The global financial markets have started the year in full-blown risk-off mode. While global asset markets are not hitting new lows and, in fact have rallied last week, volatility has risen dramatically. Since the end of 2015, volatility in U.S. Treasuries, the Japanese yen (JPY), oil, and equity markets have skyrocketed. The dovish European Central Bank (ECB) press conference on January 21 has raised expectations of another rate cut and more quantitative easing (QE) that would add more liquidity to the global financial system and help ease global financial conditions somewhat.
U.S. financial conditions, while remaining pretty tight, eased a bit from -0.643 on January 20 to -0.307 on January 28 (see chart below). While further easing by the ECB will be welcomed by global markets, it may not be enough to fully offset the start of Fed rate normalization. Ongoing concerns about global growth, especially China, a free fall in oil prices, and rising disinflationary concerns will continue to put pressure on global markets from time to time. Nonetheless, the improvement in U.S, financial conditions helped trigger a broad-based rally during the past week. Global equities rallied, led by Nikkei, Hang Seng, FTSE, Bovespa, Eurostoxx and the S&P 500 Index. Interestingly, Shanghai was one of the few markets that continued to implode, declining -7.8% over the last five trading days and -25% year-to-date. In foreign exchange markets, G10 commodity and emerging markets (EM) currencies have been gaining. The high yield and emerging markets bond (EMBI) market also rallied, rising 1.7% and 0.5%, respectively. Oil prices staged a furious technical rally despite U.S. inventory build nearing an eight-decade high and the official lifting of Iranian sanctions. WTI crude and Brent oil prices surged 12.3% and 16.5%, respectively last week. Despite the rally in global markets, G10 sovereign bonds continued to rally on the back of more ECB easing and further unwinding of Federal Reserve rate hike expectations. In global fixed income, Portugal, Spain, Italy, France, Germany and U.S. 10-year yields all rallied last week.
U.S. Financial Conditions Remain Tight but Easing Slightly