The last week of August is usually known for thin market conditions and lackluster trading as the movers and shakers of the world enjoy the final days of vacation before coming back after the Labor Day holiday refreshed and energized.
However, there are those who vacation earlier in the summer, who prefer to use the last week of August as a time to look for price aberrations in order to better position themselves in stocks, bonds, FX and commodities, for the final months of the year.
In August 2013, global investors bought the dip in the S&P 500 from the Friday’s August 23 close at 1663.50 to 1,628.05 August 30. The S&P 500 hit a high of 1729.86 September 19, after it became clear that the Federal Reserve was not going to be tapering its asset purchases, as had been widely expected.
The euro closed at $1.3383 Friday August 23, 2013 and closed at $1.3222 a week later, driven by the notion that Fed tightening might be coming sooner than expected and drive the dollar higher.
Again, come mid-September 2013 when the Fed didn’t taper, short euro positions were reversed and the euro tested a high near $1.3569 on September 19.
The last week of August 2011, the market deemed Fed Chairman Ben Bernanke’s Jackson Hole speech as being a ‘Goldilock’s’ speech, one that suggested scope for more QE if needed, but no time frame. Operation Twist was announced September 21, 2011.
Ahead of Bernanke’s Jackson Hole speech in 2011, U.S. 10-year Treasury yields were trading just under 2.30%. A week later, U.S. yields were around 2.18% and were below 2.0% after Labor Day that year.
On August 22, 2008, spot gold closed around $823.03/oz, and in the subsequent week hit a high of $844.30 before closing Friday August 29, 2009 at $831.15. By September 11, 2008, the precious metal had fallen to $736.65, weighed by deleveraging. Lehman’s bankruptcy would come a few days later.
Flash forward to the dog days of August 2014 and global investors, looking at instruments currently, can easily find what can be deemed price overshoots and undershoots.
Earlier Monday, the S&P 500 posted a new life-time high of 2001.95, and the index may see a record high close over the psychological 2,000 mark today also.
Many in the market fret that with the Fed tapering expected to be concluded in October, and U.S. Treasury yields set to start pricing in Fed tightening after that, U.S. stocks should not be at such lofty levels.
“After a mini pullback through late July and early August, the bears have all but taken a bucket of ice water over the head, as stocks have shaken off a number of disruptive events – turmoil in the Middle East and Ukraine, an Ebola outbreak, U.S. housing market soft patch and even an imposter Canadian employment report,” said Robert Kavcic, economist at BMO Capital Markets.
“One major factor overriding all of this is that we’re still smack in the sweet spot of the cycle for equities, the period of transition from central bank easing to early tightening, with a backdrop of accelerating growth,” he said.
BMO Capital Markets maintained their call for Fed rate hikes to start in Q2 2015.
If Fed rate hikes will start as many expect, around the middle of next year, many players wonder why U.S. Treasury yields are so low.
Traders pointed out that U.S. yields have been dragged lower by Bund yields, which earlier Monday hit a record low around 0.925% in response to a weak IFO number and on expectations of further European Central Bank easing.
U.S. yields also have been weighed to a degree by safe-haven U.S. Treasury demand in light of geopolitical tensions.
Even so, U.S. 10-year yields stand at 2.396% Monday afternoon, a far cry from the 2.68% high yield seen July 3, in the wake of a particularly upbeat U.S. non-farm payroll number, and well outside the 2.60% to 2.80% range that contained yields for many months at the start of the year, when data sets were not as promising as recent ones.
U.S. non-farm payroll data for August, at +209,0000, was the sixth consecutive reading over 200,000. And while the unemployment rate rose by 0.1^ to 6.2%, this was due to a rise in the participation rate. Most other U.S. data has been fairly upbeat in recent weeks and yet U.S. yields can’t seem to push higher, traders said.
CFTC data released Friday, for positions as per Tuesday August 19, showed that net Treasury longs stood at $14.9 billion, compared to $10.2 billion in the prior week, said Gennadiy Goldberg, analyst at TD Securities.
“This leaves net Treasury market longs at their highest levels since April 2013, suggesting that investors likely did not expect much hawkish rhetoric from the minutes or Yellen’s Friday remarks,” he said.
In terms of net Eurodollar positions, shorts were trimmed for the second straight week, though investors remain broadly positioned short as the net position continues to hover around record lows, he said.
“Open interest has also continued to slip in the past few weeks, but remains close to record highs as investors largely expect the Fed to hike rates sooner rather than later,” Goldberg said.
If U.S. yields have been reluctant to press higher, this has not been the case with the dollar, with FX market players decidedly dollar bullish.
Yield differentials have been moving in the dollar’s favor versus the euro, with the pair posting a low of $1.3184 earlier Monday, the lowest level seen since September 9, 2013.
Traders would not be surprised to see the euro test the September 6, 2013 low near $1.3105 or perhaps even the psychological $1.3000 mark in the months ahead.
But there is less conviction about what sterling should be doing in that the Bank of England is still expected to start normalizing monetary policy before the Fed does.
After a mid August dip to 2.32% and subsequent rally over 2.40%, UK 10-year yields have stabilized around 2.40%, even as U.S. yields have shown more willingness to go below that level.
Cable, currently at $1.6582, posted a low of $1.6501 earlier, the lowest level seen since March 24, when the pair fell to lows near $1.6460.
From the $1.7192 high posted July 15 to today’s lows, sterling had fallen 4.0%.
In contrast, from the euro’s July peak at $1.3700 to Monday’s lows near $1.3184, the pair was off 3.8%. The euro trades at $1.3196 in afternoon action.
Should cable have fallen as far as it has given that, in the wake of the release of the BOE’s meeting minutes for August, released last Wednesday, some analysts saw scope for the central bank to begin raising rates in 2014, rather than wait for next year.
There is a case to be made also that the euro has come too far too fast, especially with CFTC data showing that as per last Tuesday, speculators had a net euro short of 138.825 contracts, the largest net short since July 31, 2012.
After Labor Day, world financial markets will return to normalcy and full liquidity as traders again man their desks.
There will be no shortage of event risk to drive, from the release of U.S. non-farm payrolls Friday September 5 to four major central bank decisions (Bank of Canada, ECB, BOE and Bank of Japan) next week.