Make no mistake about it, the Fed minutes from last month’s meeting today are a big risk. Economic data is a big driver of the market right now, and nothing could be more important than the Fed’s attitude on rates. If the minutes show a very hawkish Fed, then expect some volatility as investors interpret the odds for more and faster rate hikes. If the notes are dovish, expect gains. The minutes may include the Fed’s views on how the tax cut will affect the economy, which is another x-factor.
FINSUM: The market seems have grown slightly less worried about higher rates over the last couple of weeks, which we were readily expecting. But this could still be a risky minutes release.
Investors need to be on red alert today, as this is the day markets have been waiting for. US inflation data for January comes out this morning, the piece of information which will either assuage or accelerate fears about pending Fed rate hikes and a possible recession. Not only will the data affect US markets, but if inflation accelerates, it will also impact other asset classes, such as the Dollar, and by extension, emerging markets.
FINSUM: If inflation is ahead of forecasts, or looks at all strong, it will likely panic markets. If it is weak, there may be a relief rally.
Everyone is blaming last week’s big volatility on the VIX index. Explanations for the big falls are swirling and include an over-reliance on VIX-linked funds and insurers’ volatility strategy. However, FINRA is now looking into another potential cause—deliberate manipulation of the VIX. FINRA suspects traders have been trying to deliberately influence the VIX to move the price of derivatives. The tip on the behavior was given by an anonymous whistleblower.
FINSUM: Given the track record of misbehavior (e.g. Libor), it would be no surprise if traders were trying to manipulate the VIX. However, it is unclear what role that might have had in last week’s crash.
One of the biggest names on Wall Street is warning investors that a recession is coming. Ray Dalio, head of the world’s biggest hedge fund, says that we are likely in for a recession as the Fed has to navigate a tricky tightening cycle. Dalio says the economy is in a hard-to-navigate period of tightening rates that will be hard for the Fed to get right. Rates are likely to rise quickly, which could spark a recession. The view is a reversal for Dalio, who had been until very recently saying that it was foolish to be wary of the stock market.
FINSUM: Dalio’s calls from Davos just a few weeks ago look foolish now, but he does make a good point that this will be a tricky period for the Fed to navigate well.
The last two weeks could hardly have been worse for investors. Stocks plunged and bonds are falling, with the former led by obsession over the VIX. However, according to Bloomberg there is a ticket timing much bigger than the VIX, and one you probably aren’t paying much attention too—ETF loan funds. The market is much bigger than the $8 bn of volatility linked ETFs that got wiped out over the last couple of weeks, try $156 billion between loan ETFs and mutual funds. The big worry is that since these kind of illiquid underlying investments—actual loans—cannot be sold so quickly as the ETFs, that it could cause huge losses as ETFs stampede out but fund managers cannot liquidate the underlying quickly enough.
FINSUM: So this is a provocative spin on a common argument. Our counter, however, is that credit worthiness is pretty good overall, so it doesn’t seem like an exodus will occur.
One of the Financial Times’ most respected columnists has just published an article making a grim comparison. Saying that he dreads even mentioning it, John Authers argues that the current state of markets and the context of the losses are very similar to the summer of 2007, or the eve of the Financial Crisis. In particular, just like then, stocks moved higher even as bond yields did, all until a yield threshold is broken, when stocks finally panic. Then, even though fixed income started the worries, equity investors flee into the safety of bonds. The important extension of the argument is that all the associated fallout will not occur this time, as the economy is stronger and more balanced.
FINSUM: So this is only a half comparison. The actual market event may be similar, but the condition of the economy, and its link to markets is very different, and almost inarguably better this time around.