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US-North Korea spat remains in focus

Here are the big questions for markets as a new trading week begins.

Time for buying the dip?

After a customary languid start to August, the escalating verbal spat between Donald Trump and North Korea over that country’s nuclear weapons has triggered the return of market volatility.

Following months of clear sailing, marked by growing angst among investors over slumbering volatility, and elevated asset prices across developed world equities, emerging markets and corporate debt, a “healthy” correction may finally beckon.

“There has been no apparent attempt by either North Korea or the United States to ease the rhetorical flourishes that have made global investors nervous,’’ says Marc Chandler, strategist at Brown Brothers Harriman.

Not surprisingly, the tip of the spear for bouts of market aversion is a liquidation of currency carry trades. A stronger Japanese yen and Swiss franc reflects such funding being trimmed, while high-yielding assets have come under mounting selling pressure.

Here the usual cocktail of thin liquidity and absence of investors during August could well intensify the current rise in volatility and selling across markets.

At some point, sharply lower asset prices as seen after the UK vote for Brexit and jitters over China in February of 2016 and the August devaluation of the renminbi in 2015, will lure buyers of the dip. Michael Mackenzie

How much more can the bitcoin bubble grow?

A couple of weeks ago bitcoin, the decentralised crypto currency, experienced a splintering event that saw it spawn a rival version of itself known as “bitcoin cash”. That new version, upgraded to handle many more transactions a minute than the original, is now worth a collective $54bn on the market. Yet, rather than skim value from the original currency, as its creation might have been expected to in an efficient market, the splintering has led to an explosion in the price of the original. Bitcoin originals were fetching in excess of $3500 a coin on Friday — that’s up more than 23 per cent on the week.

But the question everyone wants to know is just how realisable are these prices in practice? It’s one thing to put a price on a fantasy asset and trade it within a close-knit community that believes all their fantasy assets are equally valuable, and another to see it hold that value in the real world. Take, for example, an artist who decides a sculpture he has made is worth $1m. If he can only trade it for another sculpture by another artist who also decides his sculpture is worth $1m, does that really prove it’s worth $1m?

While it’s true that some real-world trading against fiat currencies goes on in bitcoin, it pales into insignificance compared with the recent explosion in trading against “alternative” crypto currency coins, where self-dictated valuations rule the roost. That, in short, is not a stable underpinning for any price explosion. Izabella Kaminska

Does US junk’s stumble presage a wider credit sell-off?

US junk-rated corporate bonds suffered their deepest sell-off in months at the end of last week, as the risk premium investors demand to hold subinvestment grade debt increased dramatically.

There were specific technical factors at play: a softening backdrop in broader markets coincided with a glut of new supply from US high-yield bond issuers such as Tesla and Restaurant Brands.

But there is an uneasy feeling of déjà vu for investors in other areas of credit.

In 2015, August also marked the start of a nasty sell-off in US high-yield, that mutated into a full-blown market rout by the end of the year.

In November 2015, underwriters failed to sell debt backing the year’s largest LBO — Carlyle’s $8bn buyout of Veritas — and by the start of 2016 yields on risky triple-C bonds hit an eye-watering 20 per cent. Credit markets were soon in a deep funk on both sides of the Atlantic, exacerbated in Europe by concerns over whether Deutsche Bank could continue to pay coupons on its riskiest class of debt.

The European high-yield bond market has already seen some spillover this week. The iTraxx Crossover — a closely watched index of credit-default swaps — blew out as far as 256 basis points on Friday, a sharp move from its 230 basis point level just a week earlier.

Market participants point out that European high-yield bonds themselves have held up better than the derivative index, which often records sharper moves as it provides one of the easiest ways for investors to express a negative view on European credit.

But fears have long been growing that valuations looked increasingly stretched in European junk, particularly in the double-B segment of the market, which carries greater duration risk due to the bonds’ generally longer maturities and lower coupons.

Bank of America Merrill Lynch analysts noted this week that 60 per cent of euro double-B rated bonds now yield less than equivalent US Treasuries, including €23bn of Italian bonds from the likes of Telecom Italia and Finmeccanica.

While relating yields on euro corporate bonds to US Treasuries is very far from an apples to apples comparison, it does illustrate just how vulnerable the European high-yield market could be if there is a wider repricing of credit risk. Robert Smith

Has the oil market finally turned for Opec and crude bulls?

If you just looked at the spot price of Brent crude, you might be forgiven for thinking little of note had happened in oil last week. Prices started the week at about $52 a barrel and ended the week about 50 cents lower. So far, so tedious, with the market apparently still stuck in a relatively tight range near $50 a barrel that it has been in for much of 2017.

But a closer look reveals a significant shift in the market took place, which could have big implications for the oil outlook.

The spot price, or the front-month Brent futures contract, climbed above those for later delivery for the first time since late-2014 this week. This move in the market structure — which has occurred in the first three contract months for Brent, but not US benchmark West Texas Intermediate (WTI) — is known in industry jargon as “backwardation” and is generally seen as a sign of tightening supplies.

The last time Brent was backwardated occurred when oil was still above $100 a barrel.

The question for the market now is whether we are seeing a shift of the oil futures curve towards backwardation — a key indication that Opec is succeeding in mopping up excess supplies, which should prove supportive for the spot price.

Demand has been strong over mid-2017 and maintenance in the North Sea and Russia has contributed to tightening the market, but if backwardation stays it may bring more bullish bets from the fund community. Traders will be watching to see if WTI can follow Brent into backwardation next week. David Sheppard