Well, last week started with a bang and ended with a whimper. Movements on Sunday night in Japanese financial markets in particular wreaked havoc.
Overdone though the moves might have been, and distorted though the markets became, the important message, yet again, is that the only thing that is unthinkable in financial markets is that anything is unthinkable.
The idea that the Fed would jump on a sharp fall in Japanese and a lesser fall in US equities (and yields) was clearly misguided. If it had morphed into a 1987 "crash" or we heard of financial institution failures, or the credit markets froze up etc. then yes, an emergency move would have been on the cards.
But none of that happened. And, by the way, if that does happen at some stage it will not be a 25 bp's move. It will be anything from 50 to 100 bp's in that event.
But that is for another day , whether in this cycle or further down the line.
Despite all that last week was clearly a warning that markets are fragile, and that complacency is dangerous.
For moves like that to take place clearly warns that "aftershocks" are also very possible if not probable. We still do not know if any financial institutions of note may have "skeletons" than can be exposed. What we do now is that we are in markets where liquidity can disappear in an instant and that dramatically changes the risk dynamics, volatility and VAR.
Market participants are both going to be more cautious on risk taking/ careful on risk avoidance and liquidity is going to be shocking at times. Every piece of relevant news and data is in danger right now of creating outsized moves in markets.
All that being said I still think the triple analogs we have focused on are the best roadmap here.
Analog 1: Japan markets are trading just like 1990 after the Nikkei almost reached 40k, USDJPY went over 160, The BOJ was tightening (175 bp's) and the Fed was easing (125 bp's) that year.
The Nikkei ended up halving in value over 10 months and USDJPY fell to 123.75 in a similar period.
The BOJ will not tighten as they did in 1990 (175 bp's)- maybe they will not even tighten again.
But yet again I think it is misguided to look at these moves and believe that they were caused by another potential 25 bp's of tightening coming up.
They were caused by the fact that the move higher in both was a "bubble" and I suspect that the corrective phase will still have a way to run.
I don't think it would be unreasonable for the 2020-2024 USDJPY rally to give back as much as 1/2 the gains (132.50 ish) and the Nikkei to do the same (Sub 30k)
This whole Japanese debacle also clearly distorted moves in other markets- not necessarily in terms of direction but certainly in terms of magnitude and speed of moves. That got us to places we expected to go (eg US 2-year yield down to 3.55-3.65%) but a lot quicker than expected.
The last week has, I feel, rebalanced that and I still expect those moves to likely happen again but at a more controlled pace.
Analog 2: The US equity market fell sharply from 17th of July 2000 into late July/early August before then recovering into the end of the month.
We fell a little more than in 2000 from the 17th of July 2024, but the timeframe was very similar, and we now look like we are starting that bounce led by the big rally on Thursday last week.
Back in 2000 we ended up recovering most of the losses before turning lower again after peaking on 01 September in what was the "real move lower".
That path will be a work in progress because clearly in 2000 that came when the Fed refused to cut rates at the August 2022 meeting or anytime in 2000 thereafter. That was despite a clearly deteriorating equity market, a deteriorating employment picture and a slowing economy.
At the time the Fed Funds rate was at 6.5% and real yields stood around 400 bp's. They finally cut, too late, in January 2001 and the first five cuts into May 2001 were 50 bp's each.
I do not think they wait for January this time and actually expect them to cut 50 bp's in Sept and absent some of the tail risk events mentioned above cut another 25 bp's in November and December
There is a danger that this path, if seen, could help Equities show greater resilience - maybe even into October
Analog 3: The amazing similarity to the way the bond market is trading (In particular the 2-year yield) into and out of the July employment data released on 02 August and that seen into and out of the same number on 03 August 2007.
Then. as now, we missed on the July NFP number and saw revisions lower but then saw another weak employment series for August (a scenario we also saw without any Fed reaction in 2000). That paved the way for a 50 bp's cut on 18th Sept 2007 (same date as next month's meeting FWIW)and 2 further 25 bp's cuts by year end.
Despite those aggressive cuts and the aggressive cuts after the Fed started to reduce rates in Jan 2001 they were, as they are now, way behind the curve and ended up having to do a lot more as a consequence.
The next cut in January 2008 was 75 bps and in a 12-month period (Sept 2007-Sept 2008) they cut rates 325 bp's. In the 12 months from Jan 2001, they cut rates 475 bp's but more relevant is that prior to 9/11 they had already cut 300 bp's.
We did see a move back up in rates for 3-4 trading days into 08-09 August 2007 before they started to move lower again- just as we have just seen.
The Equity market started to bounce on 16 August 2007 and continued higher all the way into October 11th before bad news overcame the positive reaction to the Fed cuts.
Bottom line these are analogs of not just price action but also financial and economic history and for me still the best ones to focus on in determining where we may head over then rest of 2024 and beyond.
Right now, my bias is that:
The Japan path continues of lower USDJPY and lower Nikkei but possibly not as aggressive as in 1990
US equities will come under pressure again as it becomes clear that the Fed is behind the curve, employment and the economy slow further and inflation moderates (as a consequence). It is possible, however that equities can hold up into Sept and maybe even October before that happens
US yields will go back to the lows posted so far (and may have already peaked on this bounce) and likely lower and we will eventually break that pivotal level on 2's 5's (my financial Bible) at minus 19 to minus 21 basis points enroute to a bull steepening that will take us well into positive territory.
All of this is still, of course, a work in progress but as stated above I will continue to look at these as the best roadmaps until proven otherwise.
Stay safe
Fitz.