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There are enough illogical patterns in the market that we can safely assume that a lot of big money was caught offside by the new interest rate environment, and that managers are now scrambling to cover their bets.
The Fed has changed the game; that much is clear. Much of the recent market upheaval can be attributed to markets attempting to find a new interest rate equilibrium. With Chairman Bernanke threatening to take his giant wallet and go home, any investment – bond or equity – that benefitted from the declining rate environment becomes less attractive.
Outside of that, however, there are a bunch of things going on in global markets that simply make no sense. These three recent trends are particularly mystifying:
One, emerging markets currencies are in full retreat as assets flee, but the destination for the funds is unclear. They're certainly not headed into U.S. Treasuries, the S&P 500 or European sovereign debt – those markets are all selling off almost as hard.
Secondly, inflation expectations remain subdued, so the intensity of the bond sell-off is surprising. The year-over-year U.S. consumer price index has fallen to 1.4 per cent, which is less than half of the September 2011 peak of nearly four per cent.
Third, there are signs that global investment banks have been caught offside by the rapidity of market movements. Barron's reported that Citigroup had stopped accepting orders to redeem the underlying assets in some of their ETFs. "We [Citi] are unable to take any more redemptions today . . . a very rare occurrence due to capital requirements we are maxed out on the amount of collateral we have out."
State Street also halted cash redemptions in its municipal bond ETFs after market liquidity dried up. They would only transfer the municipal bonds themselves to clients because there were not enough bids to sell into for cash.
Investor concern over these developments is justified, but panic is not – for now, at least. Large institutions have to adjust for the rising rate environment, but there are no signs that any of them are in trouble with, say, a highly leveraged trade they can't get out of.
Still, it'd be nice to have stable U.S. bond yields for a couple of days, as well as to know where all the cash being removed from emerging markets is going.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .
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