By Michael O’Neill, Agility FX Senior Analyst          

Canadian Thanksgiving feasts have given way to turkey sandwiches.  Western Canada has already had to dig themselves out of snow, Ontario and Central Canada are clinging to summer and Eastern Canada is drying off from the remnants of Hurricane Mathew. All in all, it is a pretty normal start to the final quarter of the year.

Except it isn’t.

FX markets have had to contend with a mysterious plunge in the British pound against the US dollar, a sharp rise in oil prices without the commensurate rise in the Canadian dollar and a US presidential election that pits Side-show Bob against Bonny Parker incarnate. That is in addition to the seemingly endless US rate hike debate.

October was barely a week old when the British pound collapsed, losing 6% -10%, within two minutes, depending upon the FX platform. No one knows the catalyst for the plunge although there is a lot of speculation that the move was a result of a fat-finger or an errant algorithim.

Whatever the reason, traders became spooked and the FX jitter needle moved to HIGH from ELEVATED on the Homeland Security Scale.

security-alertThere is a good reason for the nerves. History. History hasn’t been kind to equity markets in October.  There was the Panic of 1907, the Wall Street Crash of 1929, Black Monday in 1987, the Friday the 13th crash of 1989, the Asia Crisis crash in 1987, the downturn of 2002, and the Bear Market of 2007.  It is no wonder why nerves are frayed.

Future historians may add the October 7, 2016 Sterling “flash crash’” to the list if it becomes the preamble to much broader financial malaise.

There is good news. The risks to financial market instability from the US election are rapidly fading every time Donald Trump opens his mouth. This is probably the first time that a presidential nominee is openly feuding with the party that nominated him. The impact of a Trump presidency on global markets is the great unknown while Hillary Clinton represents the status quo.

The fourth quarter of every year has had to deal with some recurring issues.  The most important is the deterioration of liquidity in December as books get closed for year end. Price movements get exaggerated as portfolio rebalancing flows occur sporadically throughout the month.  That’s because investment managers and hedge funds attempt to avoid trading in a really thin December 30th market.

Source : Wikkipedia

Another issue is the Federal Open Market Committee Meeting (FOMC) scheduled for December 13-14th.  The risks are rising that this will be the meeting when the FOMC raises US rates for only the second time since 2006.

Still, the fact that, according to the CME FEDWatch tool, only 64% of the market believes such a move will occur, sets the stage for some wild FX price moves, in the event of a hike. The moves would be exacerbated by seasonal liquidity issues.

Furthermore, the Committee will provide a new Summary of Economic Projections. Last year’s dot-plot estimates convinced markets that the FOMC would raise interest rates four times in 2016.  Ooops. That erroneous conclusion was a major issue for financial markets for all of 2016.

The 171st Organization of Petroleum Exporting Countries (Opec) meeting in Vienna, Austria on November 30th could be explosive. It will mark the 2-year anniversary of Saudi Arabia’s decision to forgo price in an effort to protect (or gain) market share.

The Saudi’s may have achieved their market share goals but wreaked havoc on their balance sheet and those of producer nations.  A change in Saudi Arabia’s ruling elite appears to have precipitated a “rethink” of the strategy. A $98 billion budget deficit, which Bloomberg reports, is the highest among the world’s 20 biggest economies, will do that to you.

Opec announced an agreement, which included Iran, to introduce production caps at a meeting in Algeria in September.  They were joined by Russia. On October 11 in Istanbul, President Vladimir Putin announced that his country would participate in Opec’s efforts to limit oil production.

Oil traders were singing “Happy Days Are Here Again”. West Texas Intermediate (WTI) rose from $42.52/barrel on September 20 to $51.58 on October 10. Saudi Oil Minister, Khalid Al-Faiih suggested that $60.00/b prices were “not unthinkable by year-end.  BP President Bob Dudley, agreed with him.

Apparently everything is sunshine and unicorns in the land of Opec. What could possibly go wrong?  A lot of things. For starters, Opec is talking about production caps while simultaneously pumping crude at volumes not seen since 2008. In 2008, global growth, led by China, was still rising.  That isn’t the case in 2016 or 2017. Global growth forecasts have been cut fairly often by various bodies including OECD, IMF and the World Bank.  Goldman Sachs analysts suggested that even if Russia and Opec agree to a production cut, higher production from Libya, Nigeria and Iraq will delay the rebalancing of the market. The oil price gains may not be sustainable.

The fourth quarter of 2016 has barely started.  Markets have already been exposed to exaggerated and volatile price swings in the form of the Sterling “flash crash”.  That move could be a sign of things to come.  There are plenty of risk catalysts lurking in the weeds, particularly from surprise policy announcements by any one of the major central banks that will be meeting between now and year end.  Be alert, be nimble and enjoy the ride.

‘Don’t be spooked by Quarter four, just be ready’             photo: Shutterstock