Turbulence spread across financial markets again on Tuesday as the receding chances of a Federal Reserve interest rate increase failed to assuage mounting investor concerns that a correction is overdue.
A record 54 per cent of investors surveyed by Bank of America Merrill Lynch said a combined measure of bonds and equities was now overvalued, and fund managers’ cash holdings have nudged up again in September, underscoring the growing nervousness.
Both stock and bond markets took another beating on Monday, with the 10-year US Treasury yield rising above the 1.7 per cent mark for the first time since June, eurozone government bonds selling off and the FTSE World equity index tumbling another 1.3 per cent to its lowest level since early August.
The Vix index, a gauge of expected volatility and a popular proxy for investor nervousness, remains below its long-run average but is on track to close at its highest level since the post-Brexit market mayhem.
JJ Kinahan, chief market strategist at TD Ameritrade, said the renewed turbulence had started with a sell-off in oil markets but then spread to bonds and then other markets. “We are still at a very nervous time. We had this incredible rally yesterday and bonds just started getting weaker, weaker, weaker, and people started getting nervous and sold stocks.”
Markets first swooned last Friday when investors grew skittish over central bank support, after the European Central Bank refrained from extending its bond-buying programme and Fed officials talked up the possibility of a US interest rate increase later this month.
Investors’ interest rate fears were assuaged by a dovish speech by Fed governor Lael Brainard on Monday, but Tuesday’s resumption of turbulence underscores how many money managers and analysts are nervous that a steeper correction is on the cards after an unusually tranquil summer where many stock market indices hit new highs.
“It feels like something might break,” said one hedge fund manager. “We’re trying not to take any big bets either way.”
It feels like something might break. We’re trying not to take any big bets either way
Some delayed selling pressure may be coming from automated investment strategies such as commodity trading advisers, risk parity funds and other vehicles that respond to jumps in volatility by paring their exposure.
Chintan Kotecha at Bank of America Merrill Lynch estimates that Friday’s turbulence alone could trigger about $52bn of “near-term selling” in global equities, about half of which would happen in the US. “In a fragile market with low conviction, the risk is that negative price action alone drives further selling,” he wrote in a note on Monday.
Risk parity funds have been particularly badly hit by the twin blows to bonds and stocks. Rebecca Cheong, head of US equity derivatives strategy at UBS, estimated that based on a simple risk parity model with a 10 per cent volatility target, the strategies could sell $45bn in government bonds, $40bn in global equities, $25bn in corporate debt and $10bn in commodities over time.
Collin Martin, director of fixed income at Schwab Center for Financial Research, was sceptical that the sell-off was the start of a sharp move higher for US Treasury yields, but warned that given uncertainty about global monetary policy and how long accommodative asset purchase programmes in Europe and Japan will remain in place, “there probably will be bouts of volatility going forward”.
Sample the FT’s top stories for a week
You select the topic, we deliver the news.