Commodity is the new ‘black’

There is no denying that the flavour at the moment is on the commodity ‘rout’.

Federal Reserve building
Source: Bloomberg

With Greece’s bailout deal almost as good as completed and China’s equity markets seeing good support, albeit government-engineered, these two countries, have been key risks at the start of July, but have now receded into the background as we head towards the end of the month.

It is still worth mentioning some new developments in China. Firstly, the Caixin (formerly HSBC) Markit flash PMI unceremoniously underwhelm consensus. While the market was still looking for a figure below key 50, it was expected to be a mild improvement to 49.7, from 49.4.

The actual number was at 48.2, 1.5 points below the estimate, and the market reaction was immediate. The Aussie crashed 50 pips through 0.7350 to around 0.7300, touching over six-year lows. A second blow to AUD came from S&P warning of a rating downgrade if the national budget does not improve, or if the economy experienced an external shock.

The currency tested the option barriers below 0.7300, trading as low as 0.7269 at one point, based on Bloomberg figures. The triple combination of weak Chinese data, soft commodity prices and threat of a credit rating downgrade dragged market sentiments in Australia.

We saw domestic equities getting whacked, particularly resource companies and financials. ASX ended 0.3% lower, which could have been worse if not for a mild recovery in energy and utility counters.

Meanwhile, the State Council said that it will allow the yuan to trade in a wider band against the dollar, although it did not provide a timing nor the scope for the adjustment. Currently, the CNY is allowed to trade within 2% of either side of a daily PBOC mid-point fixing. Analysts were speculating about a band widening to 3%.

This announcement came on the back of an IMF statement back in May that the CNY needs to be more flexible even if it’s no longer undervalued. The IMF also said that Chinese authorities should limit the amount of intervention. While capital outflows appeared to have slowed of late, any relapses may make it difficult for Beijing to pursue its plan of increasing yuan’s flexibility.

Chinese equities continued its controlled recovery, with the CSI 300 climbing towards 4300, although the A50 struggled to build gains. However, H shares in Hong Kong fell and weighed on the Hang Seng Index. The restriction on short selling in A shares could have led foreign investors to offload the H shares instead.

The AH Premium Index showed that H shares were stubbornly trading at a 40-50% premium over the A shares for most of July. It is also interesting to note that the recent tumult in Chinese equities has benefitted Indian stocks.

According to Bloomberg, international investors seemed to have pulled out of China and straight into India. They have invested $705 million in Indian equities since 12 June. The Nifty 50 had rallied over 7% in the period.

What’s ahead next week?

The key event in the coming week is without dispute the FOMC decision (Thursday, 30 July). While almost no-one is expecting the Fed to raise interest rate in the July meeting, everyone is watching for their comments, particularly on the economic and inflation outlook.

We hold on to our belief that there will be interest rate increase this year as long as we don’t see a derailment in the trajectory of the US economy. Employment data remains solid, and global jitters, especially Greece and China, have subsided. What’s left in the puzzle is the inflation perspective.

There is some concerns that the strengthening dollar is dampening inflationary pressure, which would cloud the Fed’s judgement on when to raise rates. Nonetheless, Fed Chairperson Yellen remains adamant that the central bank will start normalising interest rates this year, although she was careful to convey the message that any increases will be gradual.

Turning to Europe, UK is slated to release its Q2 GDP figures, while German IFO and Eurozone consumer confidence and inflation numbers will be of interest. In China, the official manufacturing PMI for July (Saturday, 1 August) will be closely watched, especially after the Caixin PMI spectacularly underwhelmed expectations, raising worries that the Chinese economy may see further weakness. Japan will also release its inflation numbers as well as industrial production reading.

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