‘Bad News Is Good News’

Financial markets commentary Oct. 2-Oct. 8
October 8, 2014 Updated: October 8, 2014

Financial markets ended a volatile period on a positive note after the U.S. Federal Reserve minutes released on Wednesday implied that rates would stay low given concerns of slowing global growth. 

The past five trading sessions had their share of market-moving events, but the general trend of a strengthening U.S. economy with the backdrop of weakness in Europe and China remains the same.

Most importantly, the U.S. jobs report from Oct. 3 was robust. The unemployment rate fell below 6.0 percent for the first time since July 2008, to 5.9 percent. 

A new Fed gauge that relies on 19 separate jobs-related measures also showed that the labor market recovery quickened in September; however, the labor force participation rate (62.7 percent) reached a new low since the late 1970s.

Market tone went south with the International Monetary Fund’s (IMF) gloomy global economic outlook released Tuesday. It discussed the eurozone’s three largest economies—Germany, France, and Italy—facing slower growth prospects than previously estimated. German industrial production fell 4 percent, adding salt to the wound.

The IMF’s global outlook improved for Canada (2.3 percent this year and 2.4 percent in 2015) and the U.S. (2.2 percent this year and 3.1 percent in 2015) from what it was six months ago.

The interesting dynamic, though, is the euro strengthening after it had hit its low for the period after the strong U.S. jobs report. The U.S. dollar saw profit taking after a brief period of strength. It had hit a four-year high last week and was discussed by some Federal Open Market Committee (FOMC) members as slowing the “gradual increase in inflation toward the FOMC’s 2 percent goal.”

Adding to Europe’s woes, the European Central Bank (ECB) adopted a wait-and-see mode on Oct. 2. It did not announce a target size for the asset-backed and covered bonds they will soon begin buying. The ECB’s balance sheet has been gradually sinking, while the Fed’s has continued to rise over the past three years, which is one sign the ECB has not acted decisively enough to stimulate its economy. 

Oil on a Slippery Slope

Oversupply (U.S. shale, Libya) and weak global growth prospects have sent West Texas Intermediate and Brent crude down 11.3 percent and 17.3 percent year to date respectively. The effect on Brent is more magnified due to less demand from Europe. 

It remains to be seen what OPEC decides to do with the oil supply it controls. For now, the path of least resistance seems to be lower for oil.

Still, the boost given by the Fed minutes should be temporary as the Fed’s asset purchases end this month, while the bigger picture is that rates are expected to rise in the middle of next year. 

Some concerns about U.S. corporate earnings have also emerged given the falling oil prices and strong U.S. dollar’s impact on export-driven companies. 

But for the time being, the bad news is taken to mean central banks will keep rates low, which the stock market thinks is “good news.”

Rahul Vaidyanath is a Chartered Financial Analyst (CFA) with 15 years of capital markets experience. He has worked in the Financial Markets Department at the Bank of Canada as Principal Trader, Foreign Reserves Management. He has also worked as a mortgage bond trader in the U.S. Follow him on Twitter @RV_ETBiz.


Changes in Key Financial Market Variables

  01-Oct 08-Oct Change
S&P 500 1,946.16 1,968.89 1.2%
Dow 16,804.71 16,994.22 1.1%
Nasdaq 4,422.09 4,468.59 1.1%
US 2yr yield 0.53% 0.45% -0.08%
US 5yr yield 1.69% 1.55% -0.14%
US 10yr yield 2.41% 2.32% -0.09%
Oil 90.86 87.65 -3.5%
Gold 1,215.30 1,216.70 0.1%
Euro 1.2619 1.2732 0.9%
Pound Sterling 1.6184 1.6167 -0.1%
Yen 108.865 108.125 0.7%
TSX 14,805.44 14,666.47 -0.9%
Canadian $ 0.8954 0.8998 0.5%
Cdn 2yr yield 1.11% 1.05% -0.06%
Cdn 5yr yield 1.58% 1.49% -0.09%
Cdn 10yr yield 2.10% 2.01% -0.09%
VIX 16.71 15.11 -9.6%
Follow Rahul on Twitter: @RV_ETBiz