The Week Before the Fed: Anxiety Dominates the Markets. Again

For the last several weeks, we have been opening our weekly reviews of the markets with one of the two announcement: they had a brilliant week beating everyone’s expectations, or their performance was disastrous. Last time we wrote about the stock markets, the situation could not be better and US equities were shattering the records of the previous several months. Well, this time around the story is quite the opposite.

As of Friday, December 11, US equities were in for their worst week since August, with S&P 500 dropping 3.8% at the week end, falling below its mid-October level. Both Dow Jones and Nasdaq did their worst in a month. Volatility was also going off all scales as the CBOE Vix index, a volatility benchmark for US equity, was up 64%. European equities were not doing much better: all major stock exchanges fell about 0.5-1% on Friday.

The reason for the rout is not hidden too deep. After a notorious OPEC’s meeting on Friday, December 4, oil prices took yet another, even steeper slide, trimming 4.6% off its price since the meeting. Brent was trading at $37.36 per barrel, its lowest since December, 2008. While this already looks pretty extreme, more and more analysts are convinced that commodities still have a long way down to go.

Plummeting oil prices come as an unpleasant surprise just days before the crucial Fed’s meeting on December 15. Mounting deflationary pressures from the side of cheap commodities rekindled the markets’ concern about the Fed’s decisions to raise rates. Equities took the hit, in particular miners and energy companies. US Treasuries’ yields went down (!), indicating that traders are now less confident that the Fed will actually pull the trigger.

However, with more volatility on the market equities were not the only ones that took the hit. With more volatility on the market and higher rates [potentially] coming very soon, fixed income markets were in a turmoil. Concerned about plunging oil prices and debt-laden balance sheets, investors started to withdraw liquidity from high-yielding bonds, sending their prices down and yields up. Some $3.8B were channeled out of high-yielding bonds over the past week, the largest outflow in 3 months. The selloff was profound enough to force US asset manager Third Avenue to close the largest mutual fund in the US, sending signs of warning and waves of anxiety across the market.

Moving into the next week, all eyes of the financial world are now on the Fed. While the markets are showing signs of concern that the hike may be postponed even further, most economics agree that keeping status quo by the Fed will have a much more distorting and destructive impact on the markets than delivering what the markets are looking for. With all that being said, there is just one day to wait and find out.