Daily Agenda: Making Room for the Yuan in the IMF Reserve Basket

China must now deal with global currency flows; Japan’s government-run pension fund saw sharp drawdown in August; the UN climate conference begins in Paris.


Today is expected by most analysts to be the first day the Chinese yuan is part of the International Monetary Fund’s Special Drawing Rights reserve basket. This milestone demonstrates how far Beijing has come in liberalizing its monetary system but also underscores how much more will be required to keep pace with the current trajectory of reform. With hundreds of billions of dollars waiting in the wings, Chinese regulators must now grapple with the fact that capital, by its nature, flows in both direction—in and out of the country. Recent handwringing over the effect of foreign capital on the rout in equity markets suggest than China’s political leaders will not find this to be an easy transition.

Japanese government-managed fund takes hit on stock market selloff. The Government Pension Investment Fund of Japan suffered a drawdown of more than $64 billion during the global equity market retreat in August, according to documents released today. The setback amounts to a nearly 6 percent decline in value for the fund which oversees more than $1 trillion.

Paris global warming conference begins. On Monday representatives from more than 100 countries met in Paris as part of the United Nation’s climate summit which is expected to last two weeks. Activists held protests in cities around the globe over the weekend to draw attention to concerns over the impact of fossil fuels on weather patterns.

Factory output rises in Japan. October industrial production data released today by the Japanese Ministry of the Economy indicates a possible rebound in activity in the country’s factories with a gain of 1.4 percent versus levels in September. Semiconductor chips and other electronic components led the gains despite still-slack export demand.

Oil prices rise ahead of OPEC meeting. In advance on Friday’s announcement from the Organization of the Petroleum Exporting Countries meeting in Vienna, oil futures markets rebounded on Monday. Front-month delivery contracts for West Texas Intermediate-grade crude climbed to more than $42 a barrel in early morning trading in New York on Monday.

India’s GDP accelerates. Gross-domestic-product data released today by India’s Central Statistics Office indicated that the pace of growth exceeded consensus expectations during the three months ending in September. Annualized headline GDP registered at 7.4 percent versus a rate of 7 percent in the prior quarter and forecasts for 7.3.


Portfolio Perspective: A Choppy March Into Year-End for Equities

Over the five years of this bull market, the S&P 500 index has risen an average of 2 percent in December (third best) with the worst year being a 0.4 percent decline, the second shallowest monthly pullback behind March. It may be more difficult for that seasonality to repeat this December.

The ECB meeting this Thursday, November employment on Friday and the FOMC meeting on December 16-17 will be the key events of the month. With the ECB having signaled that more stimulus is likely to be announced and fed-fund futures implying more than a 70 percent probability for a 25 basis point rate hike, divergent policy of the major central banks has arrived.

It is worth repeating two observations from prior tightening cycles since the early 1990s (1994, 1999 and 2004): 1) No matter how well telegraphed, the onset of a tightening cycle triggers higher equity volatility; 2) in the months following an initial rate hike equities declined, the U.S. dollar weakened and gold appreciated, all opposite of what might be considered a textbook response.

Looking beyond the near-term impact of central bank policy on volatility, a key theme into 2016 will be regime change. The floor in spot VIX has lifted relative to the last several years following the August shock. During the 1990s cycle, equity volatility transitioned higher a few years before the end of that economic expansion. If sustained, the inflection in volatility would both support the argument that the current economic cycle at almost 6.5 years is approaching maturity and suggests a more turbulent backdrop for the financial markets than has been experienced over the last several years.

Jim Strugger is a managing director and derivatives strategist for MKM Partners in Stamford, Connecticut.