October Effect in January
There’s no “January effect” in sight, as financial markets have begun 2015 as if it were mid-October last year. “Risk-off” gripped markets as oil continued to plunge while deflation in the eurozone and the threat of Greece’s exit from the eurozone came to the fore once again.
Trading in the new year began in earnest on Jan. 5, and the selloff in stocks and oil picked up as did the rally in safe-haven bonds. Some noteworthy levels were reached: U.S. 10-year bond yield moved below 2 percent; the euro hit a 9-year low; the U.S. dollar index hit a 9-year high; German 5-year bonds traded at a negative yield for the first time; and the Greek 10-year bond yield surged over 10 percent.
German inflation slowed to 0.1 percent for December (the lowest rate since October 2009), and in the eurozone, consumer prices actually fell for the first time in more than five years—truly troubling economic data for the European Central Bank.
There are a couple of risk events on the horizon. At the ECB meeting on Jan. 22, expectations are increasingly building for sovereign bond purchases. ECB president Mario Draghi won’t have the benefit of knowing the result of the Greek election, which takes place Jan. 25. Markets have all but priced in ECB purchases of sovereign bonds for some time now.
The threat of a Greek exit (or “Grexit”) from the eurozone is the kind of tail event that can send fear rippling through the market, encouraging a flight to perceived safe assets such as U.S. treasury bonds and German bunds. The consequences for Greece exiting will be hardest on the Greek people, who would be left with a rapidly depreciating Greek currency.
Default on Greek debt will have much less impact on its creditors. It remains to be seen if the Germans will agree to write off part of the bailout that has been given to Greece and end the austerity measures.
But is oil’s price plunge to blame for the fear in markets that was especially evident on Jan. 5 and 6? It shouldn’t be. The Fed feels the fall in oil prices is positive for the U.S. consumer, though inflation expectations continue to move in the wrong direction.
But falling oil prices will only exacerbate the threat of deflation in Europe. For Canada, it will impact both exports and additional investment by oil companies; this is counterbalanced by consumer spending—net, net, a much murkier picture for the country overall.
Bigger concerns for markets hinge on central bank actions like what the ECB will do on Jan. 22 and what the results of the Greek election will be on Jan. 25. Will the ECB finally do “whatever it takes?” ECB sovereign quantitative easing will attempt to fight deflation head on, but does the bank have all the details figured out yet?
Global growth remains weak aside from the U.S., and the speed of the decline in oil prices is more alarming than the level at which it is actually trading currently. Some stability in oil prices will go some way toward settling down equity markets, though there are other red flags on the horizon.
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 and as a mortgage bond trader in the U.S. Follow him on Twitter @RV_ETBiz.
|US 2yr yield||0.67%||0.61%||-0.06%|
|US 5yr yield||1.65%||1.48%||-0.18%|
|US 10yr yield||2.17%||1.96%||-0.22%|
|Cdn 2yr yield||1.02%||0.97%||-0.04%|
|Cdn 5yr yield||1.34%||1.23%||-0.12%|
|Cdn 10yr yield||1.79%||1.65%||-0.14%|