To be sure, traders and investors were left to cope with conflicting signals in the just-concluded trading week.
For one thing, you never want to be completely out of risk assets in an environment where the central bank put is still in place. Underscoring that was Thursday’s ECB presser where Mario Draghi made a concerted effort to be dovish, comforting markets that were getting increasingly concerned that the ECB might make a “hawkish mistake” as decent incoming data and the technical constraints of European QE make stimulus unwind inevitable.
In fact, the Draghi presser was a textbook example of how distorted things have become. Rates have effectively become negatively correlated with FX in Europe as the stronger the euro is, the less likely it is that Draghi will pull the trigger on tightening. So that creates a rather surreal dynamic where whatever negative impact a rapidly appreciating currency might have had on stocks will be at least partially (but certainly not fully) offset by the fact that the stronger the currency, the more constrained Draghi is in his ability to exit stimulus.
“So, going into the ECB: Stocks up, periphery spreads narrower, and a stronger euro,” Bloomberg’s Paul Dobson observed headed into Thursday’s rates decision/ Draghi presser. “Is it the weaker dollar floating all other boats? Or a have-your-cake-and-eat-it trade, positioning for the ECB to be dovish without talking down the currency?,” Dobson went on to ask.
“In this world, a higher euro leads to lower European yields because it forces Mario Draghi to be even more dovish,” DB’s George Saravelos wrote on Friday, before expressing his incredulity as follows: “It is a complete regime shift from the past – interest rates are negatively correlated to FX!”
Meanwhile, the flight-to-safety bid associated with political gridlock in Washington, natural disasters in the U.S., and tension on the Korean peninsula has left traditional havens bid, as USDJPY and gold rally with both moves supercharged by the tanking dollar.
But again, the more indeterminate the outlook, the more unlikely it is that the Fed will get too aggressive. As such, the more reason to believe that the BTFD mentality will prevail, sustaining U.S. equities (which can become even more expensive as bonds rally, because they still look “cheap” by comparison) and ensuring the vol. sellers stay solvent and carry trades continue to work.
Given all of that, it’s no wonder that in the week through September 7, investors literally bought everything. Look at this flows data from EPFR:
- Investors add $1.3b to gold funds, most in 30 weeks, in week ending Sept. 7
- Global equity funds attract $3.7b in third straight week of inflows
- Bond funds add $6.6b in 25th straight week of inflows
- Government bond funds attract $1.8b inflow, biggest in 61 weeks
- IG bond funds post inflow for 37th straight week, adding $2.2b; HY bond funds post $800m inflow
- EM debt funds add $1.7b
- U.S. equity fund outflow was $0.2b vs $0.6b inflow to Europe, $0.9b to EM stocks
“Investors had a multitude of signals to react to in the first week of post-summer business as usual,” Bloomberg notes. “While rising political risks including North Korean nuclear tests and American hurricanes sent some investors rushing to haven assets, fresh signals from the European Central Bank that it is prolonging monetary stimulus gave a boost to riskier securities.”
Can everyone be right at once?