Markets have had an awful night, although the pullback seen in the S&P 500 from mid-way through the session has calmed futures predictions for the Asian session somewhat.
This paring back has seen the Aussie dollar bounce off its firm line of resistance at the US$0.6840 level and push back above US$0.69. The ASX is also one of the only markets in Asia looking to open in positive territory.
This seems partly due to Aussie bank ADRs staying relatively unscathed during the US session, which may have something to do with the brutal over-2% loss they suffered yesterday. On the other hand, the Nikkei is set to plunge deeper into technical bear market territory. The yen touched the 115 handle last night for the first time in a year, which hurts foreign investor sentiment towards Japanese stocks because, if were you to pick a bottom, any gains you might see in Japanese stocks are going to be eaten away by yen weakness as global volatility subsides.
Hong Kong will very much be in focus again today. As China has quelled speculation in the offshore Renminbi, that speculation has spilled over into short bets on the Hong Kong dollar. The HKD and the Hang Seng have been suffering far more than the CNY or Chinese equities. Hong Kong is increasingly the fault line where strict Chinese government controls and intervention meet (relatively) freely traded global markets. With the HKD pegged to the US dollar further Fed tightening alongside China’s economic slowdown and CNY depreciation pressures will lead to excessive tightening in Hong Kong’s monetary conditions. Hong Kong also has record levels of household debt at over 180% of GDP and heavily overvalued property prices, all of which puts it in a precarious position. In Oscar Wilde’s “The Picture of Dorian Gray”, the ravages of time and Dorian’s sins are only visible in his portrait while his person remains unscathed. In this belaboured metaphor, the sins of Chinese capital controls are coming to bear on the HKD as the proxy of choice.
While the HKD has withstood rampant speculation before during the AFC and the SARS crisis, short bets face at worst a move to HKD 7.75 (the band being HKD 7.75-7.85) against them and anywhere from a 20-50% upside if the peg were broken. The risk-reward balance of the trade makes it compelling even if it has a low likelihood of eventuating.
Will the Fed be forced to cut rates back down to zero this year? Those who started buying US government bonds straight after the Fed rate hike in December are looking pretty smart at the moment. US data of late has continued to disappoint, with industrial production missing last week and then CPI and housing starts missing overnight. Core CPI, however, largely came in right in line with expectations and has steadily risen throughout 2015 to grow at 2.1% YoY in December. This has likely pushed Core PCE inflation (the indicator the Fed watches for inflation) up to 1.4% - still well below their 2% target, but growing nonetheless.
According to the bond market WIRP probability, markets are only assigning a 51% chance that we see a US rate rise by September. But while US data has disappointed a bit of late, the chance of the US economy actually heading into a recession this year is still looking fairly low. The NBER classifies recessions when declines are seen in their key activity indicators, namely: real GDP, real income, employment, industrial production, and retail sales. At the moment it has only been industrial that has really fallen off, and much of that has to do with the strength of the US dollar associated with the rate rise. While a US recession still seems unlikely at the moment, it seems to be having little bearing on the performance of US equities.
