“Euphoria Turns To Terror”: Dow To Open 750 Points Lower As VIX Eruption Accelerates

Update: VIX SURGES ABOVE 50 FOR FIRST TIME SINCE AUGUST 2015

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It’s a bloodbath, with the Dow set to open 750 points lower “thanks” to the +377 fair value…

… but it could have been much worse, with S&P futures actually trading toward the highs of the overnight session after tumbling an additional 3.5% from Monday’s close, as risk assets around the world crashed then modestly rebounded even as traders remain on edge over what the implosion in the vol complex means for everyone.

World stock markets nosedived for a fourth day running on Tuesday, having seen $4 trillion wiped off from what just eight days ago had been record high values.

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“Playtime is officially over, kids,” analysts at Rabobank said. “Rising volatility painfully reminds some investors that one-way bets don’t exist.”

“Since last autumn, investors had been betting on the ‘Goldilocks’ economy – solid economic expansion, improving corporate earnings and stable inflation. But the tide seems to have changed,” said Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities.

Meanwhile, “The euphoria has turned to terror.”

There was a modest bound in European bourses, which opened sharply lower in the wake of the largest ever point loss in Dow Jones Industrial Average history. London’s FTSE 100 lost 3.5% at the opening bell, with every constituent falling and financial stocks hit hardest. The Europe-wide Stoxx 600 fell 2.2 %, while Frankfurt’s Xetra Dax 30 fell 3.5%, before recouping some losses.  As of this writing, core European cash equity markets trade around -1.5%/-2.0%.

In fact, as Bloomberg notes, the Stoxx Europe 600 Index at one point today slumped the most since Brexit, with every industry sector falling as much as 2 percent.

This came after massive falls on Asian bourses. Stocks in Japan and China were the worst hit, with Hong Kong tumbling over 6% in early trading. Japan’s Topix index was down by more than 6%, marking its biggest one-day fall in a year and a half, while Japan’s Nikkei fell over 10% from its Jan 23 high, entering a correction, after plunging as much as 7.1%, triggering JSCC intraday margin call for Japanese index futures.

And while Asian stocks also managed to rebound modestly from overnight lows it was not before the MSCI Asia Pacific index erased 2018 gains, just like the Dow Jones, which is itself on the verge of a -10% correction.

Meanwhile, in some welcome news, there was at least a little normalcy as Treasuries extend their safe-haven rally with 10-year yield down three basis points to 2.68%, while euro-area bonds found support.

The currency market was stock-driven for another day with the dollar turning negative as European equities pared losses and S&P futures traded briefly in the green, although after the Bloomberg Dollar index was modestly in the red, it has since surge higher suggesting things are about to get ugly again.

As Bloomberg notes, major G-10 FX pairs again remain relatively immune to wild equity swings, yuan rallies after PBOC says the market will have a larger role in FX rate; USD/JPY holds close to 109.00. Haven demand eased modestly, with the yen and the Swiss franc turning defensive. The euro moved above the $1.24 handle as short-term accounts closed shorts with a loss. The Aussie remains lower after uneventful RBA policy meeting.

Whipsaw in core fixed income, early trades see fading of rally in UST, Bund and Eurodollar futures before uptick in volatility measures prompts reversal; UST/bund spread wider by 7bps with futures block trades in focus, iTraxx crossover opens sharply wider but settles close to key 260bps level. Bitcoin briefly trades below $6k level.

In the commodities complex, both WTI and Brent crude futures trade lower albeit off worst levels with prices suppressed by the ongoing global risk sentiment; the recovery for WTI has also been stalled by a failure to reclaim USD 64/bbl to the upside with energy newsflow otherwise relatively light ahead of tonight’s API inventories. In metals markets, spot gold (+0.25%) continues to benefit from its safe-haven appeal and the softer USD despite the World Gold Council stating that demand for the yellow metal fell to its lowest level since 2009 during 2017.  The Bloomberg Commodity Index is trading 0.2% lower, having pared loss of as much as 0.4% earlier.

But unlike recent days, when attention was on US TSYs and the Dollar, today – and for the coming days – it will be all about the VIX, which extended its advance after Monday’s biggest-ever jump, which sent it higher by 116% on the session, heading for a level not seen since August 2011.

As of 6:39am in New York, the VIX climbed another 24% to 46.37. As discussed last night, the surge in the volatility measure is already claiming casualties, with various VIX-linked ENT set for “termination” and raising questions about the future of exchange-traded products tied to it.

And while we wait for today’s trading session to unfold, here is what else happened overnight.

Bulletin Headline Summary from RanSquawk

• European equities join the global sell-off as markets look to see whether Wall St will endure another day of heavy losses
• That said, markets have gradually pared losses throughout the morning as commentators debate whether this is a minor blip or part of a larger correction
• Looking ahead, highlights today include Canadian trade, APIs, NZ jobs and a slew of speakers

Market Snapshot

• &P 500 futures little changed at 2,608
• STOXX Europe 600 down 1.6% to 375.99
• MXAP down 3.4% to 173.27
• MXAPJ down 3.5% to 568.36
• Nikkei down 4.7% to 21,610.24
• Topix down 4.4% to 1,743.41
• Hang Seng Index down 5.1% to 30,595.42
• Shanghai Composite down 3.4% to 3,370.65
• Sensex down 1.6% to 34,198.34
• Australia S&P/ASX 200 down 3.2% to 5,833.34
• Kospi down 1.5% to 2,453.31
• German 10Y yield fell 4.8 bps to 0.688%
• Euro up 0.3% to $1.2404
• Brent Futures down 0.7% to $67.13/bbl
• Italian 10Y yield fell 2.4 bps to 1.757%
• Spanish 10Y yield fell 2.9 bps to 1.43%
• Brent Futures down 1% to $66.93/bbl
• Gold spot up 0.3% to $1,343.64
• U.S. Dollar Index down 0.1% to 89.48

Top Overnight News from BBG

• ECB’s Jens Weidmann says the greatest risk is now to assume that all problems are solved. “Shocks in specific regions or specific sectors of the economy can still put the euro area to an endurance test — despite the progress that has been made in the past years”
• RBA leaves interest rates unchanged at record-low 1.5% as seen by all 28 economists surveyed by Bloomberg; its chief, Philip Lowe, reinforced that a return of rapid wage growth remains a distant prospect despite strengthening business investment and a hiring bonanza
• Germany’s factory orders increased 7.2% y/y in December versus estimate increase of 3.1% y/y; Germany construction PMI rose to 59.8 in January from 53.7 in December
• Janus Henderson Group’s return to inflows proved to be short-lived, another sign that active managers have a long way to go before they stop the bleeding; the firm reported $2.9b of outflows in the three months through December, compared with the $700m of net new money it attracted in the three months through September
• U.S. House sets Tuesday vote on stopgap spending measure
• U.K. January BRC like-for-like retail sales 0.6% vs 0.7% estimate
• Kuroda: Carefully watching stock markets; economic fundamentals are firm
• RBA leaves rate unchanged; sees low wage growth to continue for a while
• Australia December trade balance – A$1.4b vs A$0.2b estimate; Australia December retail sales -0.5% vs -0.2% estimate

Asia stocks continued the global equity sell-off and saw hefty losses across the board, as panic selling rolled over to the region following a slaughtering on Wall St. in which the DJIA (-4.6%) tumbled nearly 1200 points and briefly  slipped into correction territory with sell programmes pushing the space lower but closed well off session lows amid a recovered on low volume. ASX 200 (-3.2%) and Nikkei 225 (-4.7%) slumped at the open in which losses in crude weighed on Australia’s energy stocks, while the Japanese benchmark was the worst performer amid JPY strength and with the index in a technical correction. Hang Seng (-5.1%) and Shanghai Comp. (-3.4%) were also heavily weighed amid the ongoing market turmoil and after the PBoC refrained again from liquidity operations. Finally. 10yr JGBs traded higher and tracked the gains in T-notes which were up over a point, as the ongoing stock market sell-off spurred a flight-to-quality and lifted bond across the curve which saw the Japanese 40yr yield drop to its lowest since April last year. Furthermore, today’s 10yr inflation-indexed auction from Japan also attracted stronger demand and higher accepted prices. PBoC skipped open market operations again today for a daily net drain of CNY 80bln. PBoC set CNY mid-point at 6.3072.

Top Asian News

• Ex-Goldman Volatility Trader Sees More Blood Before Rout Ends
• Kuroda Says 10-Year Yield Target Won’t Change ‘Even a Bit’
• Singapore, Malaysia Agree to New Stock Exchange Trading Link
• What Global Policy Makers Are Saying About the Stock Slide
• Currency Fundamentals Aren’t Shifting Much: FX Macro Ranking
• Evergrande January Contract Sales 64.4B Yuan

European equities have kicked the session off on the backfoot (Eurostoxx 50 -1.8%) in a continuation of the sentiment seen late last night on Wall Street and overnight during Asia-Pac trade. There’s been a lack of fresh catalysts in European trade for the sell-off with participants in the region catching up to yesterday’s aforementioned losses; prices have recovered modestly from initial losses but remain markedly lower with all the ten sectors firmly in the red. Losses across all sectors are relatively broad-based with some slight underperformance in financials amid the downtick in yields and a disappointing earnings update from Munich Re (- 3.9%) who sit at the bottom of the DAX. Focus in the financial sector has also been placed on Credit Suisse (-3.7%) who opened with heavy losses (-7.2%) amid fears over declines in the XIV (a product issued by the company). In the Stoxx 600, very few companies trade in the green with Intesa Sanpaolo (+1.7%) a notable exception following their pre-market earnings.

Top European News

• ECB’s Weidmann Says Complacency Is Biggest Risk for Euro Area
• Freezing Russian Air Hits Europe After Third-Mildest January
• AMS Potential Convertible Bond Placement Up to EU600m
• Investec’s Koseff, Kantor Step Down After 40 Years at Helm

In currencies, Usd/Jpy and Eur/Jpy are edging higher again as EU cash bourses pare worst losses and flight to quality flow/positioning wanes somewhat. The headline pair has rebounded above 109.00 vs circa 108.50 lows overnight and bids at that level extending down to 108.30, just ahead of strong technical support at 108.28. The cross has traded up to 136.75 from around 134.00 in Asia, as Eur/Usd briefly reclaimed 1.2400+ status and the DXY continues to struggle on recoveries above 89.6000 near term resistance (within an 89.720-370 range). Cable is back below 1.4000 and briefly took out 1.3980 ‘support’ as Sterling succumbs to more UK political/Brexit uncertainty – Eur/Gbp pulling away from 0.8900. Usd/Cad edging back down towards 1.2500 having tested 1.2550+ levels when risk aversion was running rife (Dow crashing almost 1600 points for example). Elsewhere, some marked region-specific divergence in the Aud and Nzd, as the former was hit by disappointing data (weak retail sales and an unexpected trade deficit) plus some RBA concerns about wages, household consumption and the growth/inflation outlook, if the currency  appreciates too much. Aud/Usd is now under 0.7900 albeit off 0.7835 lows, while the Aud/Nzd cross has lost the 1.0800 handle and the Kiwi is back above 0.7300 vs the Greenback.

In the commodities complex, both WTI and Brent crude futures trade lower albeit off worst levels with prices suppressed by the ongoing global risk sentiment; the recovery for WTI has also been stalled by a failure to reclaim USD 64/bbl to the upside with energy newsflow otherwise relatively light ahead of tonight’s API inventories. In metals markets, spot gold (+0.25%) continues to benefit from its safe-haven appeal and the softer USD despite the World Gold Council stating that demand for the yellow metal fell to its lowest level since 2009 during 2017. Elsewhere, base metals were seen notably lower overnight in-fitting with the lack of global risk appetite with nickel said to have led the complex lower.

US Event Calendar

• 8:30am: Trade Balance, est. $52.1b deficit, prior $50.5b deficit
• 10am: JOLTS Job Openings, est. 5,961, prior 5,879

DB’s Jim Reid concludes the overnight wrap

If you turned off your phone after dinner last night in Europe or if you had to leave early in the US you’ll be waking up to an extra-ordinary last hour on Wall Street. In fact the DOW dropped c.800 points in 10 minutes at 3pm NY time to be down -5.87% at the time. The DOW and S&P 500 eventually closing at -4.60% and -4.10% respectively – the worst day since August 2011. 10 yr Treasuries rallied 13.6bps (18bps from the day’s highs) to 2.707% – the biggest rally since June 2016. The biggest talking point though has to be the VIX which saw its biggest daily climb EVER, both in percentage and absolute terms (+116%, +20.0 to 37.32). This was the highest level since August 2015 when the Shanghai Comp.’s c8.5% drop briefly led to a vol spike after their currency devaluation. However before that you’d have to go back to October 2011 to see a higher close. Indeed if we look at the 7,077 trading days since VIX data is available (back to 1990), yesterday’s close would be in the top 96.85% percentile with most of the higher points occurring in 2008/09. Given how many products (including leverage ETFs) that have set up to exploit low vol, yesterday surely would have done some serious damage.

This morning in Asia, markets are extending the US selloff. The Nikkei (-5.23%) is on track for the largest fall since November 2016, while the Kospi (-1.36%), Hang Seng (-4.03%), and China’s CSI 300 (-2.55%) are all down as we type. S&P futures are 1.5% lower. The UST 10y yield is another c2bp lower and the House Republicans will vote later today to extend government funding until 23 March.

Indeed the last few days have really emphasised how easy it would be to get the next financial crisis if inflation really started to misbehave as most of this price action stems from a hint of it. When we published the note of the same name last September, we said the next crisis was inevitable soon and that the most likely cause over the next 2-3 years was if what we called the great withdrawal of unconventional policy coincided with higher inflation, especially given what are still record high levels of global market debts. If higher inflation materialised then central banks would be unable to respond in the way they have done in recent years (and even decades). Our structural view was that the next financial crisis was probably unavoidable before the end of the decade. In our 2018 outlook the base case was higher than expected inflation and yields but a controlled widening of spreads as the year progressed reflecting this and the likely associated higher levels of vol that this would bring. So the price action of the last few sessions is an extreme version of our 2018 view but perhaps more in line with medium term views.

For 2018 it all still rests with inflation. If US inflation is just a bit above expectations this year then our base case is still probably something we feel comfortable with (IG +25bps and HY +100bps over 2018). However if US inflation beats by more, the glue that has held the carry trade – and associated recent multi-year risk rally – will unfold very quickly and the timing of the next financial crisis will be brought forward. The problem is that a number of US labour  market statistics look increasingly stretched. So could wages really break out much higher in 2018? One to ponder but Torsten Slok’s latest chart book on the stretched US labour market is useful on this.

For balance, we should say if this fails to lead to US inflation breaking out on the upside then we will almost certainly go back to carry and risk will rally back big time. So inflation is absolute key. If we get through 2018 without some pick up, economists may have to throw out all their inflation/wages models. In listening to one of our US economists Matt Luzzetti last night, he made the point that this recent move will matter in so far as in impacts financial conditions. They have tightened sharply from record easy levels but their analysis suggest that the tightening needs to last for at least 6 weeks for it to impact growth momentum. So we have some time before growth expectations should be materially influenced. Interesting Bloomberg’s March Fed hike calculator went down from 82% to 80% yesterday. Not a big move so far.

Staying with rates, a big difference yesterday was that bonds seemed to benefit from a flight to safety even though they are the root cause of the move. Interestingly DB’s Alan Ruskin has shown that consecutive weeks of higher US bond yields and lower equity prices, have become progressively less common since the 1980s/1990s, and especially since the 2008 financial crisis. Three weeks of equities down, 10y yields up (as we’ve just seen) has not happened for more than a decade. The normal crisis relationship between equities and bonds was restored yesterday.

In Europe, 10y Bunds fell as much as 4.7bps at one stage to 0.715% before paring that move to close just over 3bps lower by the end of play. The Stoxx 600 however tumbled -1.56% and suffered its biggest one day and two day fall (-2.92%) since July 2016, while the six-day tumble of -4.64% is the biggest since June 2016. However this all happened before the bulk of the US sell-off so stand by for a wild ride at the open this morning. It’s worth highlighting that the moves in the last two days have now pushed most major US/European markets into negative territory YTD.

Rounding out the stats for the US, all sectors fell with losses led by the financials, health care and industrials sectors. Wells Fargo dropped 9.2% after the story we discussed yesterday concerning the Fed banning the bank from increasing its total assets beyond their size at the end of 2017 (US$1.95trn) until it cleans up its consumer and compliance issues.

Turning to currencies, the US dollar index gained for the second consecutive day (+0.40%), while the Euro and Sterling fell -0.77% and -1.13% respectively, with the latter weighed down by softer PMI readings. In commodities, WTI oil retreated for the third consecutive day to $63.55/bbl (-0.94%). Elsewhere, precious metals rebounded given the risk off tone (Gold +0.47%; Silver +0.87%) and other base metals were mixed but little changed (Copper +0.92%; Zinc  +0.79%; Aluminium -0.24%).

Away from the markets, the ECB’s Draghi seemed relatively dovish on his annual report to the EU parliament. On rates and inflation, he noted that “while our confidence that inflation will converge toward our aim of close to 2% target has strengthened, we cannot yet declare victory”. Further, he added “monetary policy will evolve in a fully data-dependent and time consistent manner” and that “….patience and persistence with regard to monetary policy is still warranted for underlying inflation pressure to build up”. Elsewhere, the Fed’s Kashkari noted in last Friday’s jobs report “we saw a little hint that wages might finally be rising…

but its’ not yet enough”. He added “it could be a blip, but let’s not ignore it”. In Germany, today may be the deciding day for Ms Merkel to form the next coalition government as talks resume at the CDU’s headquarters. The Saxony State Premier Haseloff expects a coalition deal with the SPD today and noted “we’ve covered most topics (with the SPD), just several fundamental questions on health care policy remain”. On the other side, the SPD General Secretary Klingbeil said today “is the decisive day…it’ll be decided whether we successfully close the talks or not”. He added “all of us are willing to get to a solution, but the talks are contentious”.

Now onto some of the Brexit headlines. The EU negotiator Barnier and the UK’s Brexit secretary Davis have met  officially for the first time in 2018 but their respective positions seemed broadly unchanged. Mr Davis emphasised that the UK has been “very clear” on what it wants, but Mr Barnier disagreed and noted “the time has come to make a choice” and that barriers to goods and services are unavoidable if the UK leaves the customs union. For now, the EU side “will wait for an official UK position of the government, in the next few weeks”. Elsewhere, the head of the UK’s Financial Conduct Authority warned that both sides need to reach a transitional agreement for financial services by March, in part as some derivatives and insurance financial contracts may no longer be “serviceable”.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the January ISM non-manufacturing index was above market at 59.9 (vs. 56.7 expected) – the highest since 2005. In the details, the employment gauge rose to 61.6 – the strongest since 1997 and the new orders index rose to a seven year high. The final reading of January composite and services PMIs were unrevised at 53.8 and 53.3 respectively. In the Fed’s latest senior loan officers survey, banks reported demand for commercial and industrial loans (C&I) were broadly unchanged but weaker for auto loans and residential mortgages. Looking ahead, the survey found that banks expect to ease standards on residential mortgages and C&I loans, while tightening standards on commercial real estate and credit card loans.

The Euro area retail sales was broadly in line at -1.1% mom (vs. -1% expected), while the February Sentix investor confidence index was slightly lower than expected at 31.9 (vs. 33.2). The final reading of the Euro area January PMIs was revised slightly higher, with the composite PMI up 0.2 to 58.8 to a c11 year high and services PMI up 0.4 to 58. Across the countries, Germany’s composite PMI was revised 0.2 higher to 59 while France was revised down 0.1 to 59.7.

Elsewhere, the flash PMIs for Italy were above market, with the composite PMI at 59 (vs. 57.4 expected) and services at 57.7 (vs. 55.9 expected). In the UK, the flash PMIs were lower than expectations, with the composite PMI at 53.5 (vs. 54.6) and services PMI at 53 (vs. 54.1 expected) – the lowest since September 2016.

Looking at the day ahead, a fairly quiet data day all round with December factory orders in Germany the only release of note in Europe, while in the US the December trade balance and JOLTS job openings data is scheduled to be released. Away from that it’ll be worth keeping an eye on Fed Bullard’s comments when he speaks in the afternoon on the US Economy and Monetary Policy, while the ECB’s Weidmann speaks in the morning. General Motors and Walt Disney are due to report earnings.

Good luck navigating what looks set to be a volatile period for markets.