Fed continuing to deliver mixed signals

Outlook:

We had a wall of worry yesterday, including the Dow down 313 points from Friday and dipping under 16,000 at one point. The S&P lost 2.6%. Flows into Treasuries took the yield to 2.08% (CNBC) or 2.091% (Market News). Reuters has a combined-source yield index at 2.095%. For perspective, ahead of the Sept 18 FOMC, the yield had hit 2.30% and even last week we saw 2.22%.

Contributing to the misery is the Fed continuing to deliver mixed signals. Free speech and all that but honestly, the Fed isn’t doing its reputation any favors. Yesterday NY Fed Pres Dudley and San Francisco Fred Williams agreed that a hike is appropriate this year, but Chicago Fed Evans prefers next year. Today we get consumer confidence and CaseShiller house price indices, letting traders lick their wounds ahead of a heavy calendar tomorrow that includes the ADP private sector jobs forecast, the Chicago PMI and a ton of Fed speakers (Yellen Dudley, Bullard, and Brainard). Then it’s on to Thursday when we get the famous Chinese PMI data.

To be fair, yesterday’s rout was caused as much by Swiss commodities firm Glencore as China fear. Glencore crashed by 29% yesterday (and it back up 5.4% this morning so far). The ghost of Marc Rich lives on. We can blame VW, too, where the story is just beginning. Here we can see the pinballs hitting suppliers, other auto companies, the reputation of Germany itself, and of course the vast penalties to be imposed on VW—over $35,000 per car in the US. But fear is fear, no matter the cause. Sometimes the cause is fictional or exaggerated, but probably not this time. We have good cause to see the US as the main bulwark of economic stability and growth (okay, add the UK and Ireland) in a world of deflation and stagnation.

How on earth can the Fed hike rates in a period of financial market turmoil when it just declined to hike rates because of financial market turmoil? The FT notes the Bloomberg estimate of Fed funds futures indicating only a 41% probability of a December hike. Oh, dear.

Explanations of various sell-offs are quite interesting. If your equity or commodity portfolio has just taken a giant hit, you need to buy a disproportionate amount of notes and bonds to re-jigger the portfolio toward a less risky mix. Market News reports “Analysts at Credit Agricole estimated Monday that with the lower stock prices, a $100 billion US fund "needs to sell USD2.0bn of Treasuries to get back to balance. It is important to look at this in comparison to the past because $2bn is the biggest quarterly bond liquidation requirement that we have calculated since 2012. In Europe, the situation is more significant, with a EUR3.2bn switch being required." This did not get much play in the bond rally but it could gain more attention. Credit Agricole says this rebalancing usually takes place in the first week of the new quarter.”

Sovereign funds are said to have been heavily invested in VW, for example, and now scrambling for less-risky alternatives. The commodity rout has gotten silly—Market News reports that lumber futures took a bath yesterday. We wonder if the fixed income crowd is not the best place to look for clues. The US 2-year, the most sensitive to sentiment toward policy change, is at 0.67% this morning, a hair over the 10-year Bund but well down from 0.81% two weeks ago.

In a nutshell, it ain’t over yet. That’s the bad news. The good news is that at various points along the way, we get pullbacks in the downmove that present splendid buying opportunities, if short-term. And when the final lowest low is discovered, the upside opportunity is very fine, because we expect a high greater than the last high. So, if you missed a move, wait for the pullback—a classic strategy in good standing. The problem, of course, is that your timing has to be perfect. If not, you are trying to catch a falling knife. In the case of the dollar/yen below, it’s a case of catching a flying knife—the dollar rout “should” resume.