Spread betting – equity markets and bonds suffer steep sell-off after a very benign summer.

The summer for markets has come to an abrupt end after a steep sell-off in global equities and bonds signalled a return to more volatile trading.

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Since Britain’s rejection of EU membership in June – when stocks, bonds and currencies seesawed wildly on uncertainty – global financial markets have been remarkably calm.

A sense of complacency pervaded markets. Bulls were off the leash and no one was stopping them. Measures of volatility were at record lows during one of the calmest Augusts in memory.

The CBOE Vix index, a proxy for market volatility, sagged at just over 11, after hitting 26 in the immediate aftermath of the Brexit vote.

The quiet came to a shuddering halt on Friday, September 9th, as US stock markets plunged by more than 2%. The Dow Jones gave up 400 points, while all ten sectors of the S&P 500 slid.

Having seen the S&P 500 notch up 50 sessions where it did not close down by more than 1%, the index tripped up badly.

European and Asian markets took their cue from the US and were down heavily on Monday, sinking to multi-week lows. The CBOE volatility index spiked to 20. Bond yields rose firmly as prices fell.

Fed Up

 

The big question is what’s driving the price action and, crucially, are we in for a serious correction.

Bonds and stocks have been hugely crowded trades so there is a sense that these over-inflated balloons just need to let some air out. But could we be in for a broader, deeper selloff?

Looking at bonds, there seems to be a growing sense that central banks will not be there to hold investors’ hands for much longer. Negative yields look a lot less appealing without unending central bank support and increasingly investors are positioning for a post-stimulus world.

Speculation that central banks don’t have the appetite or the firepower to permanently support markets was at the heart of Friday’s selloff.

In terms of stocks, equity valuations only really look appropriate in a world of record low bond yields. If these are going up then equities must fall. Deutsche Bank suggests the S&P 500 could drop by 8-10%, citing rising bond yields, weak capital expenditure, faltering earnings growth and persistent uncertainty stemming from the US elections and the timing of the Federal Reserve’s expected interest rate hike.

The Fed has raised the prospect of hiking rates when it meets in September although conflicting messages from various officials have, as usual, left markets guessing. The kind of tantrum we’re seeing now suggests the Fed will refrain, especially with the US presidential election just around the corner.

CME’s FedWatch tool suggests a 24% chance Fed officials will vote to tighten when they meet on September 21st. Odds for higher rates by December are roughly 50/50. Whether it chooses to raise rates this month or December, investors realise accommodation has to end sooner or later.

Clinton’s Health

 

The health of Democrat presidential candidate Hillary Clinton is another factor that could be weighing on sentiment. Markets have pretty much priced in the 68-year-old becoming the next president, so anything that upsets this belief is sure to ripple through markets.

So news that Mrs Clinton has pneumonia has only fuelled doubts that she will be able to see off Donald Trump in November. Polls put the pair neck and neck and a tight race is guaranteed, which should fuel some further volatility now that we’re out of the summer lull.