VIX spike last Monday an overreaction, but market psychology may have changed

AShmore

Economic

Commodity

Energy

Political

Summary:

Markets retraced losses after a very reactive VIX spike and risk sell-off last Monday. However, as the economy continues to slow down, the narrative is shifting from‘when will cuts happen?’ to ‘will cuts work?’

Global Macro

Stocks

The S&P 500 started last week with a sharp drop of nearly 4% on Monday, but managed to recover all its losses as the week progressed. Some investors likely saw a plunge in global markets as a chance to buy tech and other stocks for bargain prices, with the market probably driven artificially lower by forced selling by some traders. Despite the rebound, the index remains down 4% MTD.

In our view, the market remains in a fragile state. Whereas a deep recession remains a very unlikely scenario, US economic growth has been slowing and is likely to run at around half the pace over the next 18 months than in the prior period when nominal GDP growth was around 6.5%. This means sales and earnings growth, which is priced for a return to the previous macro environment, are exaggerated, keeping US stocks more volatile. The same cannot be said for several Emerging Markets (EMs) which are pricing a very soft economic environment, which is against the ongoing growth outperformance across several EM countries.

Rates

The risk-off market sentiment led to a swift repricing of US yields, causing the yield curve to briefly ‘disinverts’ on Tuesday – a signal often associated with impending recession. By this morning, some of the bearish sentiment had eased, with the two-year yield at 4.05% and the 10-year at 3.94%, respectively.

However, the debate is now shifting from the timing of rate cuts to whether these cuts will be effective. The lowest interest rate small businesses can borrow at currently is prime, and the US prime rate is currently 6.5%, the highest this century. This is starting to bite consumers and the labour market harder, raising the question of whether cuts now will be enough to avert more disruptive slowdown.

That is why consensus is now swinging towards deeper cuts, with a 68% probability now priced for a 50bps cut in September. Meanwhile, rate cuts in Mexico and Peru, (despite rising food prices bringing about notably higher monthly inflation readings) indicate growing confidence in weakening demand and a dovish US monetary runway from here on.

JP Morgan increased the H2 2024 recession probability by 10% to 35%. It sees economic activity remaining solid, but hints from the private sector, and its impact on the labour market, demands a more cautious scenario analysis.

Geopolitics:

US Presidential elections: Kamala Harris confirmed Governor of Minnesota Tim Walz as her running mate. The Democratic Party continued to gain momentum in the polls with several pollsters pointing to a Democratic victory across the swing states. This suggests the race will be significantly closer than expected before Joe Biden dropped out, which should lower the odds of the Democrats winning both Houses of Congress. The Republicans need only to win three out of the 12 disputed Senate seats to have a 51 to 49 majority.

Israel: The US, Egypt, and Qatar have scheduled ceasefire talks for Gaza on Thursday, 15 August. These discussions are seen as crucial to preventing a potential Iranian retaliation following Israel’s assassination of a senior Hamas official inside Tehran. A ceasefire is widely regarded as the best way to avert direct a hostile reaction from Iran, which could escalate the already tense situation. The decision by the US to delay the talks by a week appears to be a strategic move, likely aimed at defusing tensions and providing time for cooler heads to prevail, even if the talks themselves ultimately fail.

Nevertheless, Axios reported the Israeli intelligence community believes Iran is preparing to respond to the assassination within days. The main risk is if Iran causes significant civilian casualties within Israel, which would be seen as a severe escalation. While the Iranian regime may be careful to avoid civilian casualties for self-preservation purposes, the risk of miscalculation is always present.

Russia/Ukraine: Ukraine’s incursion into Russian territory expanded last week, with drones striking a military airfield in the Lipetsk region. Moscow declared a state of emergency in the region, along with the Kursk region, where the Kremlin has lost control of roughly 350km2 of territory.

Commodities:

Copper hit its lowest close since March as stockpiles rose by the most in four years, underscoring weak demand in Asia. The London Metal Exchange index has fallen 19% since peaking in May, almost erasing all of 2024’s gains. Oil moved down alongside other risky assets early this week, before bouncing 6%, moving from USD 72 back to USD 76 dollars per barrel.

Commentary

Bangladesh: President Mohammed Shahabuddin dissolved parliament on Tuesday and agreed to calls from student protesters for Nobel Prize winner Muhammed Yunus to be named Chief Adviser, essentially Prime Minister, for an interim government that would hold power until a new election is held. With the country currently in a state of severe upheaval, Yunus appealed to the citizens in a press conference upon his return “to save the country from anarchy so that we are able to move ahead on the path that we have chosen.” This came after reports of attacks on ethnic and religious minorities.

Brazil: Although rates are still high, restrictive policy is not feeding through to the economy due to higher fiscal spending. Stronger economic activity data and higher inflation expectations in Brazil now makes a hike more likely than a cut by the central bank. Our low-confidence base case is that the BCB will keep a hawkish stance and avoid a hike, but that is contingent on the BRL performance within the next weeks. Be that as it may, there is a clear divergence from other LATAM countries like Peru and Mexico, who are turning more dovish.

Colombia: Petrobras confirmed a gas discovery in the Tayrona block, in deep waters off the coast of Colombia. The discovery is being developed by a consortium formed by Petrobras as operator with a 44% stake and Ecopetrol with a 56% stake.

Mexico: The Central Bank preference to cut policy rates despite higher-than-expected inflation numbers over the last months shows they are more concerned about GDP growth slowing down. This is an important signal to global monetary policy, considering the importance of the US GDP growth to the Mexican economy – suggesting the Fed should be moving towards a more‘doveish’ stance.

In political news, the incoming administration plans to encourage state oil company Pemex to pursue equity partnerships with private firms, a strategy not favoured by the current president. This approach aims to boost Pemex’s reserves and manage its substantial debt, according to sources familiar with the plan. These partnerships, like previous Pemex joint ventures with private producers known as farm-outs, were initially introduced through energy reforms about a decade ago, allowing private and foreign companies to collaborate with Pemex on exploration and production activities.

Over the coming weeks, outgoing President Andrés Manuel López Obrador will be pushing several controversial reforms through Congress. The impact on markets and investor appetite for Mexico that the specifics around the reforms will bring will be closely watched.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

You understand and acknowledge that there is a high degree of risk involved in trading. Following any strategies or investment methods may lead to potential losses. The content on the site is provided by our contributors and analysts for information purposes only. You are solely responsible for determining whether any trading assets, securities, strategy, or any other product is suitable for investing based on your own investment objectives and financial situation.

Add to Favorites

Devin

Economic

UK wage growth slowed to the lowest rate in almost two years in the three months to June, according to official data, though the unemployment rate also fell.

Annual earnings growth, excluding bonuses, slowed to 5.4 per cent from a revised 5.8 per cent in the three months to May, the Office for National Statistics said on Tuesday.

This was in line with forecasts by economists polled by Reuters.

The statistics office also reported that the UK unemployment rate declined to 4.2 per cent in the three months to June, down 0.2 percentage points in the quarter.

Annual pay growth including bonuses slowed to 4.5 per cent from 5.7 per cent over the same period, in part due to one-off payment to NHS staff in June 2023 that was not repeated this year.

Sterling rallied after the data was released, increasing 0.23 per cent on the dollar to trade at $1.28.

Investors scaled back interest rate expectations slightly, continuing to price in one rate cut in November but attributing a lower probability to a second reduction in December.

Members of the Bank of England's monetary policy committee closely monitor wage growth as a key indicator of domestic price pressures and inflation.

The BoE cut interest rates for the first time since the pandemic by a quarter of a percentage point to 5 per cent on August 1, but investors expect it will keep the benchmark rate on hold in September.

Chancellor of the exchequer Rachel Reeves MP said: "Today's figures show there is more to do in supporting people into employment because if you can work, you should work."

"This will be part of my Budget later in the year where I will be making difficult decisions on spending, welfare and tax to fix the foundations of our economy so we can rebuild Britain and make every part of our country better off," she added.

Source: FT

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

Warren Takunda

Economic

Producer inflation in Japan continued accelerating to 3.0% in July, as expected, after the government ended its 18-month campaign to provide hefty subsidies for electricity and natural gas but the prices charged among firms are set to drift lower again as a similar scheme has been revived over the summer, data released Tuesday by the Bank of Japan showed.

It followed a 2.9% increase in June and a jump to 2.6% in May from 1.2% in April. The 42nd straight year-over-year increase was led by a 6.7% rise in utilities, following no change in June, a 7.2% drop in May and a 19.6% slump in April, as well as stabilizing flat costs for lumber/wood products and iron/steel – the two main factors that had driven business prices lower in reaction to the pandemic era spike triggered by the global supply chain breakdown that was made worse by heightened geopolitical risks.

Non-ferrous metals still grew 18.5% on year in July after surging 19.4% in June and 20.9% in May on concerns that the pickup in the world’s second-largest economy would cause shortages of copper and other metals. More recently, the prices for coper and other non-ferrous metals have turned softer amid growing fears that China’s uneven pickup will falter. Metal products and production/general machinery also showed slighter easing price pressures.

The pace of increase in overall prices charged between businesses remains the fastest since the 3.4% increase in August 2023, but far below the recent peak of 10.6% hit in December 2022. The prices for food and beverages have perked up again, above 4%, after showing stabilizing earlier below 3%, while those for transport equipment are steady between 1% and 2%.

The government discontinued subsidies for electricity and natural gas supplied to households and businesses in June, which was reflected in July bills, after halving them the previous month. Prime Minister Fumio Kishida reversed his decision as he saw voter approval rates dip from already low levels. Many people are unhappy with high living costs while the government is raising taxes to boost its military spending to cope with what it terms as a Chinese threat. He revived a similar scheme for three months ending in October to help cushion an expected surge in utility costs during Japan’s dangerously hot summer and warm autumn.

On the month, the corporate goods price index (CGPI) rose 0.3%, in line with the median forecast of a 0.3% rise and following increases of 0.2% in June and 0.7% in May. It has eased from the recent peak of the 1.6% rise reached in April 2022. The increase in July was led by utilities (electricity, natural gas) and farm produce (polished rice, pork, chicken eggs).as seen in the prior month. It was also driven higher by transport equipment (auto parts and passenger cars) and food/beverages (snacks).

The CGPI’s import price index in yen terms rose 10.8% in July, which remains the highest since the 15.0% rise in February 2023 and follows a 9.5% rise in June. In contract currencies, the index rose 1.6% after inching up a revised 0.5% in June and falling for the 14th consecutive month in May with a 2.9% drop (down 16.3% in July 2023). The yen-based import cost increase peaked at 49.5% in July 2022.

The yen depreciated further to an average ¥158.09 against the dollar in July during Tokyo trading hours from ¥157.82 in June and ¥156.13 in May. Last year, the yen’s relative strength in a range of ¥130 to ¥134 in the first four months of 2023 helped lower import costs, which slumped as much as 14.7% in yen terms in July 2023.

In August 2024, the yen has regained most of its lost ground for the year, quoted at around ¥147 on Monday, on market expectations that the BOJ was set to raise its short-term interest rate target more often than previously believed, although it would be still at a snail’s pace compared to other major economies. In July, the dollar hit a fresh 38-year high above ¥161.70 but it has eased to around ¥154 on stealth yen-buying invention on July 11 and 12 by the Ministry of Finance took advantage of the US CPI data for June that showed easing inflation. The data prompted some dollar selling on the notion that the Federal Reserve may lower interest rates in September.

In the July CGPI data, the prices for foods and beverages — a category with a high share of 14.5% of the domestic CGPI — rose 2.6% on the year after rising 2.7% in June. Those for transport equipment (15.1%) rose 1.3%, also easing slightly from a downwardly revised 1.4% gain the previous month. The prices for petroleum and coal products (5.3%) posted the 13th straight rise but the pace of their increase also moderated considerably to 1.1% from 4.6%.

Prices for lumber and wood products were nearly flat, down 0.1% from a year earlier for the 20th straight drop, moderating further from a 2.0% drop the previous month. Iron and steel prices were also flat after dipping 0.3% the previous month.

Metal product prices rose 3.1% on year after rising 3.8% in June. The increase in the prices for production machinery also eased to 2.9% from 3.9%. Meantime, general machinery accelerated slightly to 2.7% from 2.3%. Those for chemicals rose 2.5% following a 2.1% rise.

Source: MaceNews

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

Goldman Sachs

Economic

London-based Michael Bruun told Private Equity International that these conditions are playing out in three ways: better valuations for buyers; more time and potentially more exclusivity as a buyer; and enhanced downside protection for buyers when structuring deals, such as via the use of earnouts for sellers or guaranteed minimum returns for buyers.

“Big sums of capital have been raised, and not necessarily all of that capital has been returned to the extent that the industry has seen in prior years. It has created a wall of assets that needs to change hands over a reasonably measured period of time,” Bruun said.

“The issue for the industry is that less capital has been returned from deals made between 2019 to 2021, leading to less DPI and a prolongation of hold periods.”

There is a nervousness among some sellers around taking their assets to market for fear of failure or fear of having to transact below their expectations, Bruun added.

“There is less competitive tension, and that is leading to nice new deal formation [structures], from our perspective.” While enhanced downside protection is present at any moment during a cycle, Goldman has seen more of these transactions recently, Bruun said.

According to a study by Jeffrey Hooke, a senior finance lecturer who specializes in alternatives at Johns Hopkins Carey Business School, brand-name large-caps funds are holding onto significant amounts of unrealised value. Of the 51 private equity funds in the study, those between seven and nine years old still hold 50 percent of their stated asset value as unsold deals. This proportion sits at 34 percent for funds that are 10-12 years old.

In May, GSAM said its private equity business had agreed to acquire environmental risk reduction and advisory services firm Adler & Allan from Sun European Partners. The following month, it agreed to acquire French wealth management services and product provider Crystal, which has around €22 billion in assets under management.

One way managers have been delivering liquidity for their LPs is via GP-initiated secondaries processes. In a study of UK mid-market managers by investment bank Deutsche Numis last October, continuation funds were ranked as the most preferred exit method, above dual-track processes, IPOs and private auctions.

While continuation vehicles can be relevant for many situations, Goldman’s direct private equity platform is yet to utilise this strategy to exit any of its assets, Bruun said. So far, exits to strategic buyers have been the platform’s “most prevalent option”.

“It’s very important in your investment methodology that you have a clear view the day you enter [of] how you’re going to get out of the asset,” Bruun said. When investment committees are considering buying an asset, they should think about why this may be an attractive asset to another buyer in future and what the next buyer would likely pay. Evaluating managers who use continuation vehicles extensively can be a tricky exercise, he added.

Managers need to be careful not to overextend themselves in over-utilising the continuation route, he added.

Affiliate title Buyouts reported in February that Goldman had engaged adviser Evercore to explore a continuation fund process on West Street fund portfolio company Omega Healthcare. The deal would move the healthcare management services company out of its current fund, and into a continuation vehicle.

A spokesperson for GSAM declined to comment on the continuation fund.

Bruun said that overall, conditions have led to what is increasingly a buyer’s market.

“Valuations are slightly better seen from a buy-side perspective. You get more time and exclusivity if you engage as a willing buyer – that’s helpful for the depth of the diligence you can do, for deeper underwriting and planning for value creation.”

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

Thomas

Forex

Economic

A global market sell-off spurred by an unwinding of yen-funded carry trades has turned the spotlight on China's yuan, which is also used widely as a cheap funding currency.

While August has seen the yuan rise sharply by 2% against the dollar, traders say yuan carry trades are distinct and unlikely to unravel anytime soon.

What is the yuan carry trade?

In typical carry trades, investors borrow low-yielding currencies such as the Japanese yen and Swiss franc to invest in higher-yielding assets, mostly currencies but also to finance leveraged trades in stocks.

The yuan carry trade is similar, but with limitations because the currency is not fully convertible.

A large proportion of yuan carry trades are by Chinese exporters parking cash in dollars. In another version, foreigners borrow yuan to invest in mainland markets. A third type of carry trade involves using the cheap offshore yuan to buy bonds denominated in dollars and other currencies.

How did the yuan carry trade evolve?

Until 2022, when the Federal Reserve started aggressively raising rates and Beijing moved to an easing bias to aid a struggling economy, Chinese interest rates had for years been higher than their U.S. counterparts.

As dollar yields surged, Chinese exporters found they could earn as much as 5% a year if they retained their earnings in dollars, compared to paltry returns on yuan term deposits.

Rampant dollar hoarding by exporters has been a major factor behind the yuan's depreciation since April 2022.

The yuan's depreciation meant foreigners could trade dollar-yuan swaps onshore, earning a fat spread on these trades. Overseas investors could borrow cheap offshore yuan and convert those into U.S. dollars or other currencies to invest in stocks and bonds. The investors would benefit from conversion rates as the yuan depreciated, as well as the usual return on the assets. What is the Chinese Yuan Carry Trade and How Is It Different from the Yen's?_1

What is the Chinese Yuan Carry Trade and How Is It Different from the Yen's?_1

How large is the yuan carry trade?

It is hard to gauge the total size of the yuan carry trade, according to analysts, but it is smaller than yen-funded global trades, given the yen is a more liquid and open global currency.

Macquarie estimated Chinese exporters and multinational companies have accumulated foreign currency holdings of more than $500 billion since 2022.

Foreign companies have also been sending more of their earnings from China abroad instead of reinvesting in the country.

Meanwhile, foreign holdings of onshore yuan bonds increased by 920 billion yuan ($128.12 billion) since the end of 2022 to a record high in June, official data showed. That is evidence of what traders call the reverse yuan carry trade, in which foreign investors profit from lending U.S. dollars and borrowing yuan via currency-hedged swap trades and then buying yuan bonds.

Could Chinese yuan be the next carry trade to unwind?

The recent unwinding of the hugely popular yen carry trade after Japan raised interest rates sent the yuan higher and raised questions about the viability of yuan carry trades.

UBS said short positions in the offshore yuan have decreased given the currency's correlation to the yen.

Onshore carry trades could unwind if and when Chinese yields rise and dollar-yuan interest rates converge.

"The yuan carry trade will unwind once China's domestic demand turns around," said Macquarie's chief China economist Larry Hu. "It then depends on when policy stimulus could become decisive enough."

($1 = 7.1809 Chinese yuan)

Source: Yahoo

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

NIESR

Economic

The methodology is the same as before: we forecast the month-on-month inflation “drop ins” for the forecast period, and combine this with the drop outs from the previous. This forecast is based on training the MRN over all of the data from January 1999 to June 2024.

We present the intermediate MRN alongside the Simple MRN which just uses CPI (in levels and month-on-month changes) in the dashed line. Both forecast an increase in inflation in July. The main reason for this is that there is a big “drop out” of + 0.4 per cent from July 2023 (when rice fell by 0.4 per cent). The Intermediate MRN predicts a slightly positive month-on-month for July of 0.07 per cent, which leads to an increase in the headline annual figure to 2.5 per cent. The Simple MRN predicts a small fall in prices in July 2025 which leads to a more modest increase in headline inflation to 2.2 per cent. When you read this, you will probably know the actual outcome for July 2024.

The intermediate MRN predicts that inflation will fall below 2 per cent in September before rising again to a peak of 2.9 per cent in January 2025, falling thereafter. As I have stressed in previous blogs, the January Sales effect is usually negative but highly variable: the increase in inflation in January 2025 will depend on how much smaller the January sales will be in 2025 compared to 2024. The Intermediate MRN is predicting a slight increase in prices in January 2025 (0.01 per cent), which when combined with the drop out of the big sales in January 2024 produces an increase in headline inflation of 0.6 per cent, taking it to 2.9 per cent.

As in previous forecasts, the Simple MRN predicts much higher rates of headline inflation as we move on. This Simple model may work at very short horizons, but looks unreliable as we move to longer horizons. The additional variables contained in the Intermediate model no doubt provide useful patterns that the MRN can detect. We intend to undertake a full comparison of the different MRN models we have developed as well as more traditional forecasting models: watch this space. Neural Nets Forecast July Inflation to be Between 2.2% and 2.4%_1

Neural Nets Forecast July Inflation to be Between 2.2% and 2.4%_1

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

Samantha Luan

Economic

Central Bank

Panic appears to have faded following last week's outbreak of volatility in U.S. stocks, but if history is any guide, markets might remain jittery for months.

Wall Street's most closely watched gauge of investor anxiety, the Cboe Volatility Index, has rapidly eased after closing at a four-year high last week and stocks came screaming back following the year's worst tumble. The S&P 500 is up 3% from last week's lows, while the VIX hovers around 20, far below the Aug. 5 close of 38.57.

Fear Fades in US Stocks, But History Shows Quick Return to Calm Unlikely_1

Investors pointed to the rapid dissipation of market anxiety as further evidence that last week's meltdown was fueled by the unwinding of massive leveraged positions, including yen-funded carry trades, rather than longer-term concerns such as global growth.

Even so, turbulent episodes in which the VIX shot higher show markets tend to stay frothy for months after a blowup, arguing against the kind of risk-taking that lifted asset prices in the first part of the year. Indeed, a Reuters analysis showed the VIX has taken an average of 170 sessions to return to its long-term median of 17.6 once it has closed above 35, a level associated with high investor anxiety.

"Once (the VIX) settles into a range, then people will get a little more passive again," said JJ Kinahan, CEO of IG North America and president of online broker Tastytrade. "But for six months to nine months, it usually shakes people up."

Fear Fades in US Stocks, But History Shows Quick Return to Calm Unlikely_2

This month's U.S. stock market tumult follows a long, placid period in which the S&P 500 rose as much as 19% for the year to a record high in early July. Cracks formed when disappointing earnings from several richly valued technology companies last month sparked a broad-based sell-off and lifted the VIX from its range in the low teens.

More serious ructions followed in late July and early August. The Bank of Japan unexpectedly raised interest rates by 25 basis points, squeezing players in a carry trade fueled by traders borrowing cheaply in Japanese yen to buy higher-yielding assets from U.S. tech stocks to bitcoin.

Meanwhile, investors rushed to price in the chance of a U.S. slowdown following a spate of alarming economic data. The S&P 500 fell as much as 8.5% from July's records, just missing the 10% threshold commonly considered a correction. The index is still up 12% this year.

Mandy Xu, head of derivatives market intelligence at Cboe Global Markets, said the market's rapid drop and quick rebound pointed to a positioning-driven unwinding of risk.

"What we saw on Monday (Aug. 5) was really isolated to the equity market and the FX market. We did not see a correspondingly big increase in volatility in the other asset classes, like rate volatility and credit volatility," she said.

Investors have ample reason to remain jumpy in the months ahead. Many are waiting for U.S. data, including a consumer price report later this week, to show whether the economy is merely downshifting or heading for a more serious slowdown.

Political uncertainty ranging from the US election in November to the prospect of increased Middle East tensions is also keeping investors on their toes.

Nicholas Colas, co-founder of DataTrek Research, is watching whether the VIX can remain below its long-term average of 19.5 to determine whether calm is truly returning to markets.

"Until it (the VIX) drops below 19.5 (the long run average) for a few days at least we need to respect the market's uncertainty and stay humble about trying to pick bottoms in markets or single stocks," he said.

Correction watch?

The market's close brush with correction territory may be another worry. In the 28 instances in which the S&P 500 got within 1.5% of confirming a correction, the index went on to do so within 20 cases in an average span of 26 trading sessions, data going back to 1929 showed.

In the eight cases which it did not confirm a correction, however, the index took an average 61 trading sessions to hit a new high.

CPI data due on Aug. 14 and earnings from Walmart and other retailers this week could be crucial in determining investor sentiment, said Mark Hackett, chief of investment research at Nationwide, in a recent note.

"It wouldn't be surprising to see potentially overblown reactions to this week's CPI number, retailer earnings and retail sales from investors given the heightened emotional responses in the market recently."