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Daily Agenda: Rushing for the Exit?

During the recent global equity market sell-off, fear of a recession in Europe and the quarterly earnings report season are in focus.

With dramatic selling pressure in global equity markets across several sessions in recent weeks, investors are wondering whether this liquidation merits full-on panic or is merely a market swoon — and in any event, what the return of volatility means going forward. In an e-mail exchange yesterday with Institutional Investor, Robert Savage, CEO of New York–based hedge fund firm CCTrack Solutions, commented that although he does not see true fear exhibited in the present market, “We have seen a structural shift in volatility. It’s not going back to 4 percentage in foreign exchange or 8 percentage in bonds or 12 percentage in equities.” According to Savage, that uncertainty costs economic growth. While the impact of the correction in some asset classes on real world activity will play out over the next several months, in the near term, the corporate earnings reporting season should be enough to take investors’ attention away from Europe’s ills to the challenges facing the U.S. The release of disappointing retail sales data for September yesterday and market reaction underscored the fragility of confidence in the recovery.

Financial sector companies make earnings announcements. With strong showing by major financials including Citigroup, the release of third-quarter results by Goldman Sachs Group today and Bank of New York Mellon and Morgan Stanley tomorrow will bring trading profits under scrutiny after a summer devoid of volatility to exploit as the big financials continue to pare down their staff.

EU weighs fear of debt versus fear of stagnation. The submission of draft budgets by European Union-member nations to the European Commission this week brings to the forefront the debate over the impact of austerity measures on growth to the forefront. French policymakers have postponed target dates for deficit reduction in their plan while a tax cut that Italy’s cabinet passed today may bring that nation out of compliance with EU guidance.

U.S. weekly jobless claims and September industrial production data on deck. Weekly jobless claims and September industrial production data will be released this morning as investors attempt to assess whether the U.S. economy can remain resilient while the rest of the world slows.

Oil rout continues and spreads to forex. Energy Information Administration crude stockpile data, scheduled for release today, is expected to underscore the ongoing supply glut as futures contract prices for WTI, the domestic U.S. grade, reach multiyear lows. As slowing global activity and increased production weigh on oil markets, the impact on the currencies of petro-centric economies has been pronounced. The Russian ruble slid by nearly 1 percent against a basket of primary currencies today as the announcement of further intervention by the Bank of Russia has failed to inspire confidence.

Portfolio Perspective: Setup for a Possible Correction in Treasury Markets — Karl Haeling, Landesbank Baden-Württemberg

Price movements across asset classes were pretty dramatic Wednesday, with those in fixed income representing some of the biggest single-day swings in the history of the modern bond market. Volumes were the biggest ever, and the size of the early rally was the biggest in absolute terms since the depths of the financial crisis in 2009. With regard to yields, the move in Treasuries was also likely among the largest ever. Treasuries are heavily overbought while crude oil is heavily oversold and U.S. equities are moderately oversold.

The volatility is entirely consistent with an exhaustion or capitulation blow-off that suggests the present phase of the bull run is either over or nearly over. While most short positions are probably covered, an absence of net long speculative positions — much less excessive ones — should prevent a bear market from starting any time soon. We are more likely to see a moderate correction sooner or later followed by a new sideways pattern.

If the global economy melts down quickly, ebola breaks out on a widespread basis in industrialized countries or some other major geopolitical crisis erupts, then the flight-to-quality will resume. But in our opinion at Landesbank Baden-Württemberg, one of these scenarios now needs to occur to drive yields and risk asset prices much lower again.

There are clear and obvious risks. Given the recent price action having discounted so many of these risks, however, markets should now become more sensitive to positive situations and developments. Even if the global economy does slump further, it should play out more gradually than the typical time frame of most traders and investors. In coming weeks, Federal Reserve officials will probably emphasize that there is not enough weak economic data to persuade them to change their expectation to be raising rates by the middle of next year, and this could lead to a correction in Eurodollar futures and short- and intermediate Treasuries.

Karl Haeling is head of strategic debt distribution at Landesbank Baden-Württemberg’s New York office.

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