The bad news just keeps coming from China. Data published this morning shows that manufacturing in the Middle Kingdom has slowed at the fastest pace in 6 years. It’s payback time following the gargantuan monetary easing in the wake of the global financial crisis. At that time, the government could have rightly claimed credit for being the biggest reason why the world economy avoided depression, but the excesses of the past are now coming home to roost with a vengeance. It is unclear how much of that growth (since 2009) was good investment but the evidence is piling up indicating that far less than necessary was for sustainable or justifiable purposes. So far this year the major shocks that have hit financial markets – excepting the Greek crisis perhaps – seem to have come from East Asia. It seems inevitable that measures to mitigate the slowdown in China will be announced in the coming weeks, the issue is, what will they do? Ironically President Xi Jinping was speaking in Seattle during a state visit to the United States shortly before the data was published and he assured the audience that currency devaluation was not going to be a policy tool going forward. We shall see…
The dollar is getting stronger across the board. Whether you look at emerging market currencies or majors, all currencies are weakening against the greenback… except the Japanese yen. You could argue that the JPY has had a head start (JPY weakening started many quarters before the euro depreciation for example), but what is clear is that the trend for USD/JPY looks biased to the downside now (JPY appreciation). Whether this is sustainable or not is hard to tell, but it certainly looks different to most other currencies at the moment. I’ll hold off making high conviction statements for now, but it certainly looks like a bullish dollar dynamic is building. What I will say is that key trigger levels have not been bypassed yet. The most obvious would be the early September low in EUR/USD at 1.1087, but the 1.0810 – 20 zone is the most important. Through that support area the chances of a test of the year’s lows and the massive channel support that has formed since the global financial crisis. For your guide, that channel support is now close to parity. It is ironic but the Federal Reserve not hiking interest rates may just have been the most effective means of ensuring that dollar strength returns to the market. I could be wrong, but think about it, we’ll continue to speculate about when that first rate rise will happen, that’s dollar bullish right there…
Putting my technical hat on, the equity markets look poised for another leg down. It’s possible that the recent market lows will be tested, but this could represent a fantastic opportunity to buy stocks into the end of the year. The Chinese manufacturing data certainly sets risk sentiment on the right course for a short term dip in equity prices, and I see that German PMI data is slightly worse than expected this morning, that’s not going to boost risk sentiment either! French manufacturing PMI came out at the same time and as in recent times the French data is definitely experiencing an upturn of sorts. Alas that is no replacement for a booming German manufacturing sector!
Bottom line, we could be in for a rocky few days if I’m correct and equities retreat for a while. But it could be a great opportunity for some. Of more interest to me is the fact that the dollar appears to be strengthening in this type of environment. I will continue to monitor the situation, the paradigm that has been in place since at least this time last year has been dollar strength when risk sentiment is positive. I suspect that is still the world we live in, but if it’s not, best to know sooner rather than later. It usually means something significant when a paradigm shifts…
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