Dollar reigns supreme over FX space as traders rush to safety
Sterling stabilizes near record lows, gold threatens another break
Stock markets slide, valuations still too expensive for this regime
Bonds implode, dollar shines
A selloff in global bond markets has snowballed into a meltdown, sending shockwaves across every asset class. Central banks are still on a crusade to vanquish inflation and governments are finding out the hard way that markets won’t tolerate massive unfunded deficits when interest rates are so high - a combination that has generated tremendous volatility.
Liquidity dried up completely this month as the Fed ramped up its bond sales through quantitative tightening, which has translated into a meteoric rise in borrowing costs. Yields on 10-year US Treasuries just breached the psychological 4% mark for the first time in a decade.
Soaring interest rates are essentially gravity for financial markets. When rates move higher, riskier assets come under selling pressure as investors dial back their risk-taking behavior in favor of more conservative plays. It makes no sense to gamble on some risky trade if an investor can suddenly earn a decent risk-free return.
With every asset getting crushed under the boot of rising rates, there has been nowhere for investors to hide this year except in the US dollar. The greenback has obliterated everything in its path, riding the perfect wave of widening interest rate differentials and safe-haven flows as the rest of the world grapples with even uglier crises.
Sterling stabilizes, euro at new lows
In the broader FX market, the spotlight remains fixed on the United Kingdom. The pound hit new record lows against the dollar this week, becoming the shining example of what happens when an economy’s twin deficits widen uncontrollably through a trade shock and unfunded tax cuts, while rising interest rates exacerbate the debt burden.
Market participants are effectively saying irresponsible tax reductions will add fuel to inflationary pressures, forcing the Bank of England to raise rates with reckless abandon, which in turn will amplify the severity of the recession that the central bank already expects. Therefore, even an emergency BoE rate increase might not be enough to turn the tide in sterling.
Euro/dollar fell to fresh two-decade lows as Europe’s energy crisis entered a new chapter following attacks on the main pipelines carrying gas from Russia, which are believed to have been acts of sabotage. Meanwhile, the Australian and New Zealand dollars continue to tank amid concerns that China’s property crisis is intensifying. The latest reports suggest another developer - CIFI holdings - is about to default.
Gold and stocks slide
In the precious metals complex, gold prices briefly sliced below the recent floor of $1,620 earlier today. This entire quarter has been a horror show for bullion, which has lost 10% of its value since July, crumbling under the weight of an appreciating US dollar and real yields going through the roof.
On Wall Street, the S&P 500 traded at its lowest level in nearly two years yesterday, although it managed to close above those lows. The breakneck increase in interest rates continues to compress valuation multiples, and there might be even more pain in store for equities because valuations are still not cheap enough.
The S&P 500 is currently trading at 16 times forward earnings, while most of the selloffs over the last decade concluded with the market at around 14 times earnings. In fact, this bear market might bottom with an even lower multiple since interest rates are so much higher now. That’s before considering any downward revisions in earnings estimates, which seem increasingly likely as the data pulse slows, particularly in Europe and China.
As for today, traders will tune in for some remarks from Fed chief Powell at 14:15 GMT.