A mid-month turnaround saw markets calm down to recover somewhat in February, posting only modest losses after a soft January lead influenced by a volatile mix of factors.
Financial markets started February 2016 on a weak note, with equities and risk sentiment following a soft January lead, before turning around mid-month to end with only modest losses. Global unhedged and Australian Equities both returned -1.7%, while hedged Global Equities returned -1.5%, underperforming bonds. Australian and Global Sovereign Bonds returned 1.3% and 1.5%, respectively.
While the magnitude of February losses in equity markets was only moderate, losses were large on an intra-month basis, with key markets almost down 10% on a year-to-date basis at one point, before turning around. While fear in markets in January was all about slowing growth in China, and the authorities’ search for a competitive currency devaluation, investors’ minds in February were focused on determining how much the US economy, previously a global bright spot, is actually slowing. Early in the month, data indicated that payrolls growth was not just slowing but below market consensus. Lead indicators pointed to both a contraction in manufacturing activity, and signs that this may be flowing through into slower services activity. Falling oil prices also continued to weigh on markets early in the month, in particular hitting energy producers’ debt hard. Elsewhere, markets were contemplating the potential impact of a “Brexit”, a British exit from the EU, and, temporarily, the solvency of some European banks. Meanwhile debate raged about whether central banks had ‘run out of ammunition,’ and would be unable to stimulate economic activity if growth was actually slowing. The key example investors pointed to was the loss of confidence in the Bank of Japan, which introduced negative interest rates on the last day of January. This move was expected to lead to a weaker Yen and higher Japanese equities, but it actually prompted the exact opposite. While the debate over central bank ‘ammunition’ remains unresolved, the downside risks are probably overstated.
Markets calmed down mid February. A bottoming of oil prices and equities, and a peaking of high-yield credit spreads all happened at the same time, pointing to very high correlations between asset classes. Nevertheless, after bottoming, markets cautiously crept back up into month end, posting only modest losses. These gains were supported by some stronger-than-expected data in the US, including an upward revision to US GDP for the fourth quarter of 2015. Unofficial indices, which estimate real-time growth, also pointed to first quarter growth being moderate and, while not strong, far from recessionary.
In Australia, there were few significant developments. The Reserve Bank of Australia (RBA) left interest rates on hold, maintaining a moderate easing bias as it sought more information on whether recent employment gains can be maintained. February employment data (released after the RBA meeting) pointed to some job losses and was below market consensus. However, employment growth was also the highest in 2015 since 2006, so the release was quite strong despite the broader economic weakness in post-mining boom Australia. Labour market developments continue to be the key to the future direction of monetary policy.