August is one of the most popular vacation periods, but few expected the Nasdaq to take a three hour holiday on Thursday. The shutdown was blamed on a technical glitch, and the blame lies squarely with Nasdaq software unlike previous outages in 1987 and 1994 when the group accused squirrels of tampering with power lines. Regardless, the incident serves as a reminder that no matter how much technology changes, market challenges remain the same.
Market Recap: August 19th-23rd
The most notable moves on the week were in emerging market currencies as the anticipated tapering of the Federal Reserve’s QE3 monthly bond purchases saw investors buy back US dollars. The Brazilian real, Indian rupee and Indonesian rupiah all fell to notable lows on expectations of an end to cheap liquidity. While minutes from the Fed’s July meeting contained few surprises, they reinforced perceptions that members are “comfortable” with Chairman Ben Bernanke’s plan to reduce the $85bn-a-month bond buying later this year if the US economy continues to improve. Some officials called for tapering to begin in September while others want to wait for more data.
Bonds fluctuated through the week, with the US Treasury 10-year yield touching a two-year high above 2.93% Thursday before reversing lower on Friday. Stock markets were choppy, lacking direction on an absence of significant US economic releases. European data was generally upbeat, particularly UK and German GDP, while an unexpected expansion in Chinese manufacturing provided some optimism of stability in the world’s second largest economy.
The Federal Reserve Bank of New York conducted a survey of 21 primary dealers last week and found that most believe the Fed will start its tapering in September, with reduced bond-buying of $15bn per month. The dealers also expect the Fed to keep interest rates on hold until 2015. Despite all the nervousness surrounding the tapering, a $15bn reduction would still make the Fed’s monthly purchases larger than when QE3 was first announced in September last year [the program was unveiled at $40bn per month and increased to $85bn in December].
Moreover, an analysis from two economists at the San Francisco Fed asserted that the effects of large-scale bond-buying “depend greatly on the Fed’s guidance that short-term interest rates would remain low for an extended period” and that “interest rate forward guidance probably has greater effects than signals about the amount of assets purchased.” Yet even if the economic impact of tapering is negligible, don’t expect markets to react with much efficiency.
Emerging Markets Drama
The BRIC [Brazil, Russia, India, China] emerging markets are getting caught in a perfect storm of negative sentiment. Expectations of higher US rates, a reduction in cheap financing, falling commodity prices and country specific issues are combining to lead some commentators to warn of an “emerging market crisis”. Such statements seem excessive. Unlike in the late 1990s, exchange rates are more flexible today and reserve holdings are far greater. During the 1997-98 currency crises global reserves were $76bn; today Bloomberg data shows BRIC currency reserves alone are $4.4tr.
Markets settled down late last week as Brazil launched a $60bn currency intervention program and India pledged to cut its current account deficit [imports > exports] and will consider a sovereign bond issuance. Recent moves imply a correction rather than impending crisis, but that shouldn’t mask some of the problems facing the BRICs. Most notably, Brazil and Russia are overly reliant on commodity markets, Indian inflation is escalating and China’s banks are overleveraged. Hopefully recents events may spur the BRICs to reform their long-held protectionist policies and large state sectors.
Positive sentiment in Europe was aided by eurozone purchasing manager indices that showed expansion in manufacturing and services. Encouragingly, the periphery economies showed improvement. Yet periphery bond yields failed to continue their downward trend, generally finishing higher on the week likely due to thin markets and decreased risk appetite spurred by the emerging markets sell-off.
German bund yields maintained their ascent, touching a 17-month high near 1.94%, a knock-on effect of the Fed’s expected tapering and an improving eurozone outlook. While it has been a quiet summer on the political front, the governments of the periphery nations remain under intense pressure and there is still much work to do in reducing debt burdens and increasing funding for Greece, Portugal and Cyprus.
Chinese PMI manufacturing data suprised to the upside, rising to a four-month high. This followed on from upbeat July data, easing some “hard landing” slowdown concerns. The PMI sub-indices also showed increased domestic demand, a key goal of the Chinese government as evidenced by last month’s “fine-tuning” policies of tax cuts for small companies and new funding for transport infrastructure.
Yet rising house prices are a burgeoning problem. For July, prices rose 6.7% year-on-year, up from 6.1% in June according to data obtained by the Wall Street Journal. Higher prices have been aided by a sharp increase in lending in the first half of 2013 and a relaxation of strict controls on home purchases in some cities, particularly Wenzhou which has suffered from China’s exports slowdown.
“Real World” Analogy
Trading analogies are pretty common, but I didn’t expect to be thinking of one while attending a mixed martial arts event in Boston last weekend. Halfway through one of the bouts a Brazilian fighter, who was on his back, grabbed the leg of his standing American opponent. Using his weight to hook himself around the American’s leg, the Brazilian attempted a painful-looking knee-lock hold.
While instinct would be to resist the move and attempt to remain on one’s feet, the American did something different. Even though it was a situation the American hadn’t wanted, or expected, to be in, he didn’t resist the submission attempt. Instead, he relaxed his body, allowing himself to be dragged to the ground, going along with his opponent’s momentum. By keeping his leg muscles relaxed, and aided by copious amounts of sweat, the American used the momentum to roll out of the Brazilian’s grip and managed to reverse the move into a hold of his own.
The American fighter typified the discipline of a good macro trader. He didn’t forecast the Brazilian’s knee-lock attempt, but was nimble enough to adapt and didn’t try to go against the strong momentum. Ultimately he took advantage of the Brazilian’s attack. Similarly, a trader should know when not to fight against markets, even if he doesn’t agree with the fundamentals behind a strong move. Markets will go where they want to go, sometimes irrespective of logic. Unforeseen situations will arise and a macro trader must be able to recognize when his views are out of sync while simultaneously adapting to market conditions to profit from strong momentum. But if all else fails, just like the American fighter was assisted by sweat in his escape, traders will do well to stay in liquid markets.
This post also appears on Ronan Keenan’s MacroWatcher blog.