Tuesday February 23

Stocks fall along with oil prices as risk aversion returns. The S&P500 fell 1.3% to 1,921 and the Dow Jones 1.1% to 16,431. Leading the charge in equity losses were financial and energy companies. A selloff hit the banking sector after JP Morgan announced it would raise capital levels as a result of potential stresses in its oil loan portfolio. Energy shares fell as oil prices experienced a renewed selloff. Oil prices fell after comments made by Saudi Arabia’s oil minister said that the leading producers would not cut production levels to combat the market oversupply. This decisive comment sent prices downwards, as market participants had been pricing in further collaboration among oil producers. Brent prices fell 4.1% to $33.27 and WTI lost 4.5% to $31.88. In Asia investors focused on a weaker daily fix for the renminbi. Barclays analysts highlighted the idea that the PBoC will be forced to accept one of the three following actions in the next year given the unsustainability of the country’s falling foreign reserves. The PBoC will likely have to raise capital controls, tighten monetary policy, or do another sharp devaluation of the renminbi. All three of these options are unfavorable given the country’s policy goals, and would have adverse effects on global financial markets. Gold prices rose as the risk off atmosphere returned to markets. The Japanese yen rose 0.7% against the dollar to Y112.09. The 10 year Treasury yield fell 2 basis points to 1.75%.

In an investor meeting today JP Morgan announced that it would build reserves to buffer against losses in energy loans. As oil prices fall and remain at historically low levels, borrowers with exposure to oil prices become increasingly unlikely to meet their obligations as their cash flows are cramped. Banks around the world lent heavily to oil producers over the last few years during the fracking boom. These concerns sparked the selloff that hit banking shares a few weeks ago, and the renewal of these concerns sent prices lower today as well.

Vice Chairman of the Fed Stanley Fischer says that it is still too early to understand the full ramifications of the recent observed market volatility. While Fischer notes that volatility can potentially lead to natural tightening in financial and credit conditions which are headwinds to growth and inflation, in the past similar periods of volatility have not had any long lasting effects. As a result it is still too early to tell how recent market developments will affect the Fed’s policy goals. Fischer commented on higher wage growth, high core inflation, and a pickup in retail spending, however countered those tailwinds with the fact that falling oil prices will continue to weigh on inflation.

Emerging market debt continues to be a casualty if the risk aversion attitude that is spreading across global markets. Investors en masse are liquidating holdings of foreign debt that is denominated in both hard and local currencies. This dynamic is reflected through the deterioration in foreign exchange rates and the subsequent rise in yields. Over the last 12 months in Brazil, the real has depreciated almost 28% against the dollar, and the 10 year yield has risen 290 basis points to 15.7%. In South Africa the rand has fallen 23.4% and the 10 year yield has risen 190 basis points to 9.4%. In Turkey the lira has lost 17.1% and the ten year yield has risen 300 basis points to 10.7%. These countries are all plagued with some combination of negative spillover from China’s slowdown, lower commodity prices, and widespread risk off attitudes among investors. Research has showed that emerging market debt funds that invest in local bonds have experienced outflows of $12bn over the last year. Now emerging market countries are left with a heavy debt burden as a result of heavy borrowing, weakened currencies, and a lack of access to international capital.

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Tuesday February 23

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