As the Financial Times wrote on Saturday:
“Earlier this year, it all seemed so straightforward. Central banks printed money and proffered soothing words, and markets went up. Now, it’s getting more complicated.”
In fact, nervous readers might want to stay away from financial markets for a while. Just 2 weeks ago, crude oil prices suddenly rose $2/bbl and then fell $4/bbl within a few hours. Last week it was the turn of the Japanese yen. In 2 hours on Thursday, it rose 4% to $1:¥95. And this time, the impact hit other financial markets. The S&P 500 Index fell to 1600 as the yen strengthened, but then hit 1640 again as it weakened on Friday.
Nothing really changed in terms of fundamentals in these few short hours, of course. Instead, the rising volatility is being caused by the impact of 4 major cross-currents:
• Traders expect the US Federal Reserve to slow down its liquidity programme. So they buy the US$ and sell commodities and US stocks: commodities because they no longer need a ‘store of value’ and stocks because they are over-priced versus the state of the real economy
• Other traders believe the Japanese government intends to drive down the value of the yen, to boost exports, and so they buy the US$, US stocks and commodities to provide them with a ‘store of value’. They also dump government bonds, as the Fed and premier Abe’s declared aim is to boost inflation – which destroys value for bonds
• Still other traders continue to play in Brent oil markets. As a major article in Petroleum Review reminds us, Brent has been “a broken benchmark since the early 2000s” – it now trades only 120kb/day, and the total volume traded as ‘Brent’ is only 1Mb/day. Yet its “price sets the value of about 2/3rds of global oil production”
• And, of course, the high-frequency traders with the computers trading in micro-seconds can take advantage of all of this confusion. Using central bank liquidity they can trade millions of contracts every second, up and then down – or down and then up. They don’t care, as long as there is a fraction of a cent to be gained on each contract
This is the problem when governments and those with deep pockets are allowed to manipulate markets. They have taken prices well away from fundamental values in the real economy. But now the cost of continued manipulation is becoming too high, and new players are seeing opportunities to drive prices back to values set by supply and demand.
The rest of us simply get caught in the cross-fire. Volatility rises to extreme lengths as the elephants fight with each other. Revisiting the blog’s Budget Outlook for 2010-13, it seems clear the end result is that we are now headed into the Downside Scenario of deflation. Today’s turmoil is only the start of this process. As JP Morgan’s CEO Jamie Dimon warned Thursday:
“As we go back to normal, it’s going to be scary, and it’s going to be kind of volatile.”
Even more scary is that Dimon is wrong to assume we will go back to ‘normal’. Ageing Western populations mean we are now entering a New Normal, which has never existed before.
The chart shows latest benchmark price movements since January and ICIS pricing comments are below:
PTA China, red line, down 11%. “Chinese filament yarn plants were running at 83% capacity, while PSF plants were running at 60% capacity”
Naphtha Europe, black, down 8%. “Market remains oversupplied”
Benzene NWE, green, down 9%. “Demand remains softer than expected given the time of year”
Brent crude oil, blue, down 7%
HDPE USA export, yellow, up 9%. “Supply for the export market has improved”
US$: yen, orange, up 11%
S&P 500 stock market index, up 12%