I suggested in my last note that we are likely to see some weakening of the data as a result of the tightening in financial conditions the past quarter. This seems to be playing out. Given historical leads, the data weakness is likely to persist for several weeks.
One thing that I’ve found interesting is that it seems like credit and equity markets have been pricing in some nominal growth weakness ahead of the sovereign debt markets. It seems like the treasury market was fixed on the Fed lift off date, rather than the data. This all has Yellen & company’s decision to hold off looking pretty good. Barring very strong employment prints the next two months, (meaning print + revision > 240k per month) a March lift off is probably the base case now for the street, with risks skewed to later.
That leads to risk assets. What was missing from the late August price action was a drop in real rates. Usually a drop in equity prices is offset by a drop in real rates, which on net mitigates the impact on financial conditions. The price action today suggests that this is changing, at least for now. For example, shortly after payrolls, the drop in 5y USD swaps yields offset the rise in HY OAS, which means that the absolute yield for the HY market was lower.
In addition, other pro risk assets have been in the process of bottoming. Oil, CNH, BRL, China A-shares are some examples. Obviously that can change, but it’s an interesting divergence. EM equities have actually been outperforming DM equities in local terms for a while.
Calling a low in any asset is foolhardy, but I do think that we are near the low for risk. I’ve been saying for a while to watch credit, but I think that correlations are quite high now, which means that it has become a coincident, rather than leading indicator. There seems to have been several articles on credit markets in major financial outlets the past week, so I that furthers that hypothesis. (If everyone is looking at a ‘leading indicator,’ it will probably no longer lead) Risk assets have a tendency to bottom on bad news. That makes sense, because the end of a correction occurs when short term players finish selling their positions to longer term, value investors. That process tends to come to a completion on days when the news and price action is initially bad.
Analogs suggest we make a low between now and early next week. We’ll see if that holds.