Investors and analysts on Wall Street are worried regarding a possible “market crash” as bouts of hype in the US stock and bond markets and a stronger dollar increase stress in the financial system.
The Treasury Department’s Office of Financial Research (OFR) indicator of US market tensions soared to its highest level since the May 2020 pandemic surge.
While Wall Street stocks are starting the new quarter higher, the OFR financial stress index is near a two-year high of 3.1, where zero means the market is functioning normally. This is another factor on the list of criteria that suggest that trading conditions for US government debt, corporate bonds and short-term instruments are becoming increasingly tight.
“The speed at which change is taking place around the world … is clearly a neon swan that tells us that we are clearly in a market disaster,” said Nomura strategist Charlie McElligott.
The increase in concerns is associated with a series of large increases in interest rates by the Fed to curb inflation. Higher borrowing costs and fears of a slowdown in economic growth led to a sharp sell-off in open markets, while strengthening the US currency at the expense of global peers.
Rate hikes by the ECB and the Bank of England, as well as the reversal of the British government’s tax cut plans, have also added to market volatility this year amid efforts by global policymakers to contain price increases.
“When financial conditions tighten so much, everyone is trying to figure out who or what will make central banks back down,” said Michael Edwards, deputy chief investment officer at hedge fund Weiss Multi-Strategy Advisors. – They are [ФРС] intend to tighten financial conditions, and [учитывая] the strong position of the economy… they should use the financial markets as a transmission mechanism. So somebody gets hurt.”
Risks to stability
Among the signs of tension in the markets, McElligott pointed to the Japanese yen falling by 20% this year, the sell-off of British sovereign debt in recent weeks and loans on bank balance sheets that lenders are unable to pass on to investors even at deep discounts.
He added that the strength of the dollar “provokes incredible economic tension … and increasingly leads to new turmoil in the markets.” The turmoil means that the markets are not working as they should: it is difficult for companies to obtain financing, it is more difficult to buy and sell securities, prices are volatile, and investors are not willing to take risks.
Conditions worsened throughout the year, but until recently, this was evident primarily in the stock market, where valuations plummeted due to higher borrowing costs and worsening growth prospects.
Private companies have been unable to list shares on exchanges, and banks have been forced to withdraw from planned debt financing for clients following investors refused to provide funds.
Last month, banks were forced to keep $6.5 billion in debt on their balance sheets to fund a buyout of software maker Citrix following they failed to find buyers for all the debt financing.
“It’s like boiling lobster. You put them in cold water and slowly turn up the heat, said George Gonsalves, head of the US macroeconomic strategies unit at MUFG. “That’s what’s happening in the markets. The Fed is stepping up pressure. But since the market is still brimming with liquidity, it is not yet clear where the weak link is.”
JPMorgan Chase economist Bruce Kasman said on Friday that the relative strength of the banking system and small funding needs for much of the corporate world mean the financial system is virtually immune. However, the US bank warned that the increase in the OFR index indicates a wider spread of turmoil in financial markets and a decrease in risk appetite due to the strengthening dollar and rising US interest rates.
“Risks to global financial stability are becoming more and more of an uncertainty in terms of the outlook,” Kasman added.
According to Marty Friedson, chief investment officer at Lehmann, Livian, Fridson Advisors, the corporate bond market is also showing increasing signs of tension.
Friedson noted that the number of high-end investors who need to increase their share of junk-rated risky corporate debt relative to safe-haven Treasury bonds has risen significantly over the past month. By his calculations, the junk bond market now reflects a 22 percent chance of a recession, compared with just 2 percent in mid-September.
Volatility and vulnerability
According to the rating agency Moody’s, from July to August the number of corporate defaults more than doubled. Strategists at Bank of America warned on Friday that their indicator of credit market stress is at “marginal critical levels” and that “the market will begin functional disruption” if it rises even higher.
Separately, it should be noted that the Goldman Sachs index, which assesses deterioration and disproportion in the market, is growing due to stress in the financial markets, as well as increased volatility in the US $24 trillion public debt market.
The yield on 10-year Treasury bonds, which is the benchmark for the cost of loans worldwide, increased this year from regarding 1.5% to 3.6%, and last week it briefly exceeded 4% for the first time in 12 years.
According to the Ice BofA Move Index, the volatility in this market has also reached its highest level since the unrest caused by the coronavirus in 2020.
Volatility can also be seen on a daily basis, with the biggest change in the 10-year Treasury market in 2021 being the 0.16% drop on November 26th. This year, larger movements have already been observed for seven days.
Although the Fed does not intend to stop raising rates, they are also monitoring the potential risks associated with a market drawdown.
“As monetary policy tightens around the world to combat high inflation, it is important to look at how externalities and financial vulnerabilities in different countries can influence each other,” Fed Vice Chair Lael Brainard said on Friday. “We are attentive to financial vulnerabilities, which might be exacerbated by additional negative shocks.”
Prepared by Profinance.ru by materials editions of The Financial Times
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