When Black Gold turns into a Black Swan
In one week a suspicion of changing sentiment with eyes fixed on falling oil prices as the cause, turned into a black swan event that caused a major rout in global equities.
By tuesday morning it was clear that a shift in sentiment had shown up in Monday’s trading.
The rules the dangers and the opportunities have changed.
There is a lot of news and a lot of consequences to recent events, so I am focusing on the hot topics this week and how understanding them can both protect us and provide opportunity.
Oil
An obvious and necessary place to start. This is the major macro theme and likely to remain so for some time to come.
During the week Opec lowered demand forecasts making an oversupply problem that much worse.
There is a ton of political manipulating going on as we have seen and speculation as to who is now involved. That means it becomes difficult and dangerous to predict.
There are already many countries relying only on reserves to keep going, including Venezuela, African oil producers and of course Russia. There will be other victims. This is a dangerous game.
The spiralling down we have witnessed caused a great deal of different speculation on where prices are headed next and what the low might be. The down move this week was brutal enough to unnerve the global stock markets who also saw dramatic losses, shown in detail below. Whilst oil prices have always been a key determinant to growth and economic forecasts, the current collapse is unprecedented.
The following chart shows just how fast the down move has occurred, the bulk of it since July , and gathering pace exponentially in November and December. That is why it qualifies as a black swan event.
Forex Black Swan: Global Fall-out
Understanding the major effect such an event as this will inevitably have on the global economy is perhaps something we can predict to an extent and can at least alert us to the signs to watch as these effects take hold.
We already know that we cannot make the assumption that economies importing oil will benefit from lower prices, (significantly lower) and that growth will be thus stimulated. The reason is inflation.
Globally many economies are finding it difficult to get traction enough in their growth to invoke any kind of life into inflation. It is at best stagnating and the spectre of deflation looms larger and larger as a result of this last week especially for the Eurozone and Japan.
On that note lets take a look at some of the immediate consequences.
Bonds and Equities
Starting first in equities the week saw a major sell off, the S&P lost 1.6% by friday close, leaving an impressive bearish weekly candle.
The following chart shows some of the globes major exchanges all sharing the same fate. The FTSE lost 2.5% and similar losses in the European bourses.
In the Bond market there was even more depressing news. The 10 yr Treasury bond yield fell 9 basis points , perhaps the most significant example of the sudden change in market sentiment. It was noted that they dipped below 2.2% not seen since October.
And that was not all in terms of gloomy outlook. In Germany the 10 yr bund yield touched an all time low at .63%. There is also an inflation barometer in Germany produced by subtracting the yield from a fixed bond from a yield with an inflation linked bond. It dropped below zero this week indicating that traders are expecting deflation in the Eurozone . This is a five year forecast as the comparison is between 5 year bonds.
Here is the Bund yield, courtesy of Stockcharts.com
More Bad news for the Eurozone
Thursday saw the awaited issue of TL TRO’s. It was disappointing for 2 reasons. The last issue is about to be repaid, whilst the new issue was around 50% of the total on offer. It does little to increase the ECB spreadsheet. This together with the inflation forecast from Germany may be enough to tip the balance in favour of QE when the ECB meet again in January. There seems little alternative to stave off deflation but it remains to be a political minefield.
In addition Industrial production for the zone missed the number falling to a dismal 0.1%
I shall be watching for increasing rumours of QE to find short positions especially if we remain risk averse. The euro is stuck in a range against the greenback so definitely worth watching.
Tidings of Joy
In comparative terms of course! It is a relief to be able to find some upbeat news. The US provided it once again with retail sales beating estimates at 0.7% and unemployment numbers falling also further than expected. Consumer confidence also provided a robust number.
Falling oil prices tend to stimulate economic recovery in the US but as we have seen this current situation is very different and recession on a global scale will certainly impact the US recovery in some way. It remains the only bright spark in the gathering economic gloom.
For now the index is pulling back and profits are being taken off the table. Here is the USD index on a daily timeframe;
Also in the news this week is the speculation of the language that the FOMC will use in their meeting on Wednesday. It is strongly believed that the words ‘considerable time’ (to keep rates low) will be dropped this being a hawkish change in tone and following last week’s data would be justified. It is likely that they will do so without replacing with strong alternatives so as to not seem over confident in the light of the global climate and its as yet unknown effects.
Volatility
The Vix settled out at 21. This is not an extraordinarily big number in the big picture of volatile markets. What is extraordinary is that it has nearly doubled in 2 weeks. That is enough to put us on our ‘sentiment’ guard, courtesy of Stockcharts.com
Risk-Off trading
With the Japanese election this week and an expectation of a continuation of ‘abenomics’ we might be justified in anticipating more liquidity in an already QQE’d economy! In this environment you could expect further devaluing of the JPY, but the risk environment may change the rules as when sentiment changes Yen trades are unravelled, the mass of carry trades taking advantage of high interest rates elsewhere. This pushes the Yen up and makes it very unpredictable. The sentiment pairing used to monitor the risk environment is AUDJPY so here it is on a weekly chart to show the last few months trading.
The Yen will continue to be tricky until risk aversion shows signs of establishing itself, so one to avoid, especially until after the holiday.
With commodity prices falling further this week, our commodity currencies are still vulnerable.
Still favouring shorts on the AUDUSD, watch for big news this coming week including mid-year economic and fiscal report and monetary policy meeting.
Unprecedented events in the market are uneasy inasmuch as any predictions are purely speculative . No-one can safely say where it is headed now, so it has become guesswork and prediction has become gambling. As always, we can and should rather take the snapshot after the weeks alarming events and plan from this place alone.
It is not a time for long holding. Black swan events are not for the feint-hearted and we have a holiday ahead and a lot of dust to settle.
Risk off environments also favour the USD, but we are at year end and it is traditionally time to take profit off and start thinking about a Christmas break. Volumes will drop at the end of this week . When the pot also includes a Black swan the recipe gets even more difficult to get right, so it will be soon time to take that break and return refreshed in January with a heightened perspective and an enhanced toolbox!
I will be back next week with a final pre-Christmas briefing until then safe trading !
Judith Waker
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