Financial markets are finally showing signs of stability today, as traders take a deep breath after the past few weeks of increased volatility. The S&P 500 index corrected by almost 10%, and commodities fell nearly 20%, after “King Dollar” regained prominence. Yes, the Dollar has also corrected of late, due primarily to weak retail sales data and a hint from James Bullard, an FOMC member, that QE may have no end in sight. Pundits are calling last week “Taper Tantrum II”, a not so mild reference to previous missteps.
Volatility is back, that grim reminder that fear and uncertainties really do drive financial markets. Analysts are quickly groping for the next fundamental clue as to where the market will head in the near term. At present, most of the crowd has dispensed with guessing central bank monetary policy and expectations for rate hikes. Too many other market indicia are in freefall, suggesting that there is a new game in town that must be unveiled soon to avoid more damage to portfolios. GDP growth and inflation seem to be the keys to the kingdom, so to speak, as this deciphering exercise continues.
The most compelling correlations have appeared when comparing the path of the Dollar and the recent behavior of global commodities:
The obvious divergence of the USD and commodity prices in general has grabbed the headlines. Most commodities are priced in Dollars in global markets, such that an inverse relationship is a given, but, in this case, the “delta” between the above averages is 13%. The rise in Dollar strength cannot account for the majority of the fall in value. The decline in oil prices has definitely spooked the market and given fodder for a plethora of articles on the topic. Speculations are all over the map, from a simple drop in global demand to a cabal-type conspiracy to punish Putin/Russia over their Crimea exploits. Russia depends heavily on oil exports to fund its domestic needs.
The more sober judgments are prophesizing that the global economy is again slowing down. The IMF has already adjusted their growth forecasts, and the drop in Copper prices, the bellwether of economic activity, seems to support this hypothesis. Europe is headed for another recession, and China, despite government attempts to paint a rosier picture, is not kicking into a higher gear, but pulling back a notch or two. As some analysts point out, however, lower commodity prices across the board will beat out any QE program any day as a directed stimulus program, the silver lining in this playbook.
What are we to conclude from this present situation? In the near-term, commodity currencies may still take more punishment. European currencies may take more heat, as well. Optimists will claim that these potential results have already been factored into market valuations, but Fibonacci ratios tell a different tale. The daily data for the EUR, GBP, and AUD have rebounded, but only to the 23.6% parallel, a sign that more weakness is present. The Yen, however, bounced off the 50% level, only to limp to the 38.2% line, due in part to a rekindled “carry trade” interest away from the Aussie.
Growth data is on the docket for this week, but eyes will turn to September’s CPI release for the U.S. on Wednesday. Economists swore on a stack of bibles that rampant inflation would overtake the U.S. market after various QE programs took hold, but the so-called ramp never appeared. Fast forward, and the fear of dis-inflationary pressure is now on the uncertainty table.
Will U.S. inflation remain stable or decline? Stable is good; a decline is bad.