The main action in financial markets yesterday was not in currency markets, but in equities. A sell-off in US equity markets rippled across the globe sending Asian stock markets sharply lower on the open. The US S&P 500 fell 3.3% on Wednesday, its most significant decline in eight months. The tech-heavy Nasdaq Composite was down more than 4.0%. Technology stocks have been the biggest casualties of the US equity market sell-off as they typically have the most stretched valuations.
As Asian markets opened, the sell-off continued. Japan’s Topix index was down 3.4% shortly after the open; China was down 3.0%, Hong Kong also down 3.0%. On the European open, the EURO STOXX 50 dropped 1.9%
The recent simultaneous falls in bond and stock markets – they typically move in opposite directions – appear to be a reaction to global monetary policy tightening. Last week, a sell-off in US Treasuries led to yields rising above the 3.0% threshold as investors increased expectations of Federal Reserve tightening. This move cannot be underestimated; US yields are a global benchmark not only for the price of credit but also for asset returns. A sharp move higher in US yields forces investors to re-evaluate their holdings.
Simultaneous upward movements in global bond and equity markets were a hallmark feature of the Quantitative Easing (QE) period following the 2008 Great Financial Crisis. Concurrent moves higher indicate this is QE in reverse. We previously suggested in this forum that the Fed was taking US President Donald Trump’s approach of ‘America First’ – the US central bank would continue raising interest rates regardless of the issues this created for emerging markets. Now, with an equity and bond market sell-off on home turf impacting the financial wealth of US consumers, we believe the Fed will take note. We reaffirm our call that the Federal Reserve will make its final rate increase of this cycle in Q2 2019 at the latest. This should lead to a weaker Dollar into 2019 on reducing rate market expectations.
How did currency markets respond to the equity market carnage? It was not the traditional flight to safe-haven currencies, but a ‘sell US’ theme. The trade-weighted Dollar index is currently down 0.34% since yesterday’s open and is lower against seven out of the 10 G10 currencies.
Sterling put in a strong performance yesterday as markets responded to news that the EU was close to accepting the UK’s latest proposal for the Northern Ireland backstop. This would secure a Withdrawal Agreement between the UK and EU; however, it would not guarantee that agreement passes in the UK House of Parliament. The UK remaining within the EU for an undefined length of time is sure to rile Brexiteers. We caution buying into this Sterling rally before Westminster responds.
The commodity complex, notably the Canadian (CAD) and Australian (AUD) Dollars, fared poorly in trade yesterday as forecasts Hurricane Michael is to depart the Gulf of Mexico led to lower energy prices.
In the day ahead, the Bank of England (BoE) releases its health check on the banking sector and credit conditions. Recent trends have shown increasing levels of bank funding, although investor demand for UK banks’ debt continues to fall – Brexit may be a factor. Increasing default rates on household credit cards is also a rising concern.
The main release of the day, arguably the week, is the US Consumer Price Index (CPI) for September. An upward trend in US inflation since early 2018 stumbled in August, meaning the September CPI figure will take on greater importance. The August drop was led by goods sector deflation. A stronger Dollar is depressing import prices, even after the imposition of trade tariffs, leaving the Fed in the enviable position of an economy outperforming while inflation remains contained. The Fed’s Loretta Mester noted last week that the pace of rate hikes would depend on inflation, meaning the CPI print has trumped employment figures in terms of importance. The October 6th Initial Jobless Claims, September 29th Continuing Claims, September Budget Statement, and October Bloomberg Consumer Confidence data will also be released in the US. New Zealand will report September’s Performance of Manufacturing Index.