How Much Stress is in the Financial Markets?

Jeffrey Roach:

Hi, I am Jeffrey Roach, Chief Economist for LPL Financial, with an update on what's happening in global markets and a call to action for investors. First, financial stress is still below average. Here's a chart on stress levels in various areas of the financial markets, the recent spike in volatility, and the global market sell-off created an increase in stress across the spectrum. But was the increase in stress a warning sign of more to come? Well, not so fast. The Office of Financial Research, an independent bureau reporting to the U.S. Treasury, well, they're tasked with monitoring stress within the financial system. They provide a daily snapshot of stress within credit, equities, funding markets, and safe assets. Safe assets, by the way, are gold prices, 10-year Treasuries, major currencies, such as the Yen and Swiss Franc. Ironically, stress in those safe assets, that's the gray line, were below average stress levels even during the sell-off in Japan.

Jeffrey Roach:

Stress in major markets are still below average stress levels. Second, wide interest rate differentials are seeds of volatility. It should come as no surprise that currency volatility rises when central banks are at extreme policy positions. The U.S. Central Bank tightened quickly and kept rates elevated while the Japanese central bank had rates unusually low. The divergence between the Fed policy and the BOJ was the main culprit for the imbalances that existed for years. The wide interest rate differentials between the Bank of Japan and the Federal Reserve created a fertile environment for the yen carry-trade. The unwinding of the yen carry-trade induced stress and fragility into the markets, but stress levels are still below normal. Third, July retail sales play catch up. Retail sales rose almost a full percentage point supported by a rebound in motor vehicle and part sales.

Jeffrey Roach:

Well, it's no surprise auto sales rose since new vehicle incentives were the highest in more than three years. Average incentives in July rose to 7% of the average transaction price up from 6.4% in June. Plus the downward revision to the previous month made July's monthly gain in retail sales more pronounced. However, it gets more interesting when you look at consumer choice between online shopping and department store shopping as we show in this chart. Bottom line here is solid disposable income growth gave the consumer ample opportunity to keep the retail economy growing. However, this report will not likely change the Federal Reserve's calculus about cutting rates in September. We heard recently from the Atlanta Fed President Raphael Bostic, that the Fed cannot afford to be late in cutting rates as unemployment increases. Investors should expect more volatility in the near term as the economic data likely give conflicting signals. Well, that's all for now, and if you want more insights on global market trends, follow us on social media and take care.