We are witnessing a very different financial market environment so far in 2018 compared to the steady and strong rise in global equity markets that we saw in 2017.Volatility is back! We have seen two sharp equity corrections so far this year:
- February – where US equity markets fell 10% in 9 days based on concerns over rising inflation (based on strong wage growth) which in turn, it was feared, would lead to higher interest rates. Indeed long-term interest rates / bond yields rose sharply in the first 5 weeks of the year with the US Treasury 10-year bond rising from 2.50 yield-to-maturity to 2.85%.
- Last week saw the second correction based on statements from Donald Trump on trade tariffs which prompted fears of a global trade war which has the potential to derail the synchronised global economic expansion.
China was particularly targeted: China is the largest trading partner of the US but with a US goods and services trade deficit of $385 Billion! Trump is looking to target $60 Billion of such exports including a 25% tariff on Chinese exports of steel.
Over the last few days, trade war fears have subsided somewhat as more diplomatic noises have emerged from the White house.
A further factor unsettling US equity markets last week was the Facebook data privacy problems which has wiped $60 Billion off the value of the network. This has dragged down the whole US technology sector.
Although global economic fundamentals remain strong based on a synchronised global economic expansion equity volatility looks set to be a key feature of 2018 financial markets.
Last week the key US ‘Fed Funds’ rate was, as expected, raised by 0.25% to a new range of 1.50% -1.75%. The market expects 3 quarter point rises this year and 3 rises next year. After the new Federal Reserve chairperson Jay Powell’s comments last week, the market expects the midpoint of the Fed’s target range will now be 3.4% by 2020.
US short-term rates, although rising, are still low by historical standards with the Fed Funds averaging a rate of 5.95% over the last 40 years but no-one believes such a level will be achieved in the current economic cycle given still subdued inflationary pressures.
Longer term rates e.g. 10-year bond yields have risen throughout 2018 but stabilised below the 3% level and, indeed, over the last fortnight, with stock markets under pressure, investors have bought bonds as a ‘safe haven’ asset forcing prices up and yields down in the short-term.
The US Dollar is at a 5-week low on concerns about a possible global trade war. The ‘greenback’ has had a poor last 15 months with the Dollar Index falling from 103.80 in January 2017 to 89.00 today (a circa 14% fall) due to:
- Disappointment over the pace of US interest rate rises
- A return to growth around the rest of the world with the implication of higher non-US rates in the coming months
OIL: Brent Oil is trading at $70 per barrel which is its highest for the last couple of years supported by conflict in the Middle East in the form of Iranian rebels launching missile attacks on Saudi Arabia. Such tension in the world’s largest crude producing region threatens supply and supports prices.
The key theme within financial markets right now is VOLATILITY!
S&P 500: 2672
FTSE 100: 7000
Bonds – 10 Year Government Yields
EUR/USD 1.2400 (1 euro buys 1.2400 dollars)
GBP/USD 1.4100 (1 pound buys 1.4100 dollars)
OIL: Brent: 70.00 (dollars per barrel)
GOLD: 1340 (dollars per ounce)
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