Whatever force had gripped the global capital markets since the start of the year has been broken. This simple characterization is rich. It is not clear if or what macroeconomic considerations were driving the markets.
The markets had taken the unsurprising Fed rate hike in mid-December in stride. The dramatic moves in the market did not begin until this year. Some have suggested China was at the crux of it, but the global impact seemed out of proportion.
Others suggested it was the collapse in oil prices, but that too seemed as much a cause as effect. Investors were well aware of the likelihood that Iranian oil would hit the markets, and some of the sell-off late last year was thought to reflect this anticipation.
Blanchard, formerly of the top economist at the IMF, opined that the sharp market moves were the result of “herding.” One sold because others were selling. That strikes us as under-appreciating risk and money management challenges. Nevertheless, it is instructive because it suggests the answer may not be found in the macro-narratives, but in the micro-market structure. By the time most returned from their New Year’s holiday, the markets were already swooning. The Nikkei, DAX and S&P 500 gapped lower in the very first session of the year.
With scar tissue from the summer swoon still fresh, many buyers remained on the sidelines. There were a couple of failed attempts to bottom, but the selling pressure did not exhaust itself until the middle of last week. Strong rallies in commodities, many emerging markets, and dollar-bloc currencies were seen.
Part of this was surely short-covering by momentum traders, and in the emerging market space, it is expensive to be short currencies, such as the Brazilian real or South African rand, given the interest rate differentials, with downside momentum. However, anecdotal reports suggest some value investors may have trickled in while some asset managers may have begun putting some of their high cash levels to work.
The week ahead features three major central banks, the Fed, the BOJ, and the RBNZ. We do not expect fresh action from any, but we concede that a rate cut by the central bank of New Zealand would be the least surprising. It is already in an easing mode.
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