Contrasting messages from bonds, gold and equities

September 8, 2009 — Mitul Kotecha

There is an interesting divergence developing between bond yields, gold prices and the trend in equity markets.  Whilst equities continue to go up, bond yields are falling and gold prices are rising.  Indeed the usually strong relationship between the S&P 500 and US 10 year yields has collapsed to an insignificant correlation around -0.09 over the past month compared to a high correlation of 0.84 in the month to 8 August.  

Rising equities appear to signify an improvement in risk appetite whilst bonds (US 10-year yield around 3.4%) and gold (around $1000 per troy ounce) are giving the opposite message.  So which indicator is correct and why the breakdown in the usually solid relationship?  

Growing optimism about economic recovery and the run of better than forecast data releases suggest that equities are correct but there is growing risk that so much good news is now priced in that we should pay attention to what bond yields and gold prices are telling us.  

Some of the move lower in bond yields can probably be attributed to the wall of liquidity sloshing around due to central banks’ unconventional policy measures.  However, it is still remarkable that despite the plethora of better than expected data releases, bond yields have actually declined.  This may reflect the success of quantitative easing but could also be associated with sustained economic and market fears.    

The commitment by G20 officials last weekend not to reverse stimulus policies prematurely may also have given more confidence in the view that interest rates will not be raised quickly.  Reflecting this 2 year German bund yields dropped to a record low level at the beginning of the week although longer term bond yield have pushed higher in the 30 year area.  The G20 commitment could turn out to be a double edged sword, however.  If there is no commitment to reduce burgeoning deficits, bonds could ultimately take fright.  

If bonds and gold prices are really reflecting safe haven demand then it will pose a risk to the sustainability of any equity rally over coming months.  As equity valuations begin to look increasingly stretched – the P/E ratio on the S&P 500 has reached 18.76 (according to Bloomberg calculations) compared to a low of around 10.00 at the beginning of March 2009 – it will need more to keep the rally going and high amongst the factors needed is some clarity about the pace and shape of growth once stimulus is reversed. 

For currency markets I think it will be difficult to see a trend until there is more clarity about the economic outlook and in the meantime currency markets will continue to stock watch for direction even if the influence of risk appetite is declining.  Even so, the dollar appears to be reacting more to equities than bond movements and is coming under growing pressure as equities rise.  

Many currencies are poised to break out of recent ranges to the topside versus the dollar led by risk currencies such as the AUD, NZD and CAD.  If it turns out that the equity story rather than the bond message is the correct one then the real message is a bullish one for risk appetite and given the dollar’s usually negative reaction to improved risk appetite, it could face further pressure over coming weeks.

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Risk gyrations and FX positioning

August 24, 2009 — Mitul Kotecha

I must admit it has been quite tough to get a handle on the sharp moves in markets over recent days. Market sentiment shifted from positive to negative and back again in a matter of hours, meaning that anyone wanting to put on a long term trading position has had to have had a significant risk tolerance to hold onto their positions.

Attention was focused squarely on Chinese stocks last week but market fears over tighter regulation eased as the week progressed. Market sentiment was helped by strong existing home sales data in the US, continuing the run of better than forecast US economic data releases. Globally data releases mirrored this tone.

A cautiously upbeat tone from central bankers at the Jackson Hole symposium sets up a positive backdrop for markets. Although Fed Chairman Bernanke noted that the rebound in growth was likely to be slow and ECB President Trichet talked about a “bumpy road ahead” the overall tone was positive.

Importantly there was no indication that a reversal in monetary policy was in sight, with the Fed’s Kohn even indicating that there was no inconsistency between the Fed maintaining low rates for an “extended period” and keeping inflation low. The comments should help to ensure that markets do not misinterpret the signs of recovery as a cue to begin hiking interest rates.

This week’s data slate will maintain the run of good news. However, there are a few risks. Consensus forecasts look for US consumer confidence to improve in August but the weak labour market situation may hold some downside risks for the Conference Board measure of confidence just as it did for the Michigan reading.

US durable goods orders are set to bounce back and new home sales are likely to echo at least some of the gains in existing home sales last week. In the eurozone, attention will focus on the August German IFO survey and this release is likely to mirror the gains in the PMI, with a healthy gain in the headline reading expected.

Risk trades continue will be favoured after overcoming last week’s setbacks keeping the USD under downward pressure but within ranges and risk currencies including AUD, NZD, CAD and NOK under upward pressure. The USD index is verging on testing its 5th August low of 77.428, whist the JPY is also weaker though its moves may be more limited ahead of upcoming elections.

The IMM report shows that speculative investors have cut pared back USD short positions further, but the shift in positioning was relatively small from the previous week, with net aggregate USD short positions at -94.8k contracts compared to -96.1 in the previous week. Notable shifts in positioning over the week include a cut back in net EUR long positions to their lowest level since the week of 5th May 2009.

Commodity currencies suffered some pullback in net long positioning too with speculative AUD and NZD contracts being cut although net CAD long positions did increase slightly. Given the resumption in risk appetite into this week it seems highly likely that positioning will reverse and net USD short positions will increase.

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Chinese stocks enter bear market

August 19, 2009 — Mitul Kotecha

Markets can only be described as fickle as they gyrate back and forth depending on the latest news or earnings report and as a result direction is changing not just daily but also intra-day.  Investors in most asset classes will continue to focus on stocks especially the recently underperforming Chinese equity market (Shanghai A share index) which officially moved into bearish territory after falling by over 20% from its early August high. 

Various reasons for the drop can be cited including regulator’s curbs on the stock market, high valuations, absence of new fund launches, limits on institutional buying,  high level of new accounts adding to volatility, tighter regulations on real estate, etc, but whatever the reason the direction has been clearly downwards and the impact is being felt across markets.

The turnaround in equity markets during Wednesday’s sessions was dramatic and was led by the turnaround in Chinese stocks which dragged other Asian bourses down with it.   This outweighed any positive sentiment from Market positives so far this week including a strong reading for the German August ZEW survey which surpassed forecasts by a large margin.  This followed the extension of the TALF by the Fed, and a jump in the US Empire manufacturing survey at the beginning of the week.  

Aside from weaker equities the usual FX beneficiaries including the dollar and yen strengthened on the back of the Chinese stock rout.   S&P’s affirmation of China’s credit ratings and positive comments from China’s stats office about the economic outlook in the months ahead  failed to support sentiment.  This would have been expected to provide a positive backdrop for Asian markets but Chinese stock market jitters provided a strong headwind to local markets. 

Overall most measures of risk have seen a substantial improvement over the past few months but there is no doubt that nerves are creeping back into the market.   This time the nervousness is coming from China and worryingly it is swamping the effect of any good news on the global economy and earnings.   This may prove to be a blip on the long road to recovery in risk appetite but it is difficult to ignore such a sharp fall in Chinese stocks without looking at the potential contagion to other equity markets.  

On the FX front those currencies that are most correlated with risk aversion such as the Australian dollar, New Zealand dollar, South African rand, Indonesian rupiah, Brazilian real and Mexican peso will gyrate in relation to the moves in risk appetite.   These currencies have had the highest correlations with risk aversion over the past month and in the current environment will come under some pressure at least until risk sentiment changes again, which in this market could happen at any moment and without warning.

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, equity markets, India, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »

All eyes on Chinese stocks

August 18, 2009 — Mitul Kotecha

Equity markets extended their declines overnight as European and US stocks were smacked across the board.  One of the biggest pull backs has occurred in the Chinese stock market where stocks are down by around 17% since early (3rd) August although stocks are still up close to 73% on the year.  Some of this could be on fears of monetary tightening in China as well as missed profit estimates. 

Risk trades were sold and the dollar and yen strengthened whilst bond markets continued to rally.  News that contributed to the move could have included a sharp 35.7% YoY decline in FDI flows to China in July as well as a broad tightening of lending standards in Q2 according to the latest Senior Loan Officer survey by the Fed.  In contrast there was some positive news on the manufacturing front as the US Empire manufacturing survey jumped 13 points to its highest reading since November 2007. 

The Fed announced that the TALF with a capacity of as much as $1 trillion will expire on June 30 rather than December 31 but for other asset backed securities and CMBS sold before January the plan was extended by three months.   This extension failed to prevent a drop in financial shares overnight with the S&P financials index down 4.2%. 

Commodity prices also extended their drop, with the CRB index now down by around 5.6% since 5 August.   This will continue to play negatively for commodity currencies including the Australian, NZ and Canadian dollars, with the currencies looking vulnerable to more downside today.   Expectations of rising oil inventories and a firmer dollar tone are also playing negatively for commodities. 

Some relief may come today from firmer economic data expected in the US and Eurozone.   US housing starts and building permits are set to reveal further signs of stabilisation in the US housing market whilst the German ZEW survey will rise in August on the back of better economic data and past stronger equity market performance.  It is debatable how much economic data can help counter the worsening in equity sentiment but it may at least provide a semblance of relief.  

The dollar index is trading around the top of its recent range and sentiment for the currency has clearly become less negative as reflected in the latest CFTC Commitments of Traders Report which showed a sharp pull back in net aggregate dollar short positions in the latest week.  

Nonetheless, the dollar is likely to show little inclination to break out of its recent ranges against most currencies.  Overall FX market attention will focus on the Shanghai composite to lead the way in terms of risk appetite and overall direction. Thin holiday trading will leave the markets prone to exaggerated moves over the near term.

Posted in Asia, China, Commodities, Currencies, Economics, Economy, equity markets, US. Tags: , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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