Where next for China?

We are supposed to be focusing on the FOMC meeting this week, given the market is only pricing a modest 10 basis points of tightening from the Fed over the coming three months.

China
Source: Bloomberg

However, China is firmly front and centre and calls of ‘China’s Lehman moment’ and ‘equity induced hard landing’ have been doing the rounds. It is certainly discouraging for an overseas investor/trader to have absolutely no idea why an equity market falls 5.5% in an hour and the fact it can even move that rapidly in a short space of time is equalling as worrying. Of course, this isn’t the case if you are positioned on the right side of the move (i.e. short the CSI 300), although doing so and living in the mainland could land you in trouble!

As one would expect when you see the Chinese market close at the lows of the day, we have subsequently seen fairly market-friendly rhetoric that the CSFC (China Securities Financial Corporation) will continue supporting equities. Talk that the markets main support mechanism was repaying borrowed capital early was seemingly behind the Chinese market losing $618 billion in market cap yesterday, effectively taking its share of global equity market cap to 10%, from 10.69% on Friday.

One Chinese state owned media agency even put the blame on foreign forces, going on to rally the troops to ‘defend their wealth’.

There seems a clear case of diminishing returns from the actions of the Chinese authorities. For offshore traders, however, the falls in key commodities, amid rhetoric from key personnel at companies such as VW Group, United Technologies, Kumba Iron ore, Caterpillar, Carrefour and Toyota about lower sales from China are a more direct concern.

The line in the sand for the Shanghai Composite is once again the 200-day moving average, which is seen at 3,533. It’s interesting then that the market fell three points shy of that today on open before the buyers (presumably lead by the CSFC) went to town, causing a 6% rally in one hour. It seems the Chinese authorities are going to defend the 3,500 level on the Shanghai Composite and retail traders see one very simply trade. Wait for the market to sell off heavily (6% or more) and as long as there is equity supportive narrative then there is a very good probability of a rally after the market open.

It seems that on the open of the Chinese equity market there have been positive ramifications across the broader market and news that the People’s Bank of China had injected RMB50 billion in liquidity into the repo market has also been a factor. There have been some modest buying of US futures, but this is a function of the Hang Seng, Nikkei and ASX 200 all moving off their lows in a strong, concerted effort. FX markets responded with AUD/USD moving from a session low of $0.7251 to test the $0.7300 area, helped by iron ore futures moving higher as well and you’d expect the spot price to settle higher later today.

EUR/USD has fallen modestly, paring back yesterday’s bullish move with US bond yields moving up a couple of basis points on the long end of the curve. It seems the Chinese market is now driving the USD and the simple concept here is stability in Chinese equities provides the Fed more scope to raise rates this year. A further liquidation could be a major worry for the US central bank, especially if it led inflation expectations lower. The IMF seem to have the most consistent message though – The Chinese need to ensure its market friendly policies are temporary, but at the same time are advising the Fed to look to raise the funds rate in 2016. Both messages come to a conclusion of the Fed raising later in the IMF’s eyes.

Turning to the European open it seems we will see some of yesterday’s losses being pared back with broad based gains seen. UK Q2 GDP will be the key economic release with market expecting a 30 basis point decrease in the initial estimate to 2.6% (economist range 2.5% to 2.7%), so GBP/USD will be in play, although my preference is to follow the trend and buy pullbacks in
GBP/AUD. Since May, the 20-day moving average has been the key buy area, so if we see GBP into AUD2.1035 that would be the key buy zone, although it is a fair way off current spot levels.

Also, it’s a huge night for corporate earnings with a plethora of names from various parts of the market due. Specifically BP, Merck and Pfizer will take top billing.

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