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It’s a Friday and the last day of the month and also the quarter.   Furthermore, this has been the worst quarter for equities for three years, with the MSCI World index down nearly 18% and the S&P500 down nearly 14%.   So far, this has proven to be a relatively steady week for the dollar, with the dollar index only a shade softer vs. Monday’s opening levels.  

It’s been European stocks where the gains have been concentrated, with the EuroStoxx50 up just over 9% on the week vs. around 1.5% for US stocks.   However, the fact that US equities have remain subdued into the quarter-end suggests only limited rebalancing by portfolio managers back towards benchmark levels and perhaps a greater acceptance of the weaker state of the global economy. Nevertheless, there remains scope for significant volatility today as positions are further adjusted.

Guest post by FxPro

Commentary

Kiwi shot down. The New Zealand dollar is threatening 6mth lows vs. the greenback in the wake of the ratings downgrade by both S&P and Fitch ratings agencies. The market was more prepared for the S&P move overnight, but nevertheless the loss of the AAA rating from S&P is significant and has further pushed yields on government bonds higher. Whilst New Zealand has had its domestic problems, such as the earthquake earlier this year, the concern lies more with external financing conditions and New Zealand’s ability to fund its deficit via overseas investors, the current account now in deficit to the tune of 5% of GDP.

Further evidence of China softening. There are quite a few purchasing manager indices in China, but the latest from HSBC shows the manufacturing sector contracting for the third consecutive month, the September reading coming out at 49.9.   This is unchanged from the August reading and suggests that whilst softer, activity is not declining at a precipitous rate.   Apart from Europe, there are also a variety of local concerns that are impacting negatively on sentiment. First, Chinese policy-makers are still determined to contain inflation, implying that there is unlikely to be any interest rate relief for some time. Second, the yuan exchange rate has appreciated significantly against other Asian currencies this month because of its close relationship with the surging dollar. Third, a poll conducted by Bloomberg found that investors expect Chinese growth to slow to around 5% over the next five years as the economy starts to mature.   Finally, there is a genuine fear that the country’s real estate bubble is unravelling, exposing an enormous debt burden. Recently, S&P warned that credit conditions for Chinese builders would “become increasingly severe”. Property-related stocks in China have plummeted in recent weeks. China’s local governments have accumulated USD 1.7trln of debt, and credit default swaps on Chinese sovereign debt are now at the highest level since those dark days in early March 2009.China’s markets are closed all of next week for holidays. Given the consistent selling pressure evident in recent weeks, this might be no bad thing. Right now, if China sneezes, then the world risks developing pneumonia rather than simply a common cold.

German vote causes barely a ripple.   It makes you wonder what all the fuss was about really. The German parliament comfortably gave its assent to the increase in the EFSF to EUR 440bln, with 523 for and vs. 85 against (and three abstaining). The euro barely budged on the news, but as we said ahead of the event, this was perhaps not much of a surprise. The story has very much moved on from the increase in the size of the EFSF to the extent to which its firepower can be increased via leverage and other means. This reflects the speed at which market and fiscal developments move, as compared to the political process in Europe and in particular the securing of agreements and approval for eurozone-wide measures. The fact that Merkel’s majority on this vote was greater than expected may give some support to the process of saving the periphery (more details on this awaited), but overall it’s a hollow victory for Merkel which has highlighted the political strains that the sovereign crisis is inflicting on Germany.

SNB’s franc determination. Since the SNB’s shock-and-awe announcement back on September 9th that it was imposing a EUR/CHF ceiling of 1.20, there has been very little comment from the central bank, and moreover very little challenge of this new line in the sand by the market. Over the past three weeks, EUR/CHF has traded in a tight 1.21-1.23 band. Underlining the SNB’s determination to prevent any further upward pressure on the franc, Vice-President Jordan suggested this week that the new policy was “very, very credible” and that “all measures” would be used to defend the ceiling. Jordan also made the point that the central bank “cannot become illiquid”. After more than two years of attempting to bat back a tsunami of safe-haven flows through large-scale intervention, the SNB’s foreign exchange reserves now represent around one-half of the economy. For now, it appears that the SNB has successfully diverted the safe-haven appeal of the Swiss franc onto other currencies such as the Japanese yen and (increasingly) the US dollar.