Janet Yellen testimony

Yellen facing volatility

Today has been Janet Yellen’s turn to try to reassure markets in an environment in which knocked down traders and investors are desperately looking for cues from central bankers as stocks are plummeting since the beginning of the year and credit spreads are soaring higher.

Markets approached the testimony on a slightly positive tone also on the back of some sign of relief out of Europe where financials finally gained some ground this morning following unconfirmed rumours that Deutsche Bank could buy back some of its debt.

The prepared statement was probably a bit less dovish than expected. In the Q&A session Janet Yellen admitted that “conditions are less supportive for growth” but still stressed the strength of the labour market and the transitory nature of deflationary factors.

Is the US on course?

When asked if the current market turmoil could affect the path of interest rate rises or even cause a reduction in rates, she answered that the shifts in the global economy do not point yet to significant damage for the US economy but monetary policy is not on a preset course so everything can happen if a slowdown materializes.

At the time of writing equity markets are retracing some of the earlier gains and the dollar is coming under renewed pressure with dollar/yen below 114 making quite likely some sort of intervention (at least verbal) by the BOJ to stop yen strengthening.

There is a credibility issue for central banks as this wave of risk aversion is causing euro and yen to appreciate despite easing measures already announced and new ones likely to be unveiled quite soon by European and Japanese central banks. On the contrary the dollar is sliding with the market that starts to talk about a possible reduction in US rates despite Fed’s stated intention to move along its path of interest rates rises. All these movements are going against consensus positions causing further pain among market participants.

Low liquidity and negative debt yields

Liquidity is becoming more and more a problem with new bank regulations reducing the willingness and the capacity of the market makers to take any additional risk on board. Golman Sach’s President Gary Cohn spoke yesterday of  a “ liquidity crisis” going on at the moment in which “a small amount of buying or selling has a dramatic impact on prices” and that prohibits investors to exit markets at “reasonable clearing prices”. The low liquidity plus the fact that market is dominated by algos result in unpredictable and erratic moves.

All in all, mood remains quite gloomy for risky assets. Market participants are nervous and need to be reassured that central bankers are on the case and that will respond to market turmoil.  If this is the case we could see a bit of retracement of markets that now seem a bit stretched on the downside. With one third of sovereign debt trading in negative yield territory people may be “forced” to cautiously look at stocks again.

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