Equity prices recover towards the end of a turbulent week

A week that tested the nerves of those who " have seen it all before", as investors were shocked by the speed of the correction in equity prices at the start of the week. Earlier this week we noted that the volatility within the equity markets had not been reflected in the bond market. As of Thursday, US 10 year treasury yields are within 2 basis points of where they were a month ago. Several commentators have picked up this point in the past days, also highlighting the lack of volatility in EM bonds. Frank Investments were asked to give their views on Share radio as to what were the possible reasons.

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The FT picked up this baton on Thursday in an article titled EM debt misses worst of global turbulence. EM sentiment has become extremely bearish over the past months, as many EM economies rely on oil for revenues and the sharp fall in the oil price has impacted these economies. One would have expected EM debt to be hit along with the change in sentiment towards the economies. Despite concerns about the risk posed by a surge in EM debt, the asset class has avoided the rout in capital markets. The FT points out that the return on the JPMorgan emerging market sovereign debt index so far this year is almost flat compared with a fall of over 15% in the MSCI EM equity index over the same period.

Equity market investors were soothed late on Wednesday by comments from Federal Reserve member Dudley suggesting the case for a rate raises in September was less compelling. As we also commented this week there are improving signs for the US economy, Citi forecast the US economy is growing above trend at 2.5-3%. The recent turbulence in equity prices leaves the Federal Reserve facing an even tougher decision than they were.

On the one hand they don't want to see all their efforts to reflate asset prices over the past few years end at the first move on rates. On the other hand they will be reluctant to change a path based on what may be short-term volatility in equity markets.

Global economic forecasts have been reduced for 2015 and 2016, but so far no one is predicting a global recession. The oil price fall has put pressure on EM economies, but does on the other side of the equation does improve consumer spending.

The odds a few weeks ago were that rates would rise in the US in September, the market now appears to be predicting a less than 50\50 chance. Any change in interest rate sentiment ahead of the September meeting may further buffer equity markets. Macro data will come again to the forefront of investors' minds. On Thursday the latest estimates for US Q2 GDP were revised upwards, if the US economy can continue to recover and rate expectations remain subdued a little equity optimism might return.

Posted on August 28, 2015 .