“Volatility Surge …..”

Volatility Surge

The Cboe Volatility Index (VIX index) which is a gauge of market expectations of near-term volatility breached 50 to touch its highest level since the China devaluation of the yuan in 2015.  What has begun with rising bond yields became a selloff across the global equity markets last week, as investors feared the return of inflation and higher rates which could erode profitability for companies already trading at high valuations.   The US stock market which has increased to record highs is waking up to the risks with the Dow Jones Industrial Average tumbling 666 points, the biggest drop since June 2016. A sustained stock slump has the potential to undermine consumer and business sentiment, have an adverse effect on borrowing and could start to curtail global growth.  Furthermore oil declined and metals fell while Bitcoin traded around the $7,600, at one point falling to $6000 for the first time since October.  The uneasy markets continued during the week and on Thursday stocks plunged in New York on heavy volume.  The S&P 500 slumped 3.8 percent.  Furthermore Asian shares sank on Friday and Chinese equities are on track for their worst day in two years.  Japan’s Nikkei shed 2.9 percent, for a weekly loss of 8.6 percent, which is the biggest loss since February 2016.

Cryptocurrency

The cryptocurrency hit the $6,000 level on Tuesday.  The selloff has knocked off trillion of dollars from digital coins since the beginning of January.  The main attractions of this new market which are anonymity and decentralization are being challenged by regulators.  Cryptocurrencies tracked by Coinmarketcap.com have lost more than $500 billion of market value since the beginning of January. The selloff has occurred at the same time as a rout in global equities.    Germany and France are on the forefront pushing to regulate cryptocurrencies.  Meanwhile banks and regulators are looking into whether the blockchain technology that supports bitcoin makes capital markets more efficient and stream lines cross-border payments. Currently there are more than 1,500 digital tokens on the market and concerns over whether cryptocurrency helps terrorists and criminals to cover their finances.

Oil

The American Petroleum Institute was said to have reported that US crude stockpiles declined by 1.05 million barrels last week.  This is at a time when refiners are conducting seasonal maintenance, typically lowering their demand for crude.  Oil has mirrored the movement of equities during Tuesday’s session after a broad selloff on Monday.  The US benchmark stood at $60 a barrel mark.  OPEC including Russia are working towards reducing output, however, the US shale drilling remains a constant threat.

Germany – Still With Political Uncertainty?

German Chancellor Angela Merkel said that she was ready to make “painful compromises” to secure a coalition deal with the Social Democrats (SPD) as the leader said on Tuesday that it was “decision day” for negotiators after months of political uncertainty.   Merkel’s failure to form a government four months after a national election, has raised concerns among investors at a time when Europe is facing multiple challenges such as the Brexit and the euro zone reform.   Should the SPD reject a coalition deal, Germany could face a new election or an unprecedented minority government.  The SPD is now trying to extract concessions on healthcare and employment policy that could win over sceptics among its 443,000 members who get the final say on whether to go ahead with the coalition.

The Impact on Banks From The Catalan Upheaval

Although the Catalonia situation has created uncertainty, depositors have kept their money at the Spanish lenders Caixabank and Banco Sabadell in the last three months of 2017.  Although deposit levels were stable, income has remained under pressure at the two banks.  Both banks have moved their headquarters out of the northeastern Spanish region after regional leaders pursued a secession campaign.  Spanish banks are struggling to lift earnings from loans, as interest rates are around historic lows and increasing competition causing margins to erode.  In order to offset the pressure domestically, Spanish banks have been expanding abroad to reach higher revenues.

UK – Brexit

The extent of any British post-Brexit involvement in the EU’s custom union that binds members into a trade bloc with common external tariffs has become a major issue inside May’s divided government and Conservative Party.  On many occasions Prime Minister Theresa May said that the UK needs to have its own independent trade policy and be able to strike trade deals with the rest of the world.  According to May’s spokesman the official negotiating stance had been set out in a document published in August which are:  a highly streamlined customs arrangement and a new customs partnership with the EU.” The spokesman said that Britain was still looking at both options and no deadline for a decision on which one to pursue had been set.  The deadline is March 2019 for Britain to exit the EU, and May’s party remains deeply divided over what sort of relationship will be built between the world’s sixth largest economy and the EU.  May is under pressure from Eurosceptic members in her party to quit the trading arrangement because for them the key prize is a chance to sign new trade deals with other nations such as the US, China and India.

UK Interest Rates

UK interest rates may need to rise at a steeper pace according to Mark Carney so as to prevent the Brexit-weakening economy from overheating.   On Thursday the Bank of England lifted its forecasts for economic growth and said that inflation is projected to remain above the 2 percent target under the current yield curve.  The governor also noted that a key challenge is limited capacity.  The comments have increased the expectations of a UK rate hike as soon as May and investors are now pricing about a 75 percent chance of a quarter move.

Euro-Area Companies

Economic momentum in the euro area surged at the fastest pace in almost 12 years and as a result firms have been adding additional workers.  According to IHS Markit, a composite Purchasing Managers’ Index rose to 58.8 in January from 58.1 in December.  This beats the estimate of 58.6, mainly driven by better than expected momentum in the services sector in particular Germany.  The expansion in the region has been underpinned by a pickup in global trade, the steady declining unemployment and the ultra-low borrowing costs from the European Central Bank.  In view that companies are continuing to accumulate orders, capacity is being pushed to the limit.  IHS Markit further said that the rapid pace of job creation is the fastest since the late 2000 and is likely to help growth become less dependent on monetary support.    ECB officials are currently considering when to discuss winding down their extraordinary stimulus measures that includes changes to interest rates and bond buying program.  According to Eurostat, the euro-area growth accelerated 0.6 percent in the fourth quarter of last year.  Growth in services and manufacturing has contributed to more price pressures.  Input costs and output charges have risen at the steepest rates since mid-2011.

US – New Fed Charmain

Jerome Powell has been sworn on Monday morning as the 16^th Chairman of the Fed (a day after his 65^th birthday) replacing Janet Yellen.  He is inheriting an economy that is experiencing the third longest expansion, with the lowest unemployment and inflation historically.   He will face challenges as he tries to keep the economy from overheating or getting too cold and in pulling away, as the economy gains momentum.  A concern is that the nation’s unemployment rate has fallen to 4.1 percent, less than half its crisis era peak, and far well below where most experts believe it will begin to provoke higher wages and inflation.

Friday’s US job report

According to the US job report released on Friday, the jobless rate held at its lowest level since 2000 and US payroll gains slowed by more than forecast in December.  The jobless rate was 4.1 percent for a third month, while average hourly earnings increased by 2.5 percent from a year earlier, after a 2.4 percent gain in November that was revised downwards.  The economy is at or near maximum employment which is one of the Federal Reserve’s goals.  The gains in jobs, although below what was forecasted, brings the total to 2.06 million in 2017.  Bond yields spiked on Friday after a stronger than expected January US jobs report.  The Labour Department release showed that wages are picking up and investors fear that it will be a reason for the Fed to hike rates at a faster pace.

US – Senate Deal

Senate leaders will announce a bipartisan two year budget agreement on Wednesday that will provide nearly $300 billion in additional funding.  This is an important step in avoiding a government shutdown.  The plan will suspend the federal debt ceiling until 1 March 2019, and would provide almost $ 90 billion in hurricane and wildfire disaster aid.  On Thursday a Senate vote was expected, followed by the House.   President Trump gave his blessing to the agreement.    Upon the news the dollar and the yields on the 10 year US Treasury rose.  Early on Friday the US Senate approved a budget deal, including a stopgap government funding bill, but it was too late to prevent a federal shutdown that was already underway.  The shutdown was the second this year under Republican President Donald Trump.   If the House acts before daybreak to approve the package from the Senate there would be no practical interruption in federal government business.  Otherwise, the result could be an actual shutdown, the second of 2018, after a three day shutdown in January.

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