We've been blindsided by the U.K. -- just as our head was spinning from the yen.
No, I'm not writing lyrics to a new punk song. I'm talking about the foreign exchange markets and what happened last week and into the weekend.
Just days ago, all of our attention here in the U.S. was on the Fed. Chair Jerome Powell stuck to the messaging he gave during the Jackson Hole economic symposium -- that inflation was bad and that he would fight it. The Fed produced dot plots that seemed coordinated to support the central bank's views. Powell basically revealed that he is comfortable pushing the U.S. economy into recession if that's what it takes to pull in prices. That was already tough for markets to digest, but things got far worse globally.
Two things have happened since the Powell speech that are driving markets.
First, the Bank of Japan has intervened. Japan has started to move on currency markets. The story is that Japan is (or will) sell treasuries to fund its purchases of yen. Many investors, including me, believe that for an intervention to be "successful" it needs to be large and for an extended period of time. That is particularly true of Japan as it is an outlier, along with China. How so? It had been keeping easy money while most other major economies are tightening.
Second is the dumpster fire that is the U.K. I cannot mince words here: There is no other way to put it. The pound briefly touched 1.03 on Sunday, down from 1.22 just a few weeks ago. As bad as that is (and it is bad), the moves in their bond market are simply breathtaking. The 10-year gilt was at 3.13% on last Monday and traded to almost 4.2% overnight. That is more than a percentage point in a week.
People can be accused of overusing the word "unprecedented," but last Thursday and Friday the 10-year gilt moved 51 basis points -- or more than half a percentage point -- in two days. Going back 22 years to 2000, a period that covers the dot-com crash, the Great Financial Crisis, the European Debt Crisis, Brexit and Covid, the 10-year gilt only moved that much in two days, one other time. In March 2009, it dropped by 54 bps in two days.
These two moves are weighing heavily on U.S. Treasuries.
We have not seen material buying in any sovereign debt market. These moves are now made worse by the lack of liquidity and there is no way that quantitative tightening on a more or less global basis, is helping either.
These moves, in the U.S. and elsewhere, seem incredibly overdone, but we've broken key technical levels, liquidity is low, dealers and market participants are scared, and sovereign/central bank selling carries a weight of its own.
I think the yield sell-off is incredibly overdone. Commodities are getting hit hard again and we're getting plenty of warning signs in the data, too, that the economy, already fragile, may not be able to absorb this latest shellacking. Having said that, this market is so fraught with danger, nibbling and bleeding some cash into the markets is all you can do. Or trade options to control the downside.
Stocks, despite weakness, have held in reasonably well, given the carnage in foreign exchange and rates markets. Even the Volatility Index is subdued relative to implied volatility in the FX and bond markets, where those measures are back to Covid type levels.
One "bright" spot is that the American Association of Individual Investor's investor sentiment survey has the most bears it has had all year, and that is a decent contrarian signal. You see that in the CNN Fear & Greed Index, as well. Also, seeing put option volumes were incredibly high on Friday.
For now, the "best" case is a contrarian bounce, with some help from the bond market. We could see that, and as trite as it is, we do seem to be setting up for a "Turnaround Tuesday."
I cannot imagine the Fed will backpedal at all this week, but it should consider doing so as financial conditions across the globe are tightening at a frightening pace.
Option trading and staying nimble are important. For the moment, sentiment is so bearish, I'd err on the side of adding more risk, rather than reducing risk here.
Bitcoin has held in reasonably well, as foreign exchange market volatility is attracting some attention, but if foreign exchange markets normalize, this will likely have been a good time to exit any remaining bitcoin positions.