The final week of 2018 could prove tumultuous for investors as holiday-thinned trading combines with a growing array of pressures on markets.
Traders in the $5.1 trillion-a-day currency market were among the first to respond to a partial U.S. government shutdown and a report that President Donald Trump has discussed firing Federal Reserve Chairman Jerome Powell. The dollar slipped against its Group-of-10 peers, while the yen, seen by many as a haven, gained for a seventh day.
Treasury futures climbed in early Asian hours before paring their advance. Cash bonds trading was shut in Asia due to a holiday in Japan, the first in a week that will see a number of closures across major markets.
Sentiment in global financial markets has already taken a beating with the S&P 500 Index just recording its worst week in seven years. Increased uncertainty over the leadership of the Fed could add to turmoil along with a partial shutdown of the U.S. government, although assurances from U.S. Treasury Steven Mnuchin about liquidity and the future of the central bank chief may ease some concerns.
The Treasuries yield curve last week moved closer than ever to its first post-crisis inversion and the rally in safer assets dragged the 10-year yield below 2.75 percent for the first time since April. However, given that much of the upheaval is emanating from the U.S., it is not entirely clear whether Treasuries, and also the U.S. dollar, will act as reliable havens should Powell’s leadership face a genuine threat.
Societe Generale SA’s head of U.S. rates strategy Subadra Rajappa said she thinks a change in Fed leadership is “extremely unlikely,” though she’s not ruling out the possibility of the president persuading Powell to “resign.”
“If it comes to that, given the backdrop of the recent government shutdown, investors might be less inclined to treat Treasuries as safe haven assets,” she said by email. “A change in Fed leadership will likely rattle the already-fragile financial markets and further tighten financial conditions.”
Market participants are generally of the view that Powell will not be fired, and senior administration officials say Trump recognizes he doesn’t have that authority. But even continued exploration of the possibility could make for a volatile week.
The market response to a material threat to the Fed’s independence would be complicated, according to Steve Englander, head of global G-10 FX research and North America macro strategy for Standard Chartered Bank. He said near-term uncertainty over the process and politics in a fluid situation would weigh on equity prices and bond yields. The dollar, he said, would likely face multiple opposing forces, but the “near-term response is likely negative on the risk that U.S. economic policy becomes more erratic.”
The Bloomberg Dollar Index was up more than 4 percent in 2018 at the end of last week and is close to its highest level in a year and a half, while the Japanese yen surged around 2 percent last week versus the greenback.
Chris Rupkey, chief financial economist at MUFG Union Bank in New York, is among the few eyeing the strained relations between the president and the Fed chair with equanimity.
The stock market “has discounted everything but the kitchen sink, including the loss of a Fed Chair who hasn’t been in office for even a year yet,” he said by email.
Given that the Fed is already close to the end of its hiking cycle, the markets won’t melt down if Powell leaves office, according to Rupkey. “They already did,” he said.
Those on the front lines of this week’s opening trade say markets are on a knife edge.
Mind the Machines
“If equity markets fall further, they’re going to set off machine-based selling,” said Saed Abukarsh, the co-founder of Dubai-based hedge fund Ark Capital Management. “The other risk is that experienced traders are on holiday, so the ones left will be trigger happy with every new headline.”
“I can’t see buyers stepping into this market to stem off any selling pressure until January,” said Abukarsh. “So if you need to adjust your books for the year-end with any meaningful size, you’re going to have to pay for it.”