September 14

Market Anxiety On The Rise

In the last three months, not much has changed in economic data. The US and China have been on divergent paths for a year now, while Europe muddles along in the doldrums of low inflation and growth. It has not been until recently that global equity markets suddenly recognized that China plays the role of being the world’s marginal source of economic growth. Without China rapid’s expansion, and insatiable demand for commodities, luxury goods and various American branded products the world would fall into a recession with no new sources of growth in sight.

The Monday morning three weeks ago was the first time since 2011 there seemed to be palpable fear in financial markets as US equity markets all opened down over 6%  before rebounding. We now know that many retail traders could not even access their accounts that morning, or execute trades. Liquidity completely evaporated as the NASDAQ plunged nearly 10% at the open. The US Dollar dropped hundreds of points in minutes as bets on rate hikes were unwound. Ironically, throughout all of this the market that moved the least were US bond yields. 10 year US yields opened at 1.98% , and fell to 1.91% before bouncing back to 2.01% by the close. The more policy sensitive 2 year yield was much more volatile and traded in line with the enormous swings in stocks.

More attention is being placed on these relative movements as news broke that China reduced its FX reserves by $94bn in August alone. With 3.5tn in reserves remaining, these funds are all that backs China’s massively leveraged corporate sector, trillions in local government financing schemes and ultimately the value of the Yuan itself. This dynamic is the at the center of rising anxiety in financial markets as the Dollar-Yuan peg is essentially the centerpiece of global trade. Commodity and Macau casino stocks have been decimated as investors look to sell anything that is heavily exposed to China.

Going into this week’s Fed meeting I would keep two things in mind: 1) Guidance on further tightening is more important than if they hike now or in a month or two. 2) Every hike creates more pressure on the Dollar-Yuan peg and will increase the pace that the PBOC has to draw down FX reserves.  The more pressure on the peg there is, the faster China will need to sell off US government bonds which could create a situation where bonds and stocks decline simultaneously. Looking forward, I am honestly not sure about any trades at the moment, but I do feel like something big is on the horizon and am biding time until the moment comes.