Equity markets extended their declines overnight as European and US stocks were smacked across the board. One of the biggest pull backs has occurred in the Chinese stock market where stocks are down by around 17% since early (3rd) August although stocks are still up close to 73% on the year. Some of this could be on fears of monetary tightening in China as well as missed profit estimates.
Risk trades were sold and the dollar and yen strengthened whilst bond markets continued to rally. News that contributed to the move could have included a sharp 35.7% YoY decline in FDI flows to China in July as well as a broad tightening of lending standards in Q2 according to the latest Senior Loan Officer survey by the Fed. In contrast there was some positive news on the manufacturing front as the US Empire manufacturing survey jumped 13 points to its highest reading since November 2007.
The Fed announced that the TALF with a capacity of as much as $1 trillion will expire on June 30 rather than December 31 but for other asset backed securities and CMBS sold before January the plan was extended by three months. This extension failed to prevent a drop in financial shares overnight with the S&P financials index down 4.2%.
Commodity prices also extended their drop, with the CRB index now down by around 5.6% since 5 August. This will continue to play negatively for commodity currencies including the Australian, NZ and Canadian dollars, with the currencies looking vulnerable to more downside today. Expectations of rising oil inventories and a firmer dollar tone are also playing negatively for commodities.
Some relief may come today from firmer economic data expected in the US and Eurozone. US housing starts and building permits are set to reveal further signs of stabilisation in the US housing market whilst the German ZEW survey will rise in August on the back of better economic data and past stronger equity market performance. It is debatable how much economic data can help counter the worsening in equity sentiment but it may at least provide a semblance of relief.
The dollar index is trading around the top of its recent range and sentiment for the currency has clearly become less negative as reflected in the latest CFTC Commitments of Traders Report which showed a sharp pull back in net aggregate dollar short positions in the latest week.
Nonetheless, the dollar is likely to show little inclination to break out of its recent ranges against most currencies. Overall FX market attention will focus on the Shanghai composite to lead the way in terms of risk appetite and overall direction. Thin holiday trading will leave the markets prone to exaggerated moves over the near term.