Just another manic Monday

There is no other word for yesterday’s markets but ugly. We walked in yesterday anticipating a relatively calm day with China closed, a strong jobs report from the US to chew over and limited economic data to rock the boat. We even started with equities running higher and haven currencies such as the yen and the euro retreating. We were set for a relaxed Monday session.

How wrong we were.

Markets got themselves in a state yesterday over the balance sheets and risks surrounding the European banking sector in what felt eerily similar to 2008’s credit crunch.

Investors sold banking shares following runs of poor earnings and, rightly or wrongly, the fears that banks may not be able to repay some debts. Contracts used to insure against default on these debts were heavily bought as a result, which in turn generates a feedback loop of negativity. The main target was Deutsche Bank which fell by around 10% yesterday.

This is a banking story for now and it is not necessary to go through the individual debt issues that these banks are meant to be struggling with, however, against a backdrop of fragile economic confidence, it is easy to see why markets ran so red yesterday.

The way that this translates into currency is a pure and undiluted shift into haven assets and when the proverbial is hitting the fan, traders are focused on one characteristic only; the country’s current account. If you have a strong surplus based on exporting more than you import and investment abroad then you will do well. Case in point being the yen and the euro.

If you operate a deficit, like the UK does, then you are in trouble when the skies start to darken.

Nearly two weeks ago, the Bank of Japan added negative interest rates to their policy toolkit in an effort to dissuade investors from making yen deposits. Since the announcement, however, USDJPY has lost over 5% as investors have ignored that negative rate. We are back to the thoughts of “forget about a return on my money, I just want a return of my money”. It is therefore not a surprise to see that Japanese bonds as far as 10 years out are able to pay no interest. The demand is so high and inflation so low.

We are stepping through the looking glass.

For the pound, the situation was pretty grim and following a week that looked like economic data was rebuilding sterling from its oversold lows. The EU referendum was not the cause of yesterday’s weakness but once again will act as a very real reason for investors to limit their exposure to sterling. As long as market headlines echo fears from 2008 then sterling will trade like 2008 – a dog.