The “Emperor’s New Clothes” by Hans Christian Andersen tells of a pair of dishonest weavers who sell the Emperor a new suit of clothes, saying that is invisible to those who are unfit for their positions, incompetent, or stupid. When the Emperor parades before his subjects in his new clothes, no one is brave enough to tell him that he is naked – until a child says, “But he isn’t wearing anything at all!”
A similar denouement seems to be underway in China, where a government once believed to be economically all-powerful is failing to reverse a rapid slowdown. Investors around the world seem to be finally seeing the fundamentals laid bare this morning, after a Chinese manufacturing survey was released showing that activity contracted for a third month, and closely-correlated South Korea reported that exports had fallen 15.8 percent on a year-over-year basis. This caps a long series of disappointing economic data releases, and comes despite a raft of stimulus measures launched over the last year. In short, China’s economic emperors appear to be missing their clothes.
In response, global markets are in full-fledged risk-off mode, with commodity currencies dropping as the euro and yen see strong safe-haven inflows. Traders are shifting out of economically sensitive assets as they look for any port in a growing storm, and virtually every China-proxy is coming under sharp selling pressure.
In contrast, the dollar looks like the rock in a sea of troubles – but this may be deceptive. With the Federal Reserve on a ‘data-dependent’ path toward a December rate hike, traders are strictly avoiding large directional positions on the greenback, particularly ahead of this Friday’s critical non-farm payrolls report. Despite the fact that these numbers are notoriously noisy and frequently subject to large revisions, Janet Yellen is widely expected to step on the accelerator pedal in the event that the next two reports are relatively strong.
Accordingly, while Wednesday’s ADP report and manufacturing index are likely to trigger widespread short-term volatility, most market participants will keep their powder dry until the main event on Fridaymorning. This means that optimal execution opportunities may be extraordinarily short-lived – so consider discussing strategy with your trading teams well in advance.
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