U.S. equity & debt markets sold-off again on Tuesday following Monday’s initial rebound. Both the S&P 500 & Nasdaq 100 declined -1.48% & -0.88% respectively while the U.S. dollar rose +0.5%. All ten sectors of the S&P500 finished trading lower with losses led by Energy (-2.85%), Basic Materials (-2.11%) and Telecommunications (-1.93%). The yields on U.S. government debt increased (prices falling) with the two year securities yield increasing by +2.8 basis points to 0.8023% while the yield on ten year securities also gained +5.7 basis points to +1.7288%.
So why are we seeing such a sharp sell-off? Well there is no definitive answer however over the past fortnight we’ve had a wave of Fed policymakers make a number of comments, some bullish and some bearish, and there still appears to be a lack of unity which was evident in the latest policy meeting minutes from July. This mixed message from policy makers would certainly be weighing on investor sentiment.
The market implied probability of an interest rate hike at the September 20-21st meeting is currently around 15% and December seems like the base case scenario if we continue to see improving data in terms of wage growth, unemployment and inflation over the next two months. Overall it’s important to remember the Fed has continuously stressed that any rate hikes will be gradual and data dependent with this hiking cycle expected to peak well below historical levels. Looking back to the Fed’s first hike in 2015 or even the “taper-tantrum” back in 2013 when the Fed discussed winding back their QE program, yes these were followed by bouts of volatility across financial markets, however following this demand for yield by investors pushed equity markets higher and bond yields to new record lows. I’m not saying this process will continue indefinitely however drops in prices will continue to look attractive to investors.
There has been a large amount of commentary citing concerns that central banks are at their limits, and that failed action by the ECB last week sparking concerns central banks are less inclined to add further stimulus in a world where risk assets have been boosted by easy monetary policies. While there were expectations Mario Draghi would act to extend or even increase the current QE program last week, these expectations were not overwhelming and with inflation in the EU likely to remain below the target for some time I believe there is still a strong case that the ECB will act to extend their QE program before its expiry in March 2017. Draghi has reiterated many times that the ECB has the ability to and will not hesitate to act in order to achieve its target so it’s hard to imagine a scenario where the ECB would actually reduce easy monetary policy.
While these comments above are certainly valid concerns that contribute to declines I think one of the most logical reasons for this recent sell-off is the extended period of low volatility over the past two months with equity benchmarks remaining modestly below all-time highs. Take a look at the first chart below which we have shown over the past few weeks of the S&P500 and VIX index. Typically short-term strength is actually followed by periods of short-term weakness, as prices move to new highs while buying pressure fades leaving a vacuum in demand which can exacerbate selling. After an extended period of strength with low volatility it’s natural to see a pullback in markets, after all they don’t go up in a straight line. While as an investor it is never comfortable to see such sharp declines, realistically I don’t see a large cause for concern.
In the U.K. the Pound dropped -1.11% as did the FTSE100 which declined -0.53% following CPI data which was below estimates. Year-on-year for August prices remained stable at 0.6% with expectations of an increase to +0.7% while a measure of core CPI over the same period also missed estimates remaining unchanged at 1.3% against forecasts of an increase to 1.4%. Inflation is expected to pick up over the coming months as the effect of the decline in the Pound flows through into import costs. European equity markets were also lower led by the Euro Stoxx 600 & DAX which declined -1.03% & -0.43% respectively while the EUR/USD also fell -0.17%. The main European data overnight was the German ZEW current situation survey for September which declined to 55.1 from 57.6 prior and estimates of 56. At the same time the Euro-Zone ZEW economic sentiment survey for September actually increased to 5.4 from 4.6 prior signalling positive future expectations.
Asian markets were also generally lower, with both the Hang Seng & CSI300 finished -0.32% & -0.07% weaker despite data that showed the Chinese economy continues to improve. Industrial production (YoY Aug) surpassed expectations of 6.2% with an actual reading of 6.3%, as did retail sales at 10.6% vs estimates of 10.2% and fixed asset investment excluding rural at 8.1% vs 7.9% forecasts. Meanwhile Japanese equities were mixed with the Nikkei +0.34% higher, the Topix was little changed down just -0.01% while the Yen weakened -0.63% against the U.S. dollar.
Locally the S&P/ASX 200 reversed initial gains to finish -0.23% weaker and the market looks set to open weaker again this morning with ASX SPI200 futures down 11 points in overnight trading.
Data releases:
- Australian Westpac Consumer Confidence (MoM Sep) 10:30am AEST
- Japanese Industrial production (YoY Jul) 2:30pm AEST
- U.K. Unemployment & Weekly Earnings (YoY Jul) 6:30pm AEST
- Euro-Zone Industrial Production (YoY Jul) 7:00pm AEST
- U.S. Crude Oil Inventories (Sep 9) 12:30am AEST