The relatively quiet markets of summer are about to get a wakeup call.
July and August have been mostly good for stocks and bonds with the S&P 500 hitting new highs and rising 9 percent above its late June low. Bond prices have held at rich levels, as yields stayed super low. But that could all be about to change when markets enter September — a month that will be big with central bank meetings and other events that could challenge expectations.
"I think it's potentially a turning point for volatility. Volatility was very low over the course of the summer," said Jeff Kleintop, chief global investment strategist at Charles Schwab.
It is also a time when markets could start to focus on the presidential election, and if Republican Donald Trump gains momentum, analysts expect volatility. The first debate between Trump and Democrat Hillary Clinton is on Sept. 26. Oil could also be a big story for September, with OPEC and non-OPEC members meeting in Algeria at the end of the month.
September is a month that will put the course of central bank easing to the test with the Fed meeting Sept. 20 and 21, the same days the Bank of Japan meets. The BOJ is expected to unveil a review of its own extreme negative interest rate policies. The Fed is not expected to raise rates that at that meeting, but market odds have been rising to as high as 40 percent that it could, after comments from last week.
That means the August employment report on Friday could provide a pre-Labor Day surprise for markets, since the data carry the most weight for the Fed's decision and market expectations about the Fed. While economists are still leaning toward December for the next rate hike, they note the chances are higher for September should the jobs report come in much better than the expected 180,000 nonfarm payrolls.
"After Labor Day, a lot of people better come into work ready. It's been almost too sleepy a summer," said Sameer Samana, global quantitative analyst at Wells Fargo Investment Institute. "It's probably about time we all sharpen our pencils a bit and look at all the things that happened over the last three months. They're all events that have long term implications, but very few short-term implications. It was easy to dismiss them out of hand."
"On Tuesday, you'll start to see how the real money views, not only the payrolls report, but I would throw in Jackson Hole and Brexit," said Samana.
Brexit, or the U.K.'s vote June 23 to leave the European Union, ripped markets briefly, before investors adjusted to the idea that it would not be an immediate split. The Bank of England has promised more easing, and its Sept. 15 meeting is being watched for a possible rate cut. The European Central Bank was also expected to keep an easy hand on the tiller, and when it meets in the coming week, it could detail what other type of assets it will buy.
The central bank meetings are important since it was the promise of easing that sent the markets smoothly sailing through summer, after June's washout. The time is getting closer to when the Fed will break away from the pack and tighten policy again.
"I think in September, in general, you're going to see volatility going up because not only the Fed could hike, but I think there's a chance the ECB and Bank of Japan could disappoint," said David Woo, head of global interest rates and foreign exchange strategy at Bank of America Merrill Lynch.
Woo said the easy money policies have encouraged investors to jump into the most crowded trade. That is the risk parity trade, where investors are long stocks and bonds, expecting both to rise in a low rate, easy policy environment. But he said the presidential election could shake that up, if it creates volatility, and that could send investors to the exits in both asset classes.
"We were all positioned for lower forever, and they're going to have to unwind some of that. If the economic data improves, it's going to put pressure on the Fed," Samana said. "They don't have to hike aggressively, but they will have a tough time explaining why they are close to zero."
He is also worried about crowded positioning. "Whether you're looking at the February or the Brexit lows, there's been a very big change in flows and sentiment," Samana said. "We've seen a lot of flows into the riskier parts of the market. We saw flows into high yield, emerging markets debt, emerging market equities. ... There's been this huge reach for yield. ... What's more worrisome to us is how everyone is leaning on the same side of the boat."
So, it could be the central bank meetings that send ripples to markets if they fail to meet expectations. JPMorgan economists changed their call on the ECB meeting. In the last several days, they said they no longer look for a deposit rate cut of 10 basis points or an official extension of quantitative easing beyond next March. They say they no longer see a rate cut "as the ECB is unlikely to feel enough pressure from the current growth data or from the currency."
"While it is a close call, we now expect the ECB to buy time with a sufficiently dovish statement in September, essentially hinting that QE is likely to be extended," the economists wrote.
Samana also said disappointment with central banks could be a theme for September, with the Bank of Japan possibly falling flat after BOJ Governor Haruhiko Kuroda built up expectations when he told the Fed at Jackson Hole that the central bank could do more quantitative easing and take yields further into negative territory.
"If you want to talk about folks that have raised the bar way too high, you have the Bank of Japan. That's on September 21. It's hard to make a speech like that and exceed market expectations," said Samana.
Before the central bank meetings, there is a G-20 leaders meeting in China on Sept. 4 and Sept. 5, the U.S. Labor Day holiday. That could be interesting for currency markets since the G-20 finance leaders are believed to have agreed not to engage in competitive devaluations.
China's sudden devaluation of the yuan last August rocked markets, and the currency has begun to slide recently. Also, dollar/yen has dipped below 100 and could be poised to go even lower. The strong yen has been seen as a threat to the Japanese economy, which is heavily dependent on exports.
"The currency markets have reacted in just the exact opposite way that central banks wanted them to," said Samana.
Woo said besides the impact of central banks, the U.S. election already has had an effect. He said the U.S. stock market is pricing in gridlock, with a Democrat president and split Congress, meaning a Clinton win. That gridlock keeps the Fed in play longer, as Washington would be unable to make much change in policy as is currently the case.
Kleintop said the election could become a negative factor if the polls narrow, and challenge Clinton's lead. "In five of the last 10 elections, the loser was ahead in the Gallup polls as late as the last week of October," he said. "The market could be shaken."
Strategists say the market is more comfortable with the idea of Clinton since she is well known and it would retain the status quo in Washington, while Trump brings a high level of uncertainty. "I think you'll see investors more sit on their hands and get a little worried if the race looks tighter," said Kleintop.
Sameena is cautious. "Considering we're at all-time highs on bonds and stocks, if you look at yields and prices, it's not a bad time to have little bit of dry powder. This is not us calling for a change in trend. It's just us saying, be ready for another opportunity like February, a 3 to 7 percent decline in some of the risk assets," he said. "I don't know if it will happen in September, but I would say the odds are higher over the next six months."
Crude oil prices could come under pressure in September as refiners take operations off line for seasonal maintenance ahead of winter fuel production. That requires less oil sales to refineries, which also have been working through a glut of refined product. The prospect of an oil production freeze from OPEC has helped support prices, but many analysts do not expect a deal, since they've failed before. That could drive oil lower.
If OPEC and other producers were to agree to freeze production, it would be at a time when some producers are pumping record amounts of oil and it may not do much to support the price. If oil declines because of no deal, it would create another risk for stocks, which have been sensitive to oil prices as they get closer to $40 per barrel.
"I think the technical tone, not only for U.S. stocks, but emerging market equities as well has really deteriorated. You'd expect people to take some profits on the summer rally of risk assets," said Marc Chandler, chief currency strategist at Brown Brothers Harriman.
Kleintop said another factor for stocks could be the pre-announcements from companies ahead of their third quarter earnings reports.
"We're heading into pre-announcement season. Right now, the difference between the next 12 months earnings growth and the last 12 months is the biggest since 2009," he said. "Analysts are more optimistic on forward earnings growth than they have been for a long time." Yet to be seen is whether companies are as optimistic.
What to watch in September:
Sept. 2
US August nonfarm payrolls
Sept. 4, 5
G-20 leaders meet in China
Sept. 8
European Central Bank meeting
Sept. 15
Bank of England meeting
Sept. 20, 21
Federal Reserve FOMC meeting
Bank of Japan meeting
Sept. 26
First presidential debate
Sept. 26-28
OPEC meets non-OPEC producers at energy conference in Algeria