After another difficult Asian session that saw the Nikkei fell 4.8% (12.3% on the week), the capital markets against have stabilized in Europe. Equity markets are mostly higher, with the Dow Jones Stoxx 600 up nearly 2% led by energy and financials.
The Federal Reserve warned that continued market volatility was threatening America’s economic recovery. Janet Yellen said before markets opened that the Fed continues to look closely at market volatility and would raise interest rates gradually, with the pace depending on market conditions. Equity futures rose on the news.
The continued sell-off in global equities is the main driver of the capital markets. It, along with the push lower in oil prices, is pushing core bond yields sharply lower.
After another soggy Asian session, European markets have begun on a firm note, and US shares are trading broadly higher in Europe as well. Led by the beleaguered financial shares, and healthcare, the Dow Jones Stoxx 600 is up 2%. Similarly, the peripheral bonds, including Portugal (though not Greece) are seeing a reprieve from the recent selling. Spanish and Italian 10-year benchmark bonds are off 5-6 bp while the Portuguese yield is off 10 bp. The yield on JGBS, bunds, gilts and Treasuries are 2-5 bp firmer.
Investors and policymakers continue to wrestle with the economic impact of the dollar’s rise. The Federal Reserve has argued that the dollar’s appreciation acts as a headwind on exports and dampens imported inflation. At the same time, despite the dollar’s appreciation and the fall in oil prices, core inflation rose steadily last year.
Core CPI rose from 1.6% at the end of 2014 to 2.1% at the end of 2015. The core PCE deflator lagged, but the after bottoming last July below 1.26%, it finished the year near 1.41%.
Many markets are closed in Asia, and although Tokyo managed posted equity gain, most other markets in the region that were open fell. In addition, the selling pace picked up in Europe. The Dow Jones Stoxx 600 is off 2.3%, led by information technology, industrials, and consumer discretionary. It is trading at new lows since late 2014. It is the sixth consecutive losing session, which is the longest such streak in seven months.
With many equity markets having fallen 20% from their peaks, meeting a common definition of a bear market, investors, analysts, and journalists understandably seek a narrative that gives it meaning. At the very start of the year, the culprit singled out was drop in Chinese shares and the yuan. However, the yuan has stabilized as the PBOC drew down another $100 bln of reserves in January to help ease the pressure what appears to at least in part be a speculative attack by hedge funds (who conclude the yuan is overvalued).
The US dollar remains under broad pressure after yesterday’s sharp decline. Neither dovish comments by ECB President Draghi, nor the Reserve Bank of New Zealand have managed to reverse the gains of their respective currencies. Similar, the rise in US yields and firm equities have failed to push the yen lower.
The US dollar is sporting a softer profile today as the global capital markets are trying to stabilize. Oil prices have steadied, with WTI back above $30. Bond markets are narrowly mixed though the 10-year US Treasury is steady near 1.85%. Asian and European equities followed US markets lower, but American equities have stabilized, and ahead of the ADP employment estimate and the ISM for non-manufacturing, S&P 500 is set to open slightly higher.
The decline in oil and equities are lifting European bonds and Treasuries. The US dollar is firmer against most major and emerging market currencies.
