This week has been much more interesting and volatile than previous ones on financial markets
It begun with US ISM non-manufacturing report which came out way below expectations at 51.4 vs 54.9, lowest since 2010. Coherently, after a poor manufacturing ISM and a weak S1 GDP, Fed hikes were revised downward and global rates moved lower. The most awaited event of the week happened on Thursday with the European Central Bank (ECB) meeting. Markets were expecting:
- At best QE extension after march 2017 with technical tweaks and possibly a rate cut
- At least a technical tweak coupled with some sort of QE extension preannouncement
They had nothing, Mr Draghi (ECB’s president) repeated previous meeting’s messages and gave no hint about QE extension. He was as well less worried about inflation and growth, and mentioned the economic adjustment was under progress. The latter is being helped by his easy policy which is working well to his eyes.What was the outcome? Since then, markets begin to think that ECB could be less accommodative than expected. Consequently, bond yields are up 15 to 20bps, equities are on the soft side – S&P is down 1% today, worst day since Brexit. We have written for many weeks that we think markets are potentially unsafe:
- All systematic models are long risk, long commodities, long fixed income and long US equities
- Volatility is very low, and markets is positioned heavy net short volatility
- Cross assets correlations are on a gentle rise
- Fixed income assets are very expensive (true, it’s been a while…)
- US financial firms profits are dwindling, and risky assets are pushed higher by the drop in bond yields
In short, conditions seem to be met for a correction, with bond yields on the rise, equities going down, volatility higher and possibly systematic models having to deliver, which could amplify market stress. Things might not happen this way, we could have dovish lines from ECB members next week that would calm things down. However, to us a negative scenario is the most probable option. Oddly enough, Forex is behaving in the opposite direction from our expectations. Fed is on hold and ECB less accommodative than expected, so logically EUR/USD should be higher. Same for the Yen.
La Française’s Essentiel Markets brings you an insightful analysis of the latest financial news by François Rimeu, Head of Total Return at La Française Asset Management.