Markets pick-up where they left-off last week

The week starts where last week finished:

Equity markets in Europe and North America fell again overnight, as US Treasuries, the Yen and gold prices rallied, in a start to the trading week that feels like a seamless extension of the last. The fundamentals of the market haven’t changed, so nor has the reasoning behind the night of bearish trade. The S&P 500 is down over 1%, the benchmark US 10 Year Treasury yield tumbled 10 basis points, the Yen is closing in on the 104 level, while gold made fresh 6-year highs. Nerves are frayed, and implied volatility is tipping higher, with the VIX rallying above 20 again.

Panic turns to recession chatter:

But the catalysts being pointed out as being the drivers for this specific leg lower in global equities is the increasing political instability in Hong Kong, as well as a shock election result in Argentina, that has seen that country’s debt markets trade-in-a-total-tizz. Such is the uncertainty in the market right now, the line between what’s rational and irrational is quite blurry. Goldman Sachs publicly expressed its concern that the global economy is nearing a recession yesterday; that sort of speculation more-or-less sums up the atmospherics. The global business-cycle is seemingly rolling-over, and investors are worried there is little policymakers can do to manage that.

Have the highs come and gone?

One saving grace is that activity in markets was very low overnight, due to holidays around the world. A bit like December’s sell-off last year, that could imply that moves in the market are being exaggerated by lower liquidity-conditions. In an effort to cut through the noise: the S&P 500 does look positioned for short-term weakness. It failed again to challenge its 50-day-exponential-moving-average last night. US earnings season has effectively concluded, too, and confirmed a technical earnings-recession. Sentiment could swing things for stock-markets, so fresh rallies can’t be precluded. But with these fundamentals, perhaps further rallies for the S&P 500 might be capped for a while around its last record high.

Week becomes busy from here

The rest of the week in global markets is in a big way about jobs, pay-rises, and prices. Domestically, wages data is printed on Wednesday, and the monthly jobs numbers are released on Thursday. But first, tonight will see the publishing of US CPI data, with that data to be closely watched by market participants for its implications for US Fed policy. Inflation in the US economy has proven to be quite benign, with market measures of future inflation having tumbled recently in the face of a softer growth outlook. If CPI misses in the US tonight, bets of a 50-basis point cut from the Fed next month could spike considerably.

What sort of risk is there for deflation?

In the grander scheme of things: as the global economy slows down, there are burgeoning fears within the market that developed economies could soon be confronted with the dreaded problem of deflation. The logic is simple, and concerning: the jobs market globally is quite robust, especially in the US. But wage growth, and therefore upward prices pressures, haven’t been forthcoming. If the global economy is heading for a soft-patch, the already feeble push tight labour markets are having on inflation can only diminish. That raises the prospect that rates of inflation will only fall further, necessitating more extreme intervention from policy makers across the globe.

What can central banks do to rescue the world this time?

But: what if central bankers can no longer pull an inflation-bunny out of the hat? Even those central banks, like the Fed and RBA, that can be found to be in the enviable position of having an overnight cash rate above (effectively) zero have very few cuts available to stimulate economic activity and price growth. What were once considered “extraordinary” monetary policy measures become necessary in order to have a fighting chance of spurring inflation. And even then, the desired results are far from guaranteed. A world of perpetually low interest rates, or perhaps even deflation, could become reality.

Financial markets prepare for major central bank intervention

It’s this phenomenon that broadly explains why bonds can be rallying with stocks, and why gold can be rallying with the USD. Money is trying to find yield anywhere it can be found, while it still can be found. So, bond yields are tumbling across developed financial markets. Lower risk-free rates is tipping flow into stock markets, which are moving higher despite an overarching earnings downturn. The USD is finding yield and haven flow. But gold is proving the ultimate victor, as market participants attempt to hedge against a world where the value of cash is nothing (or negative), and the global monetary system is increasingly unstable.