Another Fed Taper Tantrum?

Global markets tremors continue to escalate on Wednesday as bonds and rate sensitive sectors plunged after the Fed revealed it was open to June rate hikes. Marketwatch posed the critical question: Could this post-Fed bond selloff be a repeat of ‘taper tantrum’ which saw 10 year Treasury yields jump 140 basis points in 4 months?

Our cross asset FNA Correlations map in Fig 1 ranks Wednesday’s top surprises, with Corporate Bonds and EMBI plunging by over 2.7σ. Given key tail risks global investors are increasingly worried about, credit sensitive assets are especially vulnerable. Furthermore, emerging markets and commodities could quickly give up recent gains with continued USD strength.

Fig. 1. Cross asset FNA Correlations map ranking outliers on 18 May.

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US government bonds remain most reliable global safe haven asset

Although US government bonds fared poorly on Wednesday, their insurance value makes them valuable safe haven assets for global investors. US government bond to equity correlation remains reliably elevated at -.7 (strongest link to Financials indicated by red link). Fig. 2 ranks most impacted assets by a -3σ predictive Brexit + China shock, and highlights US 10 & 20+ year government bonds as positive outliers (with VIX)

Fig. 2. Predictive -3σ Brexit & China shock on cross asset FNA Correlations map

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Top global investor tail risks: Brexit & China

Be prepared for “a summer of shocks,” noted a recent Bank of America Merrill Lynch global investor survey. A ranking of tail risk shows Brexit in first place, followed closely by China devaluation/defaults.

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Indeed, as noted in Emerging Risks & Safe Havens we’ve seen escalating tremors in global markets since Bank of Japan’s 28 April global markets surprise.

Below is a short video where we use our cross asset FNA Correlations map to run predictive Brexit and China stress tests. The most resilient assets for each scenario: USD & US Government Bonds.

Video 1: Brexit & China Stress Test (4:22 min)

Thank you for tuning in, and feel free to suggest emerging risk themes to analyze.

 

 

 

Emerging Risk & Safe Havens

Yesterday’s cross asset FNA Correlations map revealed a classic flight to safety to US Government bonds. Global market tremors have escalated since Bank of Japan shocked markets last week by announcing no additional stimulus. The left panel on Fig. 1 ranks cross asset class 95% Confidence Level Value-at-Risk (VaR) outliers. Emerging Markets $EEM were yesterday’s top surprise with a -2.2sd plunge, followed by CAD and European equities. Chinese large caps $FXI declined as China’s PMI disappointment led to a third day of falling commodities.

Fig. 1. Cross Asset FNA Correlations 3 May outlier ranking 

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It’s worth focusing on Emerging Markets, which saw its first negative surprise since 3 Feb as volatility edged up from 100 day lows. As Fig. 2 illustrates, surprises in Emerging Markets tend cluster, so expect more volatility going forward.

Fig. 2. Emerging Markets surprises tend to cluster: get ready for turbulence

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Asset Allocation To Diversifying Safe Havens

As Emerging Market volatility jumps from 100 day lows, expect contagion to broader risk assets, especially oil, commodities, EMBI, junk bonds, financials and developed market equities. Asset allocation to safe havens will be critical to minimize portfolio volatility and drawdowns.

The short video below analyzes the most effective safe haven assets given the market’s correlation structure, focusing especially on JPY, US Government Bonds, TIPS and Gold.

Video 1: Most Reliable Flight To Safety Assets

Thank you for tuning in. Please feel free to suggest additional market themes and emerging risks to explore at alan@fna.fi.

Bank of Japan Surprises Global Markets

Illustrating once again how dependent global markets are on central bank liquidity, global markets tumbled into Risk Off mode after Bank of Japan (BOJ) Governor Kuroda offered no additional stimulus measures on April 28.  JPY jumped by an exceptional 3.2σ vs USD as Japanese equities plunged by 2.8σ, taking global equities into the red. DJIA experienced its first negative outlier since 20 Jan, showing the extent of global contagion. Fig 1. shows a ranking of cross asset outliers on 28 April, which resembles a classic flight to safety pattern (negative equity outliers & positive Gold outlier).

Fig. 1. Cross Asset FNA Correlations ranking of top outliers on 28 April

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Seatbelt time again?

On Friday, JPY rose to an 18 month high vs USD, Gold experienced another positive outlier to reach a multi-year high, and global equities bled. Global markets are getting nervous again. Although volatility declined on Monday (VIX below 15 again) as equities bounced, investors should not be surprised to see increased market volatility given significant systemic risk. A jump in global equity volatility would continue to favor JPY, as well as VIXUS 20Y+ Government Bonds and Gold. These Flight To Safety Assets have shown the most consistent negative correlation to equities (red links) throughout 2016.

Japan equity predictive stress test

Japanese equities look especially vulnerable, given lack of BOJ support. In Fig 2 below we simulate at -3σ MSCI Japan predictive stress test, ranking most affected assets on the left panel. JPY and VIX Futures are the most effective insurance, while Gold and US government bonds & TIPS also show significant appreciation.

Fig. 2. -3σ MSCI Japan predictive stress test on Cross Asset FNA Correlations

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We discuss the dynamics of last week’s BOJ surprise in Video 1 below.

Video 1: Systemic implications of JPY surge & flight to safety (4:25 min).