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Disastrous week for risk

The first trading week of 2016 is turning into a nightmare for the financial markets.

Data Chart
Source: Bloomberg

Practically every equity market across the globe saw mounting losses. The Chinese equities were hit the hardest by a potent combination of factors.

Staying on China, the Chinese securities watchdog, the China Securities Regulatory Commission announced the suspension of the ill-fated circuit breakers on the CSI 300 late Thursday.

The Index traded for all of 14 minutes, in the first half hour yesterday, after being slapped with a 15-minute halt early on. When trading resumed, the CSI 300 almost instantaneously hit the 7%, which suggests that a massive amount of sell orders must have transpired during the trading halt. This triggered a market closure for the rest of the day.

The CSRC acknowledged that the thresholds of the circuit breakers did act like a magnet. When the stock market approaches the levels, some market participants panicked and traded ahead of it, which exacerbated the decline. It’s a form of self-fulfilling prophecy.

In the overnight session, risk appetite remained in short supply, as investors dumped risk assets from Europe to the US. It was no surprise to see the VIX Index spiking 21% to 25, underscoring the increasing fear over global risks.

What was interesting, however, was the relatively mild movements in the developed sovereign debt market. Yields on the 10-year US treasuries dropped just around 2.5 basis points, adding to an accumulative amount of 12.4 basis points. This is hardly what one would expect given the extent of fear in the markets.

My colleague, Chris Weston, has an explanation for this. In a nutshell, emerging economies need to sell their FX reserves to offset the effects of capital outflows, and a chunk of this resides in foreign government bonds.

On one hand, market participants are snapping up developed market bonds on safe-haven demand, on the other, emerging market central banks are selling them to access USD to keep their local currencies stable. You can read more about Chris’s note here.

The market volatility has also dampened the outlook on US rate normalisation, where the market is pushing back the probability of the next rate hike. Bloomberg’s calculations of the implied probability of the Fed fund rates, show that the probability of a US interest rate increase by April has fallen to 35% from 50.8 at the end of 2015. As a result, the dollar retreated, which lifted the euro and Japanese yen.

With weak leads from overnight markets, and ongoing concerns in China, we expect to see a difficult session for Asia today, capping off a disastrous week. Oil-related stocks should come under more pressure. All eyes will stay on the daily yuan fixing at 9.15am SGT, where yesterday’s depreciation of 0.56% should see another lower mid-point today.

 

Markets

  • US equities were sold off aggressively, tracking the massive selloff in China. S&P 500 tumbled below 1950, shaving off -2.4%. The Dow lost almost 400 points, slumping -2.3%. European shares fared the same. Euro Stoxx 600 fell -2.2%, bringing week-to-date losses to -5.3%.

 

  • 10-year US treasuries gained modestly despite the increase in market volatility. Yields fell 2.5 basis points. Interestingly, European sovereign bonds declined, with yields on 10-year German bunds increased by 3.6 basis points.

 

  • The dollar index fell 1%, dropping to low-98 levels. The weaker dollar helped the euro and yen appreciate. EUR/USD rose +1.4%, advancing towards 1.0950. USD/JPY pulled back to below 117.50, the lowest in over four months since Black Monday on 24 August 2015. The next level to watch is around 116.

 

  • A beneficiary of the prospects of slower US rate tightening is gold. The non-interesting bearing precious metal gained above key $1100, also helped by a flight to safety. Should risk aversion persist, we could see the yellow metal improving on its current gains. The 100-day moving average is seen at $1111.12.

 

  • Oil were whacked lower after the European session came online yesterday. WTI and Brent fell -2.1% and -1.4%. The latter fell to a 12-year low at $33.75.

 

*For more timely quips, you may wish to follow me on twitter at https://twitter.com/BernardAw_IG

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