an obvious trigger for equity rout.  Most narratives link it to US rates, trade tensions, and/or positioning around earnings.  While any of these could be the spark, many investors also realize that none is needed.  Moreover, none seem compelling, and it is precisely because of this that the market's fever may burn itself out.  We note that the markets open the latest in Asia have done suffered as deep of losses and that European equities are down less than Asia, (which also speaks to technology's leadership).  At the risk of being naive, a test on 200-moving average in the S&P 500 has proven itself a good buying opportunity over the last couple of years.  Penetration has occurred, but it has been mostly brief and shallow.  
President Trump was quick to blame the Fed for what he later recognized may have been a long-overdue correction.  However, some of the Fed's critics were sympathetic to the idea that Fed tightening was at least part of the problem.  By most measures, Fed policy is still accommodative. The US reports September CPI figures today.  The headline may ease to 2.4% (from 2.7%) while the core may edge up to 2.3% from 2.2%.  The fed funds target is 2.00%-2.25% meaning that despite an economy growing well above trend, unemployment at the lowest level in a generation, adjusted for inflation, the real fed rates target is still negative.  Around 2.8%, the two-year note yield is a little below when the Fed sees the long-term equilibrium rate for fed funds....