Risk aversion rears its head

It appeared that the Volkswagen news have spooked investors to take a step back on auto equities. 

Automotive Factory
Source: Bloomberg

This coupled with flimsy market sentiments made for an explosive cocktail of risk selling. European indices tumbled over 3%, with the FTSE 100 suffering a 2.8% loss during the overnight session. US equities were also hit, leaving the S&P 500 down -1.2%, dragged by broad-based selling.

The movements in the markets this week are unlikely to be quite reactive, which means volatility could go north again. Despite the substantial moves in the overnight equity markets, the VIX Index only rose modestly to 22.4% from 20.1%. This is still around half of the 40.7% on Black Monday, 24 August, where we have a global stock rout. Nonetheless, market participants are still wrapping their heads around the timing of the Fed rate hike.

The implied probability from the Fed fund rate futures market eased to 41% yesterday from 49% on Monday, which could be due to the risk-off mood. Financial market volatility is one of the concerns of the Fed, with regards to tightening policy and renewed turbulence, would raise expectations of further delays.

From this perspective, we may not want to see further gains in the dollar as a sign of higher expectations of a rate hike this year. Falling euro was the primary cause for the rising dollar, as traders bet on more easing from the European Central Bank (ECB).

The ECB Chief Economist Peter Praet said the Bank will do what’s necessary if its inflation target is threatened, which stoked speculation that the ECB will either extend its current QE programme beyond September 2016 or increase the amount of asset purchases to over EUR 1.1 trillion.

In the option markets, the premium paid for three-month options to hedge against euro weakness has widened to 1.25 percentage points, reflecting expectations for more euro declines in the coming months.

The EUR/USD fell towards 1.11, clearing the 100-day and 50-day moving averages. As I mentioned in my trade idea, the 1.1090 is the next support to watch. Intraday bias in the single currency is firmly on the downside.

In Asia, the Caixin manufacturing PMI for September (preliminary reading) will be the main focus today. The consensus is looking at 47.5, a slight improvement to August’s 47.3. The PMI fell to an over six-year low in August, increasing concerns over Chinese growth. A bunch of other PMIs from Japan, Germany and the Eurozone will be due today as well.

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