When China sneezes, the world catches a cold

In the absence of market moving clues, China’s stock drop yesterday appeared to have more impact on global sentiments during the overnight session. European and US shares closed lower and the VIX index rose towards 14.

Man looks at data board
Source: Bloomberg

Market cautiousness is certainly thickening in the air, but not to the point of fear at the moment.

The modest decline in equities in the overnight markets reinforced the notion. The usual flight to haven assets, such as sovereign bonds, did not materialise despite global equities being under some pressure.

In fact, government debts were under a bit of pressure themselves. The treasury curve steepened slightly, leaving the 10-year yield higher by 2.3 basis points.

The US bond market was fairly quiet, I put it down to prudence as market awaits the FOMC minutes on Wednesday (or early Thursday morning in Asia Pacific).

Investors were also selling off commodities. The Continuous Commodity Index (CCI) fell to a fresh six-year low. It looks like the market is selling across asset classes and holding on to cash. The US dollar was mixed, firmer against euro and Aussie, but quite flat against the yen, and slightly softer against the CAD. This tells me that uncertainty, more than anything, is the major driver for the relatively bearish mood.

This uncertainty is going to persist in Asia today. I expect most Asian bourses to be trading carefully. Market participants will be keenly watching mainland equities after yesterday’s tumble. Bloomberg noted that rich investors in China have been taking the opportunity of state support to cash out from the domestic stock market.

The yuan devaluation has also heightened concerns of greater capital outflows, which led investors to worry whether prices would still be supported when the government starts to withdraw its rescue measures. I feel this view may be an overreaction. The Shanghai Composite is still in a broadly sideways grind and Tuesday’s drop is unlikely to derail the consolidation efforts. What we will continue to see, is the susceptibility of mainland investors to react to rumours and misinterpretation of developments.

This is the reason for sudden bouts of substantial slides in the Chinese equity markets. To be fair, the Chinese stock markets are undergoing an adjustment phase as the authorities monitor market volatility and determine a suitable time to ‘taper’ the support measures. The stability period will entail some wild swings from time to time but investors are advised to take a longer-term view.

Growing uncertainty has divided market expectations of a September Fed move. The implied probability dropped to 43%, from 54%, prior to the yuan devaluation. The Market is clearly looking ahead to the inflation data and FOMC minutes for more clarity on the timeline.

The Fed’s attention would be diverted to price levels from employment, as recent jobs data continues to show improvement in the labour market. Fed officials want to have enough confidence that the inflation trajectory is heading towards their target before giving the ‘go’ signal to lift interest rates.

The STI continued to track Chinese equities and has remained caught up in the risk-off environment. The index closed below 3050 for the first time in 18 months. The selloff was across the board, with financials leading the decline.

Noble continued to receive much attention, although it does not have a significant weighting on the benchmark index. According to Markit data, short selling interests jumped to 21.1% of free float on Monday. The stock dived 8.8% yesterday, coming under huge selling pressure in late trade.

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