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Technicals overpower fundamentals
The catalysts for the sell-off in risk assets over recent days have been the rise in 10y bond yields globally over recent months and more specifically, the significantly higher than expected Average Hourly Earnings figure in the US on Friday. To investors cosseted and emboldened by a low inflation and low rates environment for so long, there seemed to be a sudden and violent repricing of the probability that higher inflation and higher rates may be on their way.
In our view, the contrast in risk asset behavior and the timing of the equity price action in recent days – with the sell-off accelerating materially into the market close – is consistent with the rebalancing of systematic trading strategies, risk parity funds and exchange traded products that invest in short-term VIX futures in particular. The popularity of low and short volatility exchange traded products, some leveraged, has increased dramatically over the past few years as investors seek any edge to boost returns.
This reinforces our belief that while the initial catalyst to the sell-off was fear of a step change in the overall inflation and rates regime, that the subsequent risk-off momentum has been largely driven by technical rather than fundamental forces.