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Calm before the storm

I won’t go as far as saying my internal alarm bells are going off, as Asian equities extend its recovery for the fifth straight day. 

Reflection of charts
Source: Bloomberg

Global economic conditions are deteriorating, with world growth expected to slow this year. The IMF’s semi-annual world economic outlook (WEO) is likely to show as much. The main driver for the extended rally seemed to be premised on hopes that we just might see more monetary easing in the pipeline. Added to the commotion is the bunch of central bank activity this week, where market participants are looking for clues of more monetary firepower.

There are also talks that the Chinese PMIs released last Friday could have eased some fears that the Chinese economy is worsening. However, this view and the expectation of deteriorating global economy are in partial contradiction, given the importance of China in the world economic order. This is what gets me a tad worried.

I’m sure investors have all sorts of reasons to back up their trading bias, and they are likely to be substantiated by data or solid research. But the risk uptake is not supported by improving macro conditions. The fact that the VIX index fell below 20 yesterday may signal some complacency once again.

It’s worthwhile to remind that the dominant view remains that the global economy is not doing so great, or at least not as well as what was expected at the start of the year. To be sure, talks around China’s slowdown, particularly on renewed worries about a hard landing, are overblown. However, the sluggish pace in world growth is still a cause for concern. Coupled with weak prospects of the commodity sector, it does not make sense for risk assets to do well.

The only theory that perhaps explained the ebullience in equity markets since the disappointing non-farm payrolls reading is the expectation of more monetary stimulus. Even then, you can’t print (money) your way out of economic slowdown. In fact, I feel that more QE is a negative signal. It’s a sign that global economic activity still cannot stand on its own feet.

Singapore and Indonesia were among the strongest performers so far this week, rallying around 3% and 5% respectively in 5-6 October. The outsized gains may be due to their stock indices being one of the most sold off recently. The Straits Times Index (STI) slumped 15.9% in Q3, while the Jakarta Composite tumbled 14% in the same quarter.

In addition, the Indonesia rupiah (IDR) rallied 2% today, helped by improving crude oil prices and a softer USD. Chinese markets remained closed through Wednesday.

Growing expectations that the Fed may not raise interest rates this year has saw a trimming of long US dollar positions. Market still sees around a one-third probability of a rate hike in December, and one-tenth chance in October.

So is the current rally the calm before a storm? It may well be, but for the time being, it is prudent to keep a steady eye on a change in market sentiments. Needless to say, more easing hints from major central banks, especially BOJ and ECB will send risk appetite into a feeding frenzy. This means that until the dust on the central bank hoo-ha settles next week, we may not have a clear picture of the financial markets.

 

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