Shocking period for stocks; Risk aversion causing volatility in foreign exchange markets; commodity prices tumble; global growth indicators skewed to the downside

By Ian Dobbs*:

Markets are starting to look very fragile and we are in for some real volatility over the coming weeks and months. The past week has been a shocker for stocks.

In the US the Dow at has fallen over 10% from its highs and is now down on the year. Chinese stocks smashed through recent lows losing more than 8% yesterday. European stock markets are also feeling heat.

Risk aversion is causing big moves in foreign exchange with the biggest gainers so far the Euro and the Yen.

Further weakness in the Chinese economy, after Friday’s release of very soft manufacturing PMI data, has been fingered as the cause, but in all reality it’s really just the trigger.

US stock market valuations had diverged from economic reality a long time ago and sooner or later something was going to cause a correction.

Commodity prices continue to tumble, although gold seems to be benefiting from safe haven status. Bloomberg’s commodity index recently hit its lowest levels since 1999.

Inflation expectations in the US are falling to levels last seen when the Fed launched the quantitative easing programmes one, two and three.

Indicators of global trade don’t make for any better reading, with the risks to global growth all skewed to the downside.

Somehow in amongst all this, the Fed are supposed to raise interest rates for the first time in nearly ten years when they meet next month. It looks like they will need to be very brave to do so.

China on the other hand are widely expected to announce further easing measures in the coming days / weeks. This may provide some temporary respite, but the Chinese economy could yet see real trouble.

The Chinese property market rolled over last year and has been losing ground ever since (although recently the pace of depreciation has slowed), their stock market has crashed and they’ve started to devalue their currency (many expect further devaluations of the Yuan).

What China can’t afford to have happen next is a collapse of their shadow banking system. The ‘shadow banking system’ refers to the collection of non-bank financial institutions that provide lending and credit facilities to consumers and businesses.

It has seen massive growth in recent years, but it’s far less regulated and has far less transparency in relation to the quality of lending going on.

Safety margins are also lot smaller than in the traditional banking system and if the ‘shadow banking bubble’ bursts it could be potentially devastating.

In New Zealand we saw the collapse of our own ‘shadow banking system’ with a huge percentage of finance companies going bankrupt in the years after 2007.

China could be heading for a similar thing, but on a much much grander scale and with global implications.

Major Announcements last week:

  • UK core Inflation 1.2% vs .8% expected
  • US core Inflation 1.8% as expected
  • UK Retail sales 4.2% vs 4.4% expected
  • US Philly Fed Index 8.3 vs 7.0 expected
  • China Manufacturing PMI 47.1 vs 47.7 expected
  • EUR prelim. Manufacturing PMI 52.4 vs 52.2 expected
  • Canadian core Inflation 2.4% as expected

NZD/USD

The New Zealand dollar has lost ground to the USD this week, briefly breaking to fresh cycle lows last night. For a brief period of time, liquidity in the market completely dried up after panic set in when the US equity markets looked like they were going to collapse. It only took a few minutes for the market to regain composure, but it just shows how fragile the current situation is. For the time being the NZD will remain vulnerable to periods of risk aversion, but we could soon start to see the USD come under some pressure itself as expectations for a Fed tightening get pushed back, potentially into the first quarter of next year. Expect economic data to take a back seat to developments in the wider market over the coming days.

DIRECT FX Current level Support Resistance Last wk range
NZD / USD 0.6492 0.6400 0.6600 0.6280 – 0.6708

NZD/AUD (AUD/NZD)

The New Zealand dollar made gains against its Australian cousin last week trading right up to key resistance around 0.9160 (support 1.0917). We have seen a sharp rejection from that level however, thanks to volatility in the wider marker. Weakness in global stock markets caused some wild moves last night as liquidity completely dried up for a short time. Markets quickly composed themselves and in the end the NZDAUD was trading around the 0.9000 mark (AUDNZD 1.1110), but it just goes to show how fragile the situation is at the moment. I would look for the market to drift down back under 0.9000 (over 1.1110) in the coming days, but in this environment any prediction is even less certain than normal. We have a speech from RBA Governor Stevens to digest this week along with private capital expenditure data. From NZ we have the trade balance out tomorrow which shouldn’t have much impact considering what’s going on globally.

DIRECT FX Current level Support Resistance Last wk range
NZD / AUD 0.9035 0.8850 0.9160 0.8850 – 0.9150
AUD / NZD 1.1068 1.0917 1.1300 1.0929 – 1.1299

NZD/GBP (GBP/NZD)

The New Zealand dollar made some small gains against the UK Pound toward the end of last week. Those gains have however been completely wiped out in the past 48 hours as risk aversion in the wider market saw the NZD come under heavy selling pressure. Weakness in global stock markets (in particular China) was the trigger for a volatile night for currencies last night. In extremely thin market conditions the NZDGBP smashed down through recent lows around 0.4160 (2.4040). The market quickly composed itself but the pair has remained through that level and this keeps the risks skewed to the NZD downside for the time being. Only a sustained move back above 0.4160 (below 2.4040) will take the immediate pressure off the NZ dollar downside. Look for market to remain very nervous over the coming days with this period of heightened volatility far from over.

DIRECT FX Current level Support Resistance Last wk range
NZD / GBP 0.4120 0.3960 0.4160 0.4020 – 0.4275
GBP / NZD 2.4272 2.4038 2.5253 2.3392 – 2.4876

 NZD/CAD

We have seen some exceptional volatility in all currencies in recent days and this pair is no different. Toward the end of last week the pair traded up over 0.8800 for a time as declining oil prices further weighed on the Canadian dollar. But with concerns around global stock markets triggering a massive ‘risk off’ drive last night, it was the New Zealand dollar that saw pressure. The cross quickly traded back down under 0.8600 in very thin market conditions. We can expect further volatility over the coming week with the risk for the time being been skewed to the downside. I would looks for a range of 0.8500 to 0.8700 to contain trade initially.

DIRECT FX Current level Support Resistance Last wk range
NZD / CAD 0.8615 0.8500 0.8700 0.8545 – 0.8831

NZD/EURO (EURO/NZD)

We have seen some big moves in currencies in recent days and nowhere is this more evident than in this pairing. With global stock markets looking very fragile the main theme in markets has been ‘risk off’. This has the effect of supporting the Euro with heaping selling pressure on the New Zealand dollar. This result has been a collapse of the cross rate from level above 0.5900 (below 1.6950) late last week to a brief period of trade below 0.5600 (above1.7860) last night. To be fair, last night’s price action was more the result of liquidity completely drying up than intense NZ selling pressure, but the result has been much the same. The cross currently sits around 0.5610(1.7825) and the risks remain to the NZ dollar downside for now. We can expect big ranges over the coming weeks as this period of heightened volatility plays out.

DIRECT FX Current level Support Resistance Last wk range
NZD / EUR 0.5615 0.5550 0.5750 0.5392 – 0.5986
EUR / NZD 1.7809 1.7391 1.8018 1.6707 – 1.8546

 NZD/YEN

After spending the better part of seven weeks in a sideways range between 81.00 and 83.00 this pair completely fell out of bed in recent days. The trigger for the move was concerns around global stock markets, sparked off by a further 8.5% fall in Chinese stocks yesterday. This caused the classic ‘risk off’ scenario where the New Zealand dollar falls and the Japanese Yen appreciates. This drove the cross down below 76.00 for a brief time before the market regained some composure. The only thing that is certain from here is that nervous volatile trading is likely to continue over the course of this week. If we were to see some strength in the pair the 81.00 level will now provide very strong resistance. The immediate risks are however still to the downside.

DIRECT FX Current level Support Resistance Last wk range
NZD / YEN 77.30 75.00 79.00 75.20 – 82.13

AUD/USD

The Australian dollar spent most of last week ranging sideways just above 0.7280. It has been a different story so far this week however, with wider market volatility spilling over into the Australian dollar. It started yesterday with another big fall in Chinese stocks, this time some 8.5%, but it quickly spread to Europe and the US with their stock markets looking vulnerable. This caused a wave of risk aversion which pressured the Australian dollar. For a few minutes around the US stock market open liquidity in currency markets completely dried up causing momentary panic. Markets quickly regained some composure, but by this time the AUD was trading below 0.7150. For the time being expect more nervous trade with the risks still to the downside for the AUD. The situation in China isn’t getting any better and although the central bank will likely ease monetary policy further over the coming months, it’s hard to see how the current stock market rout won’t feed through into the Chinese economy and cause more ‘dominos’ to fall. The Chinese shadow banking system has long been flagged as a cause for concern after exponential growth in recent years. It will be a key area to watch in the coming months.

DIRECT FX Current level Support Resistance Last wk range
AUD / USD 0.7180 0.7050 0.7250 0.7099 – 0.7374

AUD/GBP (GBP/AUD)                            

Price action in recent days has all been about wider market risk aversion. Another big fall in Chinese stocks rippled through global markets yesterday causing momentary panic in early US trading. With the Dow Jones opening up down 1000 points currency markets went into a tailspin. Liquidity completely dried up and for a moment it looked like the AUD would collapse, but the currency quickly regained composure and against the GBP it ended up trading down below 0.4550 (above 2.1980). The risks remain skewed to the Australian dollar downside as this period of heightened volatility is far from over. We can expect bigger ranges and much thinner liquidity over the coming week as nervousness dominates the market psyche.

DIRECT FX Current level Support Resistance Last wk range
AUD / GBP 0.4555 0.4500 0.4700 0.4499 – 0.4729
GBP / AUD 2.1954 2.1277 2.2222 2.1146 – 2.2227

AUD/EURO (EURO/AUD)

We have seen significant falls for this pairing in recent days as broad ‘risk off’ sentiment swept the market. The Euro has been one of the biggest winners in all the volatility as the unwinding of long term positions has resulted in buying of the single currency. The Australian dollar on the other hand has seen pressure on the increasingly negative Chinese outlook. The cross traded down below 0.6200 (above 1.6130) for a time last night before recovering. For the time being the risks remain skewed to the AUD downside. These are very uncertain times however and extra caution is advised. 0.6100 to 0.6300 (1.5875 – 1.6400) looks like a likely range for the near term, although that may prove way too narrow in the current climate.

DIRECT FX Current level Support Resistance Last wk range
AUD / EUR 0.6210 0.6100 0.6300 0.6083 – 0.6669
EUR / AUD 1.6103 1.5873 1.6393 1.5005 – 1.6440

AUD/YEN

The past 48 hours have been a wild ride for most currency pairs and the AUDJPY is a good example. It opened the week on the back foot trading down through 89.00, before a dramatic further fall in Chinese stock set of a chain reaction in global equities. The result was a wave of risk aversion during which the Yen saw appreciation and the Australian dollar saw pressure. The pair has traded down below 85.00 and although we have seen a bounce from the lows, the risks remain skewed to the downside. The market will continue to be very nervous over the coming days and with reduced liquidity we could easily see more big ranges trading.

DIRECT FX Current level Support Resistance Last wk range
AUD / YEN 85.45 84.00 88.00 83.50 – 91.70

AUD/CAD

It has been a wild start to the week for all markets. Another big decline in Chinese stocks yesterday set off a chain reaction in global equities which caused momentary panic in currency markets. In US trading last night with the Dow Jones opening down 1000 points, currency markets had what can only be described as ‘a moment’. Liquidity completely dried up and panic set in for a few short minutes. Markets quickly composed themselves, but the damage had been done to the Australian dollar that was now trading lower across the board. I would look for a range of 0.9400 to 0.9700 over the coming days.

DIRECT FX Current level Support Resistance Last wk range
AUD / CAD 0.9540 0.9500 0.9750 0.9420 – 0.9669

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Market commentary:

Markets are starting to look very fragile and we are in for some real volatility over the coming weeks and months. The past week has been a shocker for stocks. In the US the Dow at has fallen over 10% from its highs and is now down on the year. Chinese stocks smashed through recent lows losing more than 8% yesterday. European stock markets are also feeling heat. Risk aversion is causing big moves in foreign exchange with the biggest gainers so far the Euro and the Yen. Further weakness in the Chinese economy, after Friday’s release of very soft manufacturing PMI data, has been fingered as the cause, but in all reality it’s really just the trigger. US stock market valuations had diverged from economic reality a long time ago and sooner or later something was going to cause a correction. Commodity prices continue to tumble, although gold seems to be benefiting from safe haven status. Bloomberg’s commodity index recently hit its lowest levels since 1999. Inflation expectations in the US are falling to levels last seen when the Fed launched the quantitative easing programmes one, two and three. Indicators of global trade don’t make for any better reading, with the risks to global growth all skewed to the downside. Somehow in amongst all this, the Fed are supposed to raise interest rates for the first time in nearly ten years when they meet next month. It looks like they will need to be very brave to do so. China on the other hand are widely expected to announce further easing measures in the coming days / weeks. This may provide some temporary respite, but the Chinese economy could yet see real trouble. The Chinese property market rolled over last year and has been losing ground ever since (although recently the pace of depreciation has slowed), their stock market has crashed and they’ve started to devalue their currency (many expect further devaluations of the Yuan). What China can’t afford to have happen next is a collapse of their shadow banking system. The ‘shadow banking system’ refers to the collection of non-bank financial institutions that provide lending and credit facilities to consumers and businesses. It has seen massive growth in recent years, but it’s far less regulated and has far less transparency in relation to the quality of lending going on. Safety margins are also lot smaller than in the traditional banking system and if the ‘shadow banking bubble’ bursts it could be potentially devastating. In New Zealand we saw the collapse of our own ‘shadow banking system’ with a huge percentage of finance companies going bankrupt in the years after 2007. China could be heading for a similar thing, but on a much much grander scale and with global implications.

Australia

There has been very little in the way of key economic data released from Australia over the past week. Over the coming days we do have private capital expenditure data and a speech by RBA Governor Stevens to digest, both of which will be closely watched. The Australian dollar has seen plenty of pressure however, with poor Chinese manufacturing data leading to broad weakness in commodities and a further plunge in Chinese stocks. Volatility in all market has been extreme in the past 24 hours. Risk aversion has also been a notable theme in trading in recent days and is likely to remain so in the near term.

New Zealand

Although there hasn’t been much in the way of economic data released from NZ since last week’s better than forecast dairy auction, there has certainly been plenty of volatility in the New Zealand dollar. In fact last night saw some of the more wild moves in recent memory as risk aversion and fragile stock markets had everyone on edge. Chinese stocks had a very big down day yesterday falling by some 8.5%. That’s the biggest fall since 2007. When the US equity markets opened up very weak last night (the Dow Jones was down 1,000 points at one stage) markets everywhere panicked. Volume evaporated in the FX market with literally no bids in some of the NZD crosses for as far as you could see. Markets quickly regained some composure and started to function normally again, but it was a wild ride. We can expect continued nervous trading over the coming days with liquidity much lighter than normal.

United States

Data from the US has very quickly taken a back seat to wider market concerns, and in particular action in the stock market. US stocks have been trading at unrealistic valuations for some time now and all they have needed was a trigger to start a correction. That trigger came from a further big fall in the Chinese stock market yesterday. To be fair, yesterday’s move was probably more like the straw that broke the camel’s back. Concerns have been building recently on many fronts. The Chinese Yuan devaluation, global growth, commodity prices, Chinese stocks and inflation expectations have all been flashing red signals recently. The markets have been weighing these negative signals against a reasonably healthy domestic economy in the US. Solid growth and employment numbers suggest the US remains on the right track. But we now live in a much more global world and those wider concerns are now overpowering the domestic situation. It’s looking increasingly less likely that the Fed will hike interest rates next month, although some commentators still expect them to. We have seen some serious volatility this year in all markets and it seems likely this will continue through year end. Still to come this week we have durable goods orders and GDP data to digest and the market is likely to remain on a knife edge.

Europe

At the end of last week we saw manufacturing PMI for the Euro region as a whole remain steady 52.4, which was a touch better than forecast. Looking into the core nations showed manufacturing in Germany improved to 53.2, while French manufacturing declined further to 48.6. Service sector PMI’s were a little better with the overall Eurozone reading improving to 54.3 from 54.0 prior. Like most global stock markets the European bourses have seen pressure in recent days on the back of big falls in Chinese stocks. Amongst all the volatility the Euro currency has been big gainer. General risk aversion has seen positions unwound in recent days and with most speculators having been positioned for Euro weakness this year, it has resulted in a lot of buying back of Euros. The unwinding of ‘carry trades’ has also benefited the Euro and it’s impossible to say just how much further the currency may go. Tonight we get the German IFO business climate index, but to be honest, the majority of traders will once again be focused on developments in stock markets.

United Kingdom

UK retail sales released late last week were a little disappointing printing at just +0.1% for July against expectations of +0.4%. There were however, positive revisions to prior numbers that tempered the headline fall and helped to limited the GBP’s negative reaction to the release. Other recent releases of note recently include public sector net borrowing, which was much lower than forecast, suggesting the UK finances continue to improve. The Confederation of British Industry also announced they have upgraded their GDP forecasts for this year and next. They now expect GDP of 2.6% (up from 2.4) in 2015 and 2.8% (up from 2.5%) in 2016. The say a stronger productivity, robust household spending and solid business investment prospects have all lead to the improved outlook. The UK hasn’t escaped the recent market turmoil in stocks and a lower global growth profile will only provide more reason for the Bank of England to be very patient before considering to raise rates.

Japan

The Japanese Yen has seen some very big swings in recent days as wider market volatility impacted. In times of risk aversion the Yen traditionally appreciates and that was certainly the case this past 24 hours. The Japanese won’t be happy about the Yen strength as it makes their exports less affordable, but for the time being there is little they can do. They will wait to see if the market corrects over the coming days and barring a further sharp sell off in stocks it will likely do so, at least to a degree. All this uncertainty will only add to the expectation of further easing measures from the Bank of Japan over the coming months. Prime Minister Kuroda has said in recent days that he accepts the BOJ’s explanation that hitting the 2% price target with the self-imposed deadline has become difficult given the sharp fall in oil prices. Later this week we get data on household spending, inflation, retails sales and unemployment.

Canada

Canada produced better than forecast data for retail sales and wholesales sales at the end of last week, while inflation came in as expected at 1.3% year on year. The Canadian dollar failed to make gains on the data however, as the price of oil tumbled further side-lining the domestic data releases. Wider market volatility continues to be the main driver in FX at the moment with stock markets looking particularly vulnerable in the past 24 hours. We can expect more volatility over the coming days with markets remaining very nervous.

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Ian Dobbs is a currency analyst with Direct FX You can contact him here »