Q3 2016 RECAP

POST-BREXIT TO OPEC

 

 

  • Markets initial reaction to Brexit referendum: keep calm and carry on tested at quarter-end.

 

  • Sovereign debt peaked early in Q3, yields at record lows. U.S. 10-year 1.35%; equivalent Bunds below zero!

 

  • Equity markets uniformly rose. In the U.S., the Nasdaq composite excelled.

 

  • Currency markets: U.S. dollar range-bound vs. euro, gained against the Pound, and stayed uncomfortably close to the 1oo level versus the Japanese Yen in Q3.

 

  •  Crude oil: a bull market followed a bear market.

 

 

 

 

 
 

 

Summer opened with Brexit watchers on high alert. A major surprise shocked markets – stocks and bonds were inversely correlated for three days, then highly correlated the next two weeks. In this period, bond yields touched all-time lows in developed markets. In the U.S., the ten-year benchmark note drop to 1.35%. In Europe and Japan negative yields stayed the course. Record low sovereign yields eased once it appeared, at least in the short-term, that Brexit would not likely pose a systemic risk to the global financial system. Economic data also provided a lift, surprising to the upside. The Bank of England paused before taking decisive action on interest rates and bonds. The overnight rate was cut for the first time in seven years, while investment-grade corporate debt was included in the mix for the first time ever in the stimulus package. The sum of the parts was interpreted as a flurry of aggressive steps taken with the intent of preventing an economic recession. A tall task that may only be known over the longer-term.

Shortly after the initial shock, equity prices responded. In the U.S., the S&P 500 index, the benchmark, achieved a new high, its first since 2015. Such a long pause is not common, but is understandable considering the past 12 months saw a pair of 10% corrections and a tough start in 2016. As July was trending higher, with the three major indices seeing valuations rise, August was better characterized by low volatility – the S&P did not trade outside a one-percent range the entire month, rare indeed. September was a different story, volatility jumped, prices were mostly erratic though range-bound. By quarter-end, July’s best levels were not surpassed, but stocks remained within striking distance despite historically high valuations and expectations for a subdued earnings’ season. The earnings recession stretched to five consecutive quarters, with the energy sector consistently the main culprit.

The foreign exchange market focused on Dollar-Yen. Sensitivity ran high in Q3. The Bank of Japan’s pause on policy strengthened the Yen, breaking below 100 for a second time. Then in late September, with OPEC’s tentative agreement to reduce oil supply the Yen broke away from the century mark. The surprise announcement sparked a rally in crude oil, lifting bond yields on the possibility of higher inflation down the road.

Finally, crude oil. It proved a memorable quarter. Seldom does a bull market follow a bear market in such short order (20% moves in either direction). As summer began, higher inventories coupled with flat demand took a toll on prices. Though 2016 prices peaked before the Brexit vote, the event temporarily added to a risk-off sentiment. By September, with oil prices near their lower-bound in Q3, an informal gathering among OPEC ministers in Algiers altered the landscape. A spring meeting had failed to freeze production. With this as background, markets were skeptical of any agreement. Yet, it did happen! A tentative agreement to reduce oil output – from very high levels – was enough to lift prices 5% right off-the-bat. The rally continued through quarter-end, with $40 in the rear-view mirror, markets set sights on $50 a barrel. Going forward, will OPEC’s meeting November 30th cement the agreement? Will individual quotas be adhered to? Will an increase in non-OPEC supply fill a void preventing a targeted rise in global prices? Is the two-year collapse finally over? And, if so, is OPEC’s year-end target $60 a barrel?

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