Let’s find a way to define January: a month characterized by low volatility in the equity market together with a growing turbulence in the bond market. Overall, a lower correlation between asset classes marked the first month of 2017. Ops, I nearly forgot to mention a higher volatility into the FX market, both of the emerging crosses (Mexican Peso and Turkish Lira) but also of the G7 ones (Cable was the main protagonist).
I strongly believe that in this environment we should focus much more on the currency behaviour. They can send us clear signals about the real potential risks.
In fact the reflation theme after Trump inauguration continued to hold. It is a sufficient condition, but not necessary to explain rising bond yields and equity at all-time highs. The anticipated fiscal policies of the new administration have contributed so far to cement a movement that begun late this summer, i.e. inflation premium started to discount a different scenario since July. At the same time we can argue that outflows from foreign holders together with few concerns over the sustainability of fiscal spending, can be considered further drivers of the current reprising.
Translated into uncertainty, we are now reaching a situation whereby equity volatility, measured by the VIX index traded below 11 last week and at the same time the MOVE (Merrill Lynch’s Option Volatility Estimate Index), that measures the implied volatility in U.S. Treasuries yield curve, spiked to 77, a level that allows the spread between the two indexes to reach the levels that we have experienced during the taper tantrum of 2013.
Certainly this situation is going to converge in some way. We started to bet on rising equity volatility or, in other words, we were expecting a correction in current valuations. However the S&P Index can even continue to show little volatility in an endless sector rotation. Surely we are facing high levels of uncertainty, politically speaking; hence a cautioness profile is highly recommended. On the other hand, the classical safe haven is appearing to provide no parachute in this environment. Unless we don’t see a panic zone, it would be difficult to assist at a completely re-bounce of bonds. Whether the Federal Reserve will continue to show a hawkish stance, we are going to see higher yields levels to reflect the new monetary policy. It will be a very complicated game, by tempting to control the dollar and facing with the new fiscal policies. Ops, I was forgetting again, at a certain point the market would like to consider and analyze the measures that Mr Trump promised and eventually their impact on GDP, rather than chatting and twitting about a debatable ban. Eventually the markets need some proof to confirm them to be positioned for the right direction.
Christian Zorico: LinkedIn Profile