The Market Today
Making Sense of a Week of Extreme Financial Market Volatility
by Craig Dismuke, Dudley Carter
THIS WEEK’S DATA
Busy Week of Data with Focus on Wednesday’s CPI and Retail sales Data: This week’s economic calendar is much busier than last week with reports ranging from inflation, to consumption, to manufacturing, to confidence reports from small businesses, homebuilders, and consumers. The most important reports of the week are scheduled for Wednesday, the January reports on CPI inflation and Retail Sales. Particularly given the impact of rising inflation expectations on the markets over the past few weeks, any data pointing to rising prices could have an outsized response from stocks and/or bonds. However, core CPI is currently projected to rise just 0.2% MoM which would bring the YoY rate down from 1.8% to 1.7%. The retail sales data will also be important given the importance of a strong consumer in today’s economic cycle. January is generally the month to return holiday gifts, but the Census Bureau attempts to control for that effect with its seasonal adjustment. Based on their credit card data, Bank of America projects retail sales rose 0.3% MoM which would be a solid start to 2018.
Understanding the Recent Market Volatility: We walk through the developments leading up to the recent market volatility in this week’s MarketWatch video. For a quick summary, the U.S. economy was running at a stable, good rate of growth in 2017. Optimism went from good to great as Washington talked tax cuts and the labor market continued to improve. The Fed was more aggressive than the markets expected in 2017 with three rate hikes and the commencement of their balance sheet wind-down. Despite the tightening, the S&P rose 40% post-election through early 2018 with almost no hiccups while the 10-year Treasury yield closed 2017 within five basis points of where it began. Fears of inflation began to increase as the economy continued to heat up and with the added tailwind of tax reform. Over the past three weeks, the earnings data (what seemed like the one missing link in the whole economic cycle) show signs of more traction in three separate reports (one of those reports remains inconclusive but was convincing enough for the markets). Add to the wage data, Washington added another $300+ billion in government spending to the mix including $180+ billion in 2018 – adding even more steam to the economy. The specter of more inflation sent longer yields higher yet and once the 10-year crossed 2.80%, stocks finally came unhinged. Amplifying the volatility, the stock markets were already too tightly wound after enjoying almost a decade of a Fed put (the safety blanket of a Fed that intervenes to prop up asset prices during any damaging decline in order to keep the economic cycle on track). Going forward, there are a handful of takeaways for fixed income investors from the past few week’s market volatility.
- The recent market volatility was not an economic story – it was not the result of slowing economic data or the expectation for an economic decline
- The recent stock market volatility has reflected fears of a too-strong economy, higher inflation, rising interest rates, and future rising rates
- There was no Fed “put” – a very telling factor for future policy/rate projections
- There is a certain level on interest rates that will trigger stock corrections – presumably a level that will trigger an event more significant correction
- The only concern we would have about the past few weeks is if it proves protracted and damages consumer and/or business confidence
Overnight – Equities are Rebounding Despite Rates Moving Up Again: Global markets bounced back overnight following one of the worst weeks in years for most major equity exchanges. Markets in both Asia and Europe have made notable moves to the upside following last Friday’s late recovery in the U.S. that ended a tumultuous week of trading on an upbeat note (more below). That positive momentum has carried over into early futures trading with all three major U.S. indices higher by more than 1%. The initial catalyst for last week’s chaos was a stronger-than-expected hourly earnings figure in January’s U.S. payroll report (February 2). That stoked concerns about faster inflation and higher interest rates. The move higher in rates had a ripple effect across asset classes as it raised questions about the appropriate level for valuations in a higher-rate environment. With higher rates a reason for last week’s selling, overnight yield movements are potentially setting the stage for more market seesawing this week as investors continue to look for the right balance between rates and other stock valuations. Amidst a daily backdrop of rising rates across most sovereign curves, the 10-year yield has climbed to 2.8 bps to 2.87%, a new high since 2014. The 5-year yield is up 2.2 bps to 2.57% and the 2-year yield is 0.8 bps higher at 2.08%.
ICYMI – February 9, 2018, Weekly Market Recap: The rapid reemergence of volatility in global financial markets – an event rarely seen during 2017 – dominated headlines and upstaged a couple of solid economic reports (i.e. cycle-high ISM nonmanufacturing PMI and the 2nd lowest level of new jobless claims since 1973) and an hours-long government shutdown that ended with a two-year $300B budget deal. The swings started early with the Dow dropping 1,597 points intraday Monday before recovering to close down 1,175 (-4.6%). That sparked a worldwide sell-off that helped pushed the VIX equity index to its second highest level since the financial crisis. The volatility lasted throughout the week as big gains gave way to big losses that gave way to big gains; on an intraday percentage swing basis, the Dow experienced its second most volatile week since the financial crisis. Ultimately, the Dow dropped 5.2% in its worst week since January 2016. The S&P 500 briefly broke below its 200-day moving average. Rates were equally as volatile early in the week, but the curve settled in later to close little different than where it started. The 2-year yield fell 7 bps while the 10-year yield added just over 1 bp, leaving the curve the steepest between those two points since October. Click here to see the full recap.