BNY Mellon: In the Bleak Midwinter

21 december 2018

By Simon Derrick, Chief Currency Strategist, BNY Mellon

Comparisons have been drawn between the performance of US equity markets since the Fed’s move on Wednesday with that seen in February 1994. It’s still interesting to recall the events of close to 25 years ago.

It is by no means a perfect analogy. The US economy was only just recovering from a deep recession and the Fed was far more concerned with the formation of a bond market bubble than anything else.

Nevertheless, the FOMC’s surprise 25 bp rate hike on February 4 not only triggered a sharp rise in Treasury yields but also hit equities and the USD hard.

In particular, the USD fell from just over JPY 109 to a low of JPY 101.75 in less than two weeks (with a huge fall emerging on Valentine’s Day).

Moreover, it’s arguable that this initial move might have extended considerably further over the following weeks if it hadn’t been for the resumption of Tokyo’s intervention campaign in the currency markets on February 15 (a campaign that would continue through until November 1994).

Overnight realized volatility (measured on an open/high/low/close basis) rose throughout this period, finally peaking out on February 22 at almost 19%. 

While 1994 provides an interesting example of how the USD can lose significant support in the face of a more hawkish than expected Federal Reserve, it’s also worth considering quite how the USD can perform more generally in the face of equity market weakness.

In purely index performance terms, late 2007/early 2008 provides a particularly interesting comparison with the movements seen in the S&P 500 from October 9 of that year matching surprisingly closely to those seen since September 10 of this year (see chart).

In the initial stages of the stock market turbulence (October 9 to November 26) the USD came under increasing pressure, falling from just above JPY 117 to a closing low just below JPY 109.

Something of a recovery then emerged (sparked initially by some positive news for the banking sector) with the S&P recouping a significant proportion of its losses over the next few weeks while the USD rebounded to above JPY 114 by just after Christmas.

However, the feeling of bonhomie did not last, with the publication of weak US new home sales numbers on December 28 sparking renewed fears of a hard landing in 2008.

Between December 28 and January 23 (the day the S&P found a temporary floor) the USD managed to fall from JPY 114 to below JPY 105. As might be expected, overnight realized volatility rose through this period, peaking out north of 20%.

It’s a given that history doesn’t repeat itself. However, there are still plenty of things to be learnt.

In particular, the events of 1994 and 2007/8 highlight how high overnight realized volatility can rise and how far the USD can fall against the JPY in a short period of time when US equity markets come under pressure.