Reviewing the carnage: what happens when everybody wants to tighten

For the past few years that I have been trading, I believe Wednesday was by far the most volatile and swingy session of all. It first started very quietly in the UK morning session, and then it really went out of control before the US opened. I don’t even know where to begin…

Equities continue their correction: Eurostoxx 50 index is down more than 12% (French and German market are off 12.5% and 13.5% respectively), the Footsie and the S&P 500 both down by 9.5% since the highs reached on September 19th.

If we have a look at the chart below, we can see that the VIX, which measures the 30-day volatility implied by the ATM S&P500 options prices, surged and breached the 30 level and is now trading back to November 2011 levels, taking the equity (S&P) down with him. There is clearly more room for further correction, no buy-the-dip scenario this time unfortunately.

SPVIX(Source: Reuters)

One currency that continues to strengthen in reaction to the risk-off sentiment (a real one this time) is the Japanese Yen. After the nice August/September momentum, USDJPY, which reached its peak of 110.08 on October 1st, was sold to 105.21 in the early afternoon before recovering back to 106.00. Our favourite [carry trade] pair keeps tumbling and is now trading at a 7-month low slightly below the 93.00 level. As I usually say ‘it is all about the Yen’, you better watch carefully where the currency is going at the moment [more strength!] as it will give you an idea of the overall market.

Another big ‘surprise’ was of course the 10-year US yield (blue line) that tumbled below the 2% level down to 1.86% approximately (May 2013 levels), before ‘recovering’ to 2.1%. I always ask myself ‘where does the market like to see the 10-year yield?’ Obviously not too high, but below 2% clearly means that the market participants are not confident [at all]. On the other hand, Gold (yellow bars) continued its rally, up to 1,250 before edging lower to 1,240. The 10-minute-period chart below (USDJPY in red bars) shows you that asset classes moves clearly ‘together’ under a ‘stressed market’.

GOldYenYields(Source: Reuters)

End of POMO, what to expect from the next FOMC meeting (October 28th)?

While we are ‘kindly’ approaching the last days of QE with the Fed stepping out of the bonds market at the end of this month (October 28th, see chart in appendix), I think we may have a couple of dovish FOMC meetings concerning the central bank’s ST monetary policy. To me, it looks like the US policymakers have made a ‘mistake’ by expressing themselves on that point [rate hike] as they should have let the market swallow a period without QE. True, Fed officials are willing to start tightening. For instance, we heard San Fran Williams (one of the most dovish and apparently seen as a good ‘barometer of the views of Yellen’) saying that he would hope the Fed can tighten, mentioning 9 months to see the first hike. However, it looks to me that the higher rates world is just an illusion…

In order to avoid the ON/OFF calls that we have seen since the beginning of the year (RBNZ, BoE and now the Fed), there need to be a sort of global monetary policy coordination. Otherwise, we are going to see other sharp fluctuations and especially in the FX market (remember, nobody wants a high exchange rate, not even the US, aka the Fed).

On the top of that, oil is plunging; coincidence? WTI November 2014 futures contract is now down more than 20pts since June trading slightly above 80 (as Zero Hedge mentions: ‘if Oil plunge continues, now may be a time to panic for US shale companies’). As I believe that Oil prices and the equity market are the Fed’s two most important components, I don’t only see cheap oil prices only as a benefit (stimulus) for consumers, therefore adding pressure on Yellen’s [and Co.] team.

My view goes for a Dollar pause, and I will carefully wait for the October (28th) FOMC meeting to see how US policymakers are going to deal with the current situation. An important figure to watch will be the Inflation report next Wednesday. US CPI is expected to remain steady at 1.7% YoY in September, however I think we could see some disappointment…

Appendix:
Unknown(Source: NY Fed)

Posted in Forex Analysis, tagged with on