The Global Trading Map Looks Really Confusing Right Now
(Bloomberg) -- You aren’t just imagining it: global markets are flashing conflicting signals as they struggle to price trade friction, an easing of global synchronized growth, and the excesses of an aging bull market.
It’s a case of choose-your-narrative: A vanilla risk-on/risk-off trading climate, late-cycle dynamics that signal a sustained drop, or plain old U.S. stock volatility. Regardless, the current trading map is confounding Wall Street strategists and investors.
“There’s no clear theme in the market and no easy way of playing that,” said Steven Englander, head of research and strategy at Rafiki Capital. “With trade issues, the biggest impact will be on corporate profits so it’s clearly bad for some equities. When it comes to FX, it’s more ambiguous.”
The challenge was underscored last week as markets were whiplashed by fears over protectionism and Middle Eastern conflicts before a relief rally spurred by President Donald Trump’s conciliatory remarks on trade. Stocks notched a weekly gain, while the Treasury curve is the flattest in more than a decade -- an indication of subdued long-term growth prospects and, to some, looming recession risks.
“It’s a puzzling time for markets, with contradictions in returns, vol. and correlations,” quantitative strategists at HSBC Holdings Plc including Daniel Fenn wrote in a note.
Here we sketch the vexed trading climate in charts.
Rising anxiety over protectionism has created surging stock correlations. But the relative calm in fixed income and FX has perplexed analysts over the past few weeks.
U.S. shares swooned just before Friday’s close as traders headed into a weekend with abundant political risks. That helped push three-month volatility to near its highest level since November 2015, data compiled by Bloomberg show. Even as equity futures pointed towards a positive open early Monday, the Cboe Volatility Index climbed higher.
Still, it seems that only equities are reacting to political uncertainty, as the asset class that directly influences the terms of trade between nations -- currencies -- isn’t sounding any alarms.
Meanwhile, two-year interest-rate correlations have fallen to the lowest since at least 2002, data compiled by HSBC show. For the past six months, front-end swaps among a basket of large developed and emerging countries have charted increasingly independent paths, driven by diverging monetary policy, according to the bank.
Not all stock volatility is created equal. For the first time in nearly two years, price swings among developed-market stocks are greater than emerging-market counterparts. Typically, the latter group is seen as more risky with higher volatility to boot.
That raises the question of how assets will shift back to their historical norms -- will calm return to developed markets, or will a storm gather in developing nations?
Differences in volatility aren’t just cropping up between regions. Cyclical stock sectors are also behaving in unexpected ways.
Take energy and technology. Commodity shares tend to be more reactive to fundamental shifts given the signals they contain about the economic outlook. But even as oil-price volatility jumped on escalating tensions in the Middle East, it wasn’t enough to overtake tech share swings.
One-month historical volatility for tech stocks has climbed to the highest level compared to that of energy shares in a decade, data compiled by Bloomberg show.
For those attempting to navigate the path of rate normalization and economic expansion, trading over the past month has only muddied the narrative. Judging by declines in some growth-sensitive assets across equities and commodities, disappointing data have shaken investor confidence in the synchronized global story.
Yet a clear bid emerged for securities that protect against inflation. In March, the iShares TIPS ETF posted its best month since August 2017 as its realized volatility barely budged, notes HSBC.
And then there’s the vexing question of the trade-weighted dollar, which has failed to catch a lucky break despite the recent flight to safety and some disappointing European economic data. What’s more, as the copper-gold ratio has weakened -- indicating risk-adverse trading -- so too has the greenback. The sudden change in behavior reflects the multiple conflicting forces driving the currency, according to analysts.
“Right now, it doesn’t make sense that the dollar has generally been weak, despite the Fed raising rates and the recent improvement in U.S. economic data relative to the rest of the world,” Evercore ISI’s Dennis DeBusschere wrote in a note.
Amid the stock volatility, perhaps the smart money in interest-rate markets and currencies is banking on monetary-policy continuity and sustained economic output. But the case for bulls isn’t straightforward.
“The market is sitting and asking: What is the upside story to the business cycle?” said Rafiki’s Englander. “It’s harder to tell the positive one -- productivity is going to pick up, inflation isn’t going to be that high and the business cycle isn’t going to end anytime soon.”
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