China worries inflicting damage globally

A combination of worries on both sides of the pond has inflicted damage on risk assets globally. US equities closed lower, Treasury yields dropped, USD was weaker while gold prices rose. In Asia, China growth concerns, overexpansion of credit, and currency weakness are increasingly infiltrating markets globally.

Meanwhile in the US, consumer confidence surprisingly slipped in February, albeit from a high level while the annual pace of house price gains slowed slightly in December. The data added a further layer of pressure on stock markets and US January new home sales data will not help matters as it is likely to give further evidence of slowing housing momentum.

While it is now easy to blame much of the weakness in US economic data on adverse weather conditions hopes / expectations that US data will improve going forward will be tested soon. In the absence of first tier data today, attention will remain firmly fixed on events in China and in particular whether the CNY and CNH registers further declines.

Given all the attention on the Chinese currency, major currency markets have been lulled into tight ranges, with our measure of composite implied G3 FX volatility declining further. Our implied volatility index has now dropped to the lowest levels since the end of October last year.

USD/JPY is likely to face some downward pressure in the short term given the rise in risk aversion and lower US yields overnight. EUR/USD remains supported but remains susceptible to downside risks given the potential for easier monetary policy at the upcoming European Central Bank meeting next week.

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