Chaotic week ends, what next?

2016 did not get off to the right start for most investors, as a series of consecutive negative news took its toll on financial markets, amongst which was the disarray caused by China’s currency policy and tumbling equity markets. The interconnectivity and high correlation of markets nowadays is ever more apparent as the turmoil in China spread across the region, with the Shanghai Comp, CSI 300 and Shenzhen tumbling -9.97%, -9.90% and -14.30% respectively. The risk off stance consequently spread to the US as a result, with the S&P 500 (-5.96%) down the most on record for a first week and it also being its worst week overall since September 2011. European markets were also down (Stoxx 600 -6.69%, DAX -8.32%) while the MSCI EM index fell -6.82%.

Conflict in the Arab world didn’t little to elevate concerns over oil production, where the price oil (WTI) is now just a touch off the USD 30. Over the past week WTI has fallen -10.48% to the lowest close since February 2004. Other commodities markets were also affected, where we witnessed Copper, Iron Ore and Lead falling -4.68%, -3.31% and -9.59% respectively while Gold (+4.06%) was an exception on safe haven flows.

Credit was under pressure also with the CDX HY (high yield) spread finishing +52bps wider (although less than the big move wider in mid-December). Interestingly US HY energy spreads finished ‘just’ +30bps wider although are still hovering near those all-time wides. Given the sharp falls across risk assets, the moves in the core sovereign bond markets were probably less than one might have expected. 10y US Treasury yields ended 15bps lower, while 10y Bunds were 11bps lower in yield. Malta Government bonds also gained as a consequence, with the theoretical 10-year yield dropping from 1.56% to 1.485%.

The question on spooked investors’ minds is where do we go from here? As things stand the turmoil in China doesn’t appear to be over, with another downturn for bourses in Asia this morning hitting our screens. This however has not affected the sentiment in Europe where equity markets are trading higher by around 0.5-1% across the board as sentiment improves and European markets distance themselves from China woes. This could very well be an attractive entry point for European and US investors alike, especially since earnings season is due to kick in.

Importantly, Morgan Stanley have released a report where they believe that oil may drop to as low as $20 a barrel due to the rapid appreciation of the USD. In the report they outline that the currency appreciation has become the main driver of the price drop, as non-fundamental factors take centre stage as opposed to the previous downward pressure due to oversupply and a race for market share.

In terms of upcoming data swaying the markets this week we have the labour market conditions index print in the US this afternoon. Tomorrow we see trade numbers form Japan and in Europe we get French business sentiment data along with the UK industrial and manufacturing production data. There’s important data due out of China on Wednesday with the latest December trade numbers due. In Europe that day we’ll get French CPI and Euro area industrial production. The December Monthly Budget Statement is due in the US on Wednesday along with the Fed’s Beige Book. Turning to Thursday we’ll get the latest GDP data out of Germany, along with the BoE rate decision in the UK and latest ECB minutes from the controversial December meeting. In the US the import price index is due along with initial jobless claims. We close out the week on Friday in Europe with Euro area trade data and the BoE credit conditions and bank liabilities surveys. It’s a busy end to the week in the US on Friday highlighted by December retail sales, PPI, empire manufacturing, industrial and manufacturing production, business inventories and the preliminary January University of Michigan consumer sentiment reading.