After the previous few weeks of consolidation in the equity markets, we finally saw the market achieve some sense of direction last week, as the bears finally broke the shackles of what has been an incredible rally over the past few months. In the first three days of trading UK, US and Asian indices were down more than 4%.
One possible reason for the sell-off could simply be that buyers had finally run out of steam, giving the sellers the impetus to take some control of the market. Don't forget equity markets across the globe have rallied from 30%- 40% since early March, and some sort of correction was always on the cards. However, after a better-than-expected Philadelphia Fed figure on Thursday, which is a survey measuring regional manufacturing growth, the downward move was somewhat halted.
Interestingly Nouriel Roubini, commonly known as Dr Doom after predicting the 'credit crunch' well before it came into fruition, came out of the woodwork last week to let us know that unemployment in the US will hit 11% "for sure". He also added that the ECB has underestimated the crisis in Europe compared to the Federal Reserve's aggressive actions. These comments, coupled with downbeat forecasts from Standard & Poor's for many US Banks, also added to the bearish tone of the markets early in the week.
Despite the movements in the equity markets, most of the volatility still lies in the FX markets. The dollar in particular took centre stage as the BRIC (Brazil, Russia, India and China) countries discussed prospects of diversifying the world's reserve currency away from the US dollar. What was very interesting though, was the contradictory rhetoric coming from Russia, as the finance minister defied his president by reassuring markets that there was no alternative to the dollar and the currency was in "good shape". Despite these comments, the stance of BRIC countries did weigh on the dollar more last week.
Finally, President Obama was in the spotlight last week, and although a ridiculous amount of attention was placed on the fact he swatted a fly during an interview, his proposal of a major revamp of the US regulatory system, the biggest of its kind since the 1930s, did make the headlines of the financial press. If approved by Congress, this plan would give the Fed powers to regulate companies whose failure could endanger the banking system. For big banks, there could be an increase in regulation of hedge funds and derivatives. Obama rather optimistically said: "We have crafted reforms to pinpoint the structural weaknesses that allowed for this crisis and to make sure that these problems are dealt with so as to prevent crises in the future."
In a similar vein, Bank of England governor Mervyn King also proposed radical changes to the banking system. He commented that investment banks should be split from retail banks and generally no bank should be deemed "too big to fail". It is clear that the financial crisis will have lingering effects on the economy and such radical reform may be necessary.
Rollercoaster ride for sterling traders
As mentioned above, currency markets were volatile last week but none more so than GBP/USD, which is commonly known as cable, due to the days when a cable under the Atlantic synchronised the rate between the London and New York markets. On Monday, cable opened considerably lower and finished on the downside in a choppy day's trading. However, most of these losses were erased by Tuesday with inflation figures remaining resilient and staying above the target 2% at 2.2%.
The major focus however for sterling was the data released on Wednesday with minutes from the recent BoE rate decision being announced alongside unemployment figures. The BoE minutes came in fairly in line with expectations but unemployment actually surpassed expectations. The reaction to this data was quite a big sell-off.
However, the release of a worse-than-expected US CPI figure sparked cable to bounce back and erase most of its losses for the day. This reliance on economic figures continued through to Thursday when very poor UK retail sales figures sent cable back down.
Technically speaking, the market is showing signs of turning from the trend established in March. A few weeks ago we saw an engulfing pattern which is popular candlestick formation to signal a top of a trend. After this pattern formed on 3 June, the market did fall off heavily from a high of $1.6660 to $1.58. Since then, we did see prices pop briefly above $1.66, but it couldn't hold. Trading has been lower since, and a downtrend does seem to be ensuing.
Written by Vinay Sharma & Grace Smith, traders with Delta Index