Almost all market risk narratives converge on today’s Federal Open Market Committee decision. While futures markets now price a 25 basis point increase in the federal-fund rate as an almost certain event, the question of how long and how slow an ascent towards “normal” interest rates remains a matter of debate. Futures markets for the Standard & Poor’s 500 and other benchmark indexes advanced in early trading ahead of the announcement, suggesting that investors, for now, are confident that guidance for the pace of future hikes will be gentle.
U.K. Unemployment declines. Britain’s headline unemployment rate declined to 5.2 percent in October, according to data released today by the U.K. Office of National Statistics. The report also revealed that wages expanded by 2 percent. Both figures are calculated on a backwards-looking three-month average basis.
Jefferies returns to profit in the third quarter. On Tuesday Jefferies Group, a subsidiary of Leucadia National Corp., reported fiscal fourth-quarter earnings that reflected setbacks in some core business groups but saw the firm return to profitability. The New York investment bank reported adjusted net earnings of $189 million excluding the losses associated with the liquidation of the Bache commodity division. In an accompanying statement, company management declared that the firm was committing less risk and financing capital to its core trading businesses and indicated a refocus on corporate advisory banking.
European inflation remains weak. Consumer price inflation data reported by Eurostate Wednesday indicated that efforts by the European Central Bank to support demand have thus far achieved only modest gains. Headline prices rose by 0.2 percent in November, slightly better than forecast. Prices excluding volatile food and fuel costs remained flat on an annual basis for the month.
PBOC expects slower growth. A working paper published today by the People’s Bank of China included forecasts for annualized gross domestic product to slow to 6.8 percent in 2016 from a projected pace of 6.9 percent for this year. The bank also anticipates a further dip in producer prices next year as commodity demand remains slack.
Portfolio Perspective: A Cycle of Higher Risk has Begun
The slide deck we used for meetings last week in Boston was entitled “Inflection Time.” That is a reference to the transition we believe has been underway since August when the shock triggered a structural shift into a high-volatility regime for U.S. equities. We partnered with chief economist Michael Darda for some of those meetings and developments in the volatility cycle fit with his view that the U.S. economic expansion could end over the next 18 months.
That should not be a surprise. Volatility, economic and credit cycles are fairly well correlated with offsets. In the 1990s, the volatility cycle transition occurred in 1996/1997, four years before the economic expansion ended in March 2001. During the 2000s, that inflection happened in mid-2007, just before contraction began in December of that year, although that cycle was truncated unnaturally by the global financial crisis. No matter how much lead time the volatility cycle transition provides before recession and a bear market commence, a higher-risk environment has undoubtedly begun.
A refrain for us during much of 2015 has been that an initial Fed rate hike would likely trigger higher volatility no matter how well telegraphed it may be. Performance across equity sectors and asset classes into and through the beginning of tightening cycles in 1994, 1999 and 2004 was used to formulate that view. But recent credit-market stress suggests that if it is different this time, the outcome may be more virulent than those prior episodes.
Jim Strugger is a managing director and derivatives strategist for MKM Partners in Stamford, Connecticut.
