US stocks fell to a 14 month low yesterday with the Japanese Topix also now at an 18 month low. Also US small-caps became the latest sector to enter technical bear market territory joining the troubled German Dax amongst others. The S&P 500 last week had already wiped out year-to-date returns. Adding to yesterday’s -2% drop, and global markets also pointing to further declines today, it looks increasingly certain that, what started out as a booming year, 2018 will end in the red across a vast majority of global stock and bond indexes.
The Fed meeting today and tomorrow has for many months been expected to be a non-event but now implied probabilities suggest at least a one-in-four chance that the hike will be postponed. Moreover, with the further recent escalation in market volatility, there has been a flurry of articles suggesting that a hike alone tomorrow may not be enough to calm markets. Investors have been preparing for a dovish tone to accompany the last of the systematic hikes; but only time will tell if they have factored in beginning the transition to rate path uncertainty on what could be a highly cautionary tone.
Meanwhile, as concerns over deflation are picking up in most major markets the UK has seen a marked increase in inflation swaps in recent days. Since the results of the referendum UK stocks have fallen, but so have global equities; the British pound has fallen, but only somewhat modestly. As global growth leading indicators have flagged in recent months, 3-year spot inflation swaps in the US and Eurozone saw sharp declines (US falling from 2.3% to 1.8%). However, this is compared to UK inflation swaps this quarter which rose from around 3.3% to 3.7%. The spread between US and UK swaps has more than doubled from earlier lows in the year, rising from 0.9% in April to 1.9% now. This spike is from a combination of higher inflation expectations for the UK as well as a higher inflation risk premium: not expecting a base case of higher inflation but factoring for greater tail risk as concerns of a hard Brexit and sterling devaluation weigh heavy… A way but definitely not the most painless way to fight deflation concerns.