We’re witnessing a shift from Greek concerns to some serious attention being paid to China’s imploding equity markets, and commodity markets for that matter. As we highlighted earlier this week, each of these big macro events, in of themselves, may not necessarily be systemic, the coincidence of them all at once however, sharpens correlations. This theme runs through many of the pieces we highlight today.
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1. Market correlations: One is the loneliest number
Nicholas Colas and Jessica Rabe from Convergex write that markets, since the Global Financial Crisis, haven’t really broken free of the macro ‘’Risk on, risk off’’ gravitational pull of systematic worries. They note that this month the average correlation is 82%, while the long run average since the end of the GFC is 84%. That makes the ‘’safe’’ parking of capital hard to find in a market where volatility is on the rise (the CBOE VIX Index is up from 12.1 to 19.7 in just 10 trading days). Convergex have produced a great correlation table in this report that tells us where the safest places might me.
2. Assessing risky assets: High-yield
CreditSights reckon that plot has thickened in terms of risky asset pricing as Greece feeds the scenario spinning machine and Fed hikes potentially kick into low gear by December. In this report, Glenn Reynolds and Nathan Wenger make a risk assessment on high-yield issuance not just as a result of Greece, but also from China (influence on BRIC issuers as a whole). They also take a look at the HY E&P issuer base, as they expect the supply and demand side of oil to be front and centre under various scenarios for Iran and China over the second-half on 2015. The report discusses the link between Greek risks and the high-yield curve, even though the event itself poses little threat to the fundamentals of most US HY issuers. It is very much a combination of events, including China and Iran and their correlation effects. The report also reviews recent spread performance and updates readers on their total return expectations for the rest of the year, and how that stacks up relative to other asset classes.
3. FOMC minutes and caution to the September wind
The release of yesterday’s FOMC minutes saw Greece mentioned 3 times and China equities twice, but with events having worsened since the meeting, the odds for delaying rate hikes seems to be increasing. In this report, RBC say that even though the fundamental backdrop in the US has improved to the point where "several" Fed officials were saying labor market slack has been eliminated, events in Greece, if they do not improve from here, it could easily force the Fed to take a pass in September. And lets not forget the Fed’s mandate to maintain financial market stability. Raising rates prematurely might risk exacerbating market volatility, the report says. This week we’ve featured a few pieces that have focussed on pricing the short end of the curve given these shifting rate hike expectations, so we wanted to highlight RBC’s observations about futures positioning in the 10-year part of the curve, as at June 30. They make two key points. Firstly, that spec accounts now hold small long positions for the first time since last September, and secondly, this shift in positioning seems to have been driven by an increase in longs, rather than a reduction in shorts. The rally back below 2.20% (down 7 basis points yesterday), from a more fundamental perspective may look less attractive to those who were buying the extended dip over the last few weeks – before Greece became the markets’ primary focus, the report concludes.
4. Warehousing China’s equity risk
One of the features of the work from Neil Azous and his team at Rareview Macro is the unique perspective they bring to market events. Their piece on China’s imploding equity market yesterday caught our eye. They asked the question: How do you mitigate the risk or operationally manage a position when such a large percentage of stocks remain closed for an extended period of time? The answer is that a vehicle will have to be created in order to hold them indefinitely and dispose of them over time. They take us back to 1998 and the Asian Financial Crisis, when the Hong Kong Monetary Authority used its Exchange Fund to acquire HK$120 billion (US$15 billion) worth of blue-chip shares in a two-week market intervention to deter speculators, and it worked. Although the move was widely criticised at the time, most of the stocks acquired during that operation were successively disposed of with the creation of a tracker fund, the TraHK, in the next few years. It makes one wonder whether Chinese authorities have given the idea some thought
5. Oil: Smacking the back end
Medley oil analysts, Yasser Elguindi and Daniel Sternoff, have written this excellent piece that tries to make sense of the sell-off further out along the oil curve. One can understand how current macro volatility is contributing to the sell off in front month crude, but the price action further out the curve (2018) is much harder to fathom, they write. For instance December 2018 Brent, which never dropped below $70 even during the worst of the crude collapse in Q1, has plunged to $67/bbl. So the Medley analysts have done a pretty extensive dissection of market fundamentals in the context of a potential Grexit and the China equity bubble, and how this could impact demand. They then delve into Non-Opec supply, which is key in understanding the demand/supply dynamics further along the oil curve, before concluding whether all these factors justify the price moves we have seen this week. You will have to read the full piece to get that conclusion.