This past week started out rough and it never really got better. Monday kicked off with a stronger than expected retail sales number, but that was viewed as inflationary more than anything on the heels of the prior week’s CPI report. From there, the markets kept taking punches. The Israeli attack on Iran really triggered risk-off behavior. Treasury yields plunged, gold prices shot higher, crude oil spiked and the VIX touched its highest level since October of last year. The worst of the war-related reaction was unwound on Friday, but the damage has clearly been done. The economic strength narrative had been preventing a noticeable pullback in equities, but war is the one thing that has shaken the confidence of investors.
If you look at any of the major indicators - utilities/S&P 500, lumber/gold, low vol/high beta, growth/value, the VIX, high yield spreads - they’re ALL pointing to a pretty decisive risk-off environment. In past pullbacks, you could point to specific sectors or themes and see some pockets of strength, but there was almost none of that last week. Every risk-off and/or defensive asset class outperformed, while every risk-on one lagged. Strangely, the situation with the yen in Japan, which was probably market risk #1 entering the week, ended up being an also-ran with still no major announcement from the Bank of Japan.
The markets are pretty clearly struggling to come to terms with the idea that the Fed won’t be providing relief any time soon. The war in the Middle East has a very uncertain outcome and we know that the markets hate uncertainty. The situation in Japan where the yen shows no signs of reversing and the “will they, won’t they” status of the BoJ feels more like a pressure cooker as each day passes with no action. This may be the strongest set of risk-off conditions we’ve seen since the regional banking crisis a little more than a year ago.
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