Yesterday’s price action across most major risk asset classes was a clear indication that investors are re-positioning for rate tightening cycle. Let’s quickly refresh The S&P 500 (SPX) was down 0.5%, the yield on the 10 year U.S. Treasury yield exploded to a two week high just below 1.7%, and the the U.S. Dollar Index (DXY) broke crucial technical resistance at $96 closing at a 1 month high.
Maybe I’m being a bit dramatic on some of those moves, but what was certainly dramatic was the decline in gold, metal and mining stocks and just about any stock or sector that investors have crowded in for yield (Utilities down 7% in 10 days. U.S. telcos down 10% from recent highs and Consumer Staples, XLP, breaking below recent support down 6% from July highs).
But, the 3.5% drop in GLD (the etf that tracks the price of gold, and the 10% drop in GDX (gold miner etf) were the main event, and the moves made that much more troubling for them was the break of key technical support.
GLD may have a date with $115:
And GDX could sniff $20 before it sees $27 again:
Crude Oil was a bit of an outlier yesterday to the higher rate / strong dollar script as it threatens its first breach of $50 to the up-side since June. Make no mistake, $50 is a thing in crude:
The weird thing about the recent crude move is that it comes as the U.S. dollar has been range-bound, with data not exactly pointing to increased demand. Could a rise in commodities and coming rate increases in the coming months (Dec 14th & Feb 1st) stamp out any economic green shoots that might currently exist?
For you WIRP peeps (the Bloomberg function for world interest rate probability forecast), the probability for a Nov 2nd hike by the FOMC is 21%, very near a high recently. The probability for the Dec meeting is 60%. For those who think Fed Funds could go up too far too fast, markets don’t think so. The current probability of Fed Funds being in the 1 – 1.25% range at their Dec 2017 meeting is only 10%. I have two comments here, first, the FOMC is not in the business of surprising on rate hikes. When they meet 6 days before the election I suspect they will give their clearest indication in a long time that they will raise in Dec. And let’s remember, per Goldman:
going back to 1994, 90 percent of the 31 rate hikes were priced in at least 50 percent 30 days ahead of the FOMC meeting. Getting closer to the meeting, the median hike was 95 percent priced in, with only a few deviations, such as from the Alan Greenspan Fed in March 1997 and November 1999.
But markets are starting to show their hand ahead of all of this. And that’s assuming relative certainty, so it’s been somewhat orderly. But if they were to surprise in Nov with a hike, I suspect the SPX would be on its way to 2050, with a gap so quickly through technical support at 2100 it would make your head spin:
Assuming no surprise from the Fed on Nov 2nd, and assuming polls are correct right now for a Clinton victory the next week, then I think markets take a Dec hike in stride, and possibly rally out of it and make new highs. This does not mean that I think the impediments to further stock market gains don’t exist, I suspect Q1 2017 to be rocky, like this last one. But given certain seasonal factors, and assuming the status quo politically I don’t see major stock market palpitations emanating from within the U.S. to the rest of the world until at least next year. (as you’ve seen from things like Deutsche Bank recently, something crazy can always emanate elsewhere and then affect us)
And one last thing, the longer we go without meaningful growth globally, and the closer we get to ECB tapering, and possibly a more hawkish BOJ, the closer we are to another global recession. The last two major recessions we had in the U.S. corresponded with 50% peak to trough draw-downs in the SPX. But in both cases Fed Funds were north of 5% going in (6% in 2000 and 5% in 2007):
The next recession will enter a very different interest rate world. One that we, nor the central bankers have much experience with.