The last six months have been anything but ‘normal’ in terms of market movements. Whether equity, bond, or FX markets, the high correlations and crashing disconnects have at times been incredible – leaving every risk manager’s VaR calculation and desk-quants gamma-hedging program sorely lacking. Goldman specifically surveys the largest moves across asset-classes of the last six months and finds that it is policy announcements that have been far larger drivers of outsize market moves than economic data. This is a significant departure from the previous six months.
Goldman Sachs: US Daily: “Market Movers” – Policy News at Home and Abroad Driving Markets
- In our semiannual review of the largest single-day moves in the equity, fixed-income, and foreign exchange markets, our analysis shows that policy announcements in the US and particularly in Europe drove the majority of the largest market moves, while economic data releases had a relatively small impact.
- The largest moves in the equity market were concentrated in August as uncertainties escalated around the European debt crisis and fiscal policy in the US. The dollar exhibited an inverse trading pattern with risk sentiment. And the magnitude of the largest moves in the fixed income market fell from our previous report as the 2-year Treasury yield is close to zero and expected to stay there based on the Fed’s signals.
- With the European debt crisis and the US fiscal debate yet to be resolved and recent economic data stabilizing, we expect markets to continue to focus on new policy announcements going forward.
Today’s comment reviews the ten largest single-day moves over roughly the last six months (from May 1 to November 22) in the equity, fixed-income, and foreign exchange markets. During this period, markets were highly sensitive to each new development surrounding the European debt crisis; news on the US deficit debate and the Fed’s announcements also contributed to large single-day moves. In fact, all three markets reacted sharply on August 4th to the combination of the disappointing ECB policy announcement and the US deficit agreement. Given markets’ focus on policy news, economic data received relatively less attention, with reports on employment and output driving markets on days with little policy news.
Unlike in our previous report (see David Kelley, "’Market Movers’ – Macro Data Mostly a Tailwind for Markets," US Daily, March 23, 2011), where the equity market (represented by the S&P 500) was fueled mainly by economic releases, the market was mainly driven by policy developments in both Europe and the US in the past six months. In particular, the market went through a period of great volatility in August that recorded seven of the ten largest moves. Starting on August 4, the combination of the ECB failing to provide clear policy guidance and the US deficit reduction agreement sent the S&P down 4.8%, the second biggest drop in the past six months. The largest drop of 6.7% occurred on August 8 after the S&P downgraded US sovereign debt which led to a sharp fall in sentiment.
Over the next three consecutive days, the S&P swung in opposite directions: the index marked the biggest gain of 4.7% on August 9 in response to the FOMC easing announcement but fell by 4.4% the next day amid escalating fear over the European debt crisis. The index recovered again on August 11 following better-than-expected claims reports, although a day without major policy news likely contributed to the gain as well. Among the top ten movement days, August 18 was the only day that was driven by economic data alone; the Philadelphia Fed survey dropped to -30.7, posting a large downward surprise (the MAP score was -20) and sent the S&P down 4.5%. 3Q GDP and jobless claims reports were the other two macro drivers, but overall economic releases were overshadowed by gloomy policy news. Following a brief respite in September, the market again posted large moves in October and early November on the back of speculation on European bank recapitalizations, statements from the EU summit, and soaring Italian bond yields. Overall, the equity market was more volatile compared to our previous report. The tenth biggest change in magnitude in the current period was 3.4%, whereas the largest change was 2.2% from our previous report. The VIX index also soared from around 20 points in the beginning of the year to around 35 points since August 4.
The fixed income market (represented by the 2-year Treasury yield) in contrast saw smaller moves in terms of absolute magnitude compared to our previous report. The average magnitude of the top ten moves was 7 basis points in the current period versus 9 basis points in our previous report. This decline mainly reflects the fact that the 2-year yield is close to zero. Prior to the FOMC’s August 9 announcement, the fixed income market reacted to policy news from Europe, especially those concerning Greek debt. Compared to the equity market, the fixed income market was more sensitive to US economic releases: the 2-year yield gained 9 basis points following a better-than-expected employment report on July 8; positive ADP employment, retail sails, and Richmond Fed reports pushed up yields by 5-7 basis points; and weak GDP reports in late May and July contributed to declines of 6 basis points each. Notably, on August 9 the Fed signaled that rates are expected to stay low “at least through mid-2013.” The 2-year yield dropped by 8 basis points in response to the Fed’s strong commitment language and has moved by no more than 4 basis points since August 9.
Like the equity and fixed income markets, the foreign exchange market was also driven mainly by sentiment in response to policy news. In particular, the dollar traded mostly inversely with risk sentiments. For instance, three of the top ten moves occurred in September, when escalating uncertainty in Europe pushed investors to the dollar. On the other hand, the dollar fell when risk sentiment recovered on news such as a possible European bank recapitalization and the EU summit statement that met markets’ (already low) expectations. The dollar’s inverse relationship with risk sentiment was also evident in US data releases. The dollar fell 0.9% following easing sentiment from stable consumer confidence and the Richmond Fed reports; the favorable October GDP and employment reports helped raise risk appetite and lowered the dollar; while the weaker than expected ISM report on November 1 contributed to the second-highest gain for the dollar. One exception to this inverse relationship occurred on October 20, when the dollar gained 0.8% despite the Philly Fed survey posting a large rebound to +8.7 from -17.5 in September.
Over the past six months, the overarching driver in all three markets has been policy news in Europe and the US. Interestingly, aside from August 4, the three markets reacted during different periods of policy uncertainty. Moves in the equity market were concentrated in August in response to widespread uncertainty, the fixed income market reacted mainly to policy ambiguity and speculation until the Fed’s commitment language on August 9, and the dollar posted large moves within the past two months in response to large swings in risk sentiment. As the European debt crisis and the US fiscal debate have yet to be resolved, we expect policy news in Europe and the US to remain key drivers, especially in the equity and foreign exchange markets. Recent improvements in US economic data should help calm risk sentiments, but – as the previous six months have shown –policy news can quickly overwhelm sentiment and spark more turbulent moves across markets.
Note that we use daily percentage changes in the closing price of the S&P 500 and of the trade-weighted dollar to gauge the scale of market moves in the equity and foreign exchange markets, respectively, while daily basis point changes in the 2-year Treasury yield are used to proxy fixed-income moves.
While neither policy or economic outcomes are specifically harder to hedge, it is the Knightian uncertainty of the desparate policy-makers that is perhaps most worrisome going forward – especially given the lack of resolution anywhere in the world.