On Friday – when the Fed’s Industrial Production index for April booked its fifth monthly drop in a row and when the Michigan Consumer Sentiment took its worst dive since December 2012 – the S&P 500 vacillated languidly in a very narrow price range, and some last minute buying brought it into the green, up 1.6 points, to a fractional new all-time high, after having set a new high in a similar manner on Thursday.
Since February, it has bumped about a dozen times into the upper region of its narrow trading range, poking through it a tiny bit occasionally without being able to break out convincingly. But it hasn’t moved down either, dipping fractionally before ticking back up. All on very low volume. It’s as if normal volatility has been completely banished from stock indices.
While this sort of mild vacillation has been going on for months and has lulled investors into self-satisfied sleep, thinking that the Fed would step in at the slightest drop to save the day, all kinds of mayhem has broken out in bonds with long maturities, in the currency markets, and in commodities.
Oil plunged to multiyear lows then bounced off and was at one point up by 40% from that low, before succumbing once again to the notion that the global oil glut has not somehow magically dissolved after all. Iron ore and other commodities in over-supplied markets went through similar multi-year lows and majestic, if short-lived surges.
Currencies, oh my. The euro plunged against the dollar then rose sharply again. Earlier this year, the Swiss franc soared by nearly 30% in minutes when the euro peg was abolished , then eventually fell back and then re-climbed. Other currencies crashed and then re-soared, including the Russian ruble.
And then there are sovereign bonds with long maturities, particularly those of the Eurozone, and most particularly German Bunds. Two months ago, their 10-yield was on its way to negative, in a market that, after years of central bank interest rate repression, powerful jawboning, and finally actual QE, had become infested with risk but offered no income in return.
When the German 10-year yield hit 0.05%, seemingly destined to become part of the “negative yield” absurdity that has been playing out in Europe, it suddenly turned around. Prices plunged and yields soared. Traders who’d been front-running the ECB’s QE gravy train, suddenly jumped off and turned it vociferously into the “short of a lifetime.” Those on the wrong side, lost a lot of money in a hurry.
This is playing out when everyone, from central banks on down, has been fretting about liquidity in the bond markets, knowing that buyers will simply evaporate at current prices when the selling starts in earnest, and will have to be lured back in with much lower prices. A disturbing scenario for folks worried about “financial instability,” as it’s called in central bank jargon.
And so, Christine Hughes, President and Chief Investment Strategist at OtterWood Capital Management, posted the chart below in her Weekly Macro Insights to demonstrate how big moves up or down have impacted four different asset classes – sovereign bonds, currencies, equity indices, and commodities. She wrote:
I’ve spoken at length about vanishing liquidity in the markets, particularly bond markets, and a good chart (below) was making the rounds this week on the subject.
The important thing to take from this chart is that bonds and currencies (blue and red lines) are becoming more volatile than equities (black line).
This is completely backwards to how capital markets typically behave. It is stock market volatility that is well known and feared, but we are seeing the reverse unfold….
This is one more aspect of how central banks around the world are distorting the markets by gobbling up bonds and repressing interest rates. Their actions inflated asset prices and made the normally very volatile asset class of equities the most sanguine asset class, with investors floating complacently on cloud nine. And it introduced breath-taking volatility into currencies and into sovereign bonds that should be an island of stability.
And Hughes warns, “The exit doors in the bond markets are getting very small. Buyers beware.”
But not just bonds. Stocks, art, housing, VC portfolios of billion-dollar startups… everything is on the line. Read… Afraid of Losing Trillions, Wall Street Fights Fed Rate Hikes
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