Is Short Term Risk Shifting?
1.) VOLATILITY – Sometimes things start to shift under the surface of price before the price does. And sometimes, even when those shifts under the surface are happening, the price doesn’t shift with it in any significant way. So what’s different today from last week? A few things. First is Volatility. Volatility looks like it’s waking up a bit, which of course can be very, very short-lived. The VIX itself is still relatively low, but the Volatility of Volatility (VVIX) is rising and suggesting we could tap the top of the trend near 100. When the VVIX begins moving before the VIX itself, it can be an early signal that larger investors are starting to pay for protection. Does that spell doom for this bull market? No. Fundamentally, nothing has significantly changed in that we expect an acceleration of both growth and inflation. CPI comes out tomorrow and like PPI this morning, it will probably be a bit hot. So shorter term, this could spell the need for a little protection.
2.) JAPAN – I don’t write about it enough, but Japan is always an important macro component in terms of the Yen and Japanese bond yields. Those yields keep rising and are still historically high even after the recent 5-6 day slide in 10 to 30-year yields. Of course, rates here in the US are still elevated too. At some point, that just puts pressure on consumers, corporate profits, and market valuations. It’s not a real issue yet, but the 10YR Yield is not looking like it wants to retreat much yet either. Meanwhile, the Bank of Japan is moving away from years of extremely easy monetary policy. This could strengthen the Yen and pressure the enormous Yen carry trade. The Yen is up +4.5% in just the last 3 months, so momentum trades are now pushing it. We saw in 2014 how quickly the Yen carry trade can unwind and create selling across global markets. The Yen in relation to VIX is also an interesting perspective. There’s a wide gap between the two right now, and one of the two tends to “catch up or down.” Historically, it’s been VIX “catching up” to the Yen.
3.) OIL – West Texas Intermediate (WTI) is now over $100/barrel again, with no solution in sight as the Iran war continues to be an issue. Right now, even though oil is signaling “sell” on our internal indicators, there really isn’t any resistance until about $108/barrel. If oil remains this high or moves higher, it would likely revive inflation more, which would naturally reduce any possibility of rate cuts and put additional pressure on consumers and corporate margins. At this point, if we see $108 area, I'd expect a rejection.
It’s important to recognize that none of these factors guarantee any kind of real correction in markets. The cure for high rates remains high rates, and the acceleration of inflation doesn't guarantee a rate hike from this Fed. There are some real differences in this Fed compared to the last one. There would really need to be some form of a final catalyst for a serious correction to happen, and that catalyst has not yet become known. But all of the above, if they continue, could be the ingredients. Am I turning bearish? No… not at all. Most of those risk-off scenarios can come and go in a very short-term way. I'm just pointing out some short term risks to work through.
