- New Science in old markets -

Whatever happened to risk on/off?

Stocks, bonds commodities and non-US$ currencies have all fallen in the past few days. Some were already dropping when the US employment number came out firmer than expected on Friday but all have fallen since. This is not the customary pattern in which some markets move reliably against others (so-called risk on/risk off) and this uniform move must be attributed to a shift in sentiment about a common influence.

That common element is of course the prospect for US interest rates. Prior to the data release (an increase of 224,000 vs. an expected 160,000) there had been almost universal agreement that the Federal Reserve would soon start cutting rates in expectation of a weakening economy. This consensus is a mystery as there had been little sign that the resurgent growth seen in recent quarters had stalled. The saying goes that 'economic expansions don't die of old age' and yet the eerie feeling of impending doom has crept in to economic and market discourse lately, for no apparent reason. The number of jobs created in June was in no way remarkable but expectations had obviously been conditioned by the weak number for May, which must now be seen as an outlier. This chart shows the last 12 months' of payroll data:

Non-farm payroll

The 'confounded expectation' of lower rates soon has led to a dip in most markets and a particularly severe one in US treasury prices.

We had reported top extensions in a wide variety of markets in recent editions and this reflects the 'overcooked' nature of buyers' enthusiasm for various assets - presumably because of this mistaken expectation that rates would imminently decline. An updated summary:

various top exts

This is highly unusual. For many stock markets to be rising at the same time as almost all bond markets while commodities also push higher is irrational (even by usual market standards) and could mark a watershed. We will soon see if the result of all these top extensions in 'opposing' assets is a mere pause in the uptrend or (as we think) the start of a new phase where prices diverge again and some fall back. We are mostly sidelined here, with some small short exposure in sugar, cotton and gold and we wait.

All signals courtesy of software supplied by our friends at Parallax Financial Research www.pfr.com