Geopolitics shakes the market out of its slumber

The escalation in tensions between America and North Korea may have caused its first modest blip on the world's stage, but so far not much more than that. The US dollar has rallied this week from the lows at the start of the week, and yields on ten-year Treasuries have fallen slightly in response to the increase in tensions. However, at 2.23% they remain, like almost every asset class close to their recent trading ranges. The FTSE 100 has traded for the past three months roughly 1% either side of 7450. As the Vix index jumped sharply on Thursday the Financial Times highlighted a Blackrock report, until Thursday, we had 13 consecutive days when the S&P 500 has moved more than 0.3%. In their view looking back over historical periods of low volatility can “last a long time”.

The consensus appears to be building amongst analysts that the much anticipated and yet elusive correction could come in the third quarter. The consensus view also appears to be based on consensual assumptions. Business cycles rolling over as well as company earnings. Alongside increased political tensions combined with rising rate expectations. Intuitively should the first three of those scenarios play out it would make you conclude the fourth of those becomes less likely?

What would be better for US equity prices falling or rising bond yields? Possibly neither, falling yields would suggest the investment community would be concerned the global economy is weakening, that would suggest deflationary pressures returning. On the other hand, rising rates could lead to lower equity valuations. However rising rates and a steepening of the yield curve should also suggest further economic optimism. Which In theory should be good for equity prices.

This expectation for the bond market bubble to burst has been around for a while. This expectation of a sharp rise in yields in bond yields at some point will be the catalyst for a selloff in equity prices.  Mark Carney expressed the view recently the bond market has got it all wrong. Inflation is returning, growth is on an upward trend and central banks are starting to normalise interest rates. Later, Friday we get the latest US inflation data in the form of the Consumer Price Index. It will be interesting to see if the weakness in the dollar this year has fed through into prices. Thursday’s Producer Price Index reported a fall in prices month on month of 0.1%, so that could suggest possibly not. The funny thing about markets, unlike analysts they tend to get it more right than wrong.

Posted on August 10, 2017 .