News that the S&P suffered its first monthly decline since January really seems to have rattled confidence and already we are starting to hear calls for a ‘correction’. With the S&P just 3% from its all-time high, it certainly seems like an overreaction to start calling for a correction. Additionally, limited moves in fixed income and key currencies suggest it’s not panic stations just yet.
While there were some fundamental drivers, analysts have mainly attributed the drop to end of month hedge fund selling in equities. Additionally some investors were taking some exposure off the table heading into the non-farm payrolls data. An interesting talking point in coming days will be the spike in volatility with the VIX 27% higher. One of the concerns recently was extremely low volatility and now the market will be waiting to see if this spike can be sustained or if it’s just a flash in the pan.
Reasons behind US equities drop
Some of the fundamental drivers of the negative price action were Argentina default concerns, Banco Espirito Santo potential capital raising, mixed data and geopolitical tension. As they say ‘when it rains, it pours’ and all these factors combined to weigh on sentiment. The good news is we haven’t seen any further deterioration in sentiment in Asia, despite a bit of caution ahead of the non-farm payrolls data.
Some traders will be looking to buy the dips after yesterday’s pullback. There is an uptrend that has been in place since November 2012 that comes in at around 1920. The 1923 level is also the 38.2% retracement of the recent rally. The question now will be if traders have enough conviction to buy a pullback into support and keep the run going. In fact there has been suggestion that hedge funds were mainly responsible for yesterday’s selling in equities, while real money has been looking to buy the dips.
Markets anticipating firm payrolls reading
US dollar strength has been the dominant theme in the FX space this week as traders positioned for key events on the US economic calendar. Economists are expecting 230,000 jobs (range 310,000 to 160,000). Keep an eye on the US unemployment number which is expected to remain steady at 6.1% and average hourly earnings though, as earnings tend to be a good feed for inflation. The market is expecting 0.2% growth in average hourly earnings and this would imply an annual run rate of 2.2%. Should we see a beat in jobs today, there is a good chance the USD will extend its gains and this might weigh on sentiment further.
ASX 200 worst hit in Asia
The Nikkei is significantly off its lows today and continues to find support from the resilience in USD/JPY. The pair remains within striking distance of 103, with traders reluctant to sell ahead of the payrolls numbers. We’ve also had some positive data out of China with manufacturing activity picking up in July. China’s July official manufacturing PMI came in at 51.7, better than an expected 51.4. However, this did little for local sentiment as the ASX 200 remained heavy. It has truly been a case of up the stairs and down the elevator as we managed to erase a significant chunk of July’s gains. After 13 out of 16 positive sessions, with one flat and two negative, today’s selloff saw us start the month in the worst possible way. Today’s losses also saw the ASX 200 dip into negative territory for the week with a loss of around 0.6%. Next week we have the RBA’s rate decision along with the beginning of earnings season. Some of the big names reporting next week include Rio Tinto, Cochlear and Downer.
Europe in for a soft start
Looking ahead to European trade, we are calling the major bourses mildly weaker. Of course Europe already endured significant selling yesterday and perhaps some stability is warranted. A strong jobs reading later today could just be the trigger for another round of EUR/USD selling. The downtrend comes in at around 1.3400 and that is where we could see fresh shorts come into the frame.
On the European economic calendar, manufacturing PMIs will be in focus and a disappointment there could add to the selling pressure in the single currency.