Equity Markets

Overnight, China decided to take steps to reduce "macro financial risks." And by that they mean "do something quick to help ease pressure on the yuan" and by extension, on the PBoC’s rapidly depleting FX reserves. To that end, starting October 15 banks will have to hold the equivalent of 20% of clients' FX forward positions with the PBoC, where the money will sit, frozen, for a year, at 0% interest.

Gold rose 3.5% in August as stocks globally saw sharp falls on growing concerns about the Chinese and the global economy.  

Just like the last time when Chinese flash PMI data came out at the lowest level since the financial crisis, so overnight when both the official Chinese manufacturing and service PMI data, as well as the Caixin final PMI,s confirmed China's economy has not only ground to a halt but is now contracting with the official manufacturing data the lowest in 3 years and the first contraction in 6 months, stocks around the globe tumbled on concerns another major devaluation round by the PBOC is just around the corner with the drop led by the Shanghai Composite which plunged as much as 4% before, the cavalry arrived and bought every piece of SSE 50 index of China's biggest companies  it could find, and in a rerun of yestterday sent it to a green close, with the SHCOMP closing just -1.23% in the red. So much for the "no interventions" myth. We wonder which journalist will take the blame for today's rout.

Following China's official PMI print at a 3-year low, Caixin's PMI collapsed to 47.3 - the lowest sinec March 2009. Despite another CNY150bn liquidity injection (but the biggest strengthening of Yuan since Nov 2014 and a financial conditions tightening in FX trading), China, US, and Japanese stocks are plunging... SHCOMP -4%, Dow -280, NKY -340

Attempts to explain exactly what happened last Monday when prices for a whole host of ETFs and mutual funds diverged markedly from fair value abound and while there's no way to know for sure exactly what went wrong, FactSet has drawn some tentative conclusions after conducting a bit of "voodoo, tea-leaf reading."

While we have all seen how equity markets had decoupled from the 'reality' occurring in commodities, FX, and credit markets (as well as macro fundamentals), trading desks are anxiously eying the following 'decoupling' as this week's "pair trade."

A glitch in the Matrix (if you will) that affected pricing for 1,200 mutual funds and ETFs still wasn't wholly resolved as of Sunday evening after executives worked through the weekend in a frantic attempt to resolve the issue ahead of Monday's open. Remember, if anyone asks, none of this has anything to do with flash-crashing, broken markets.

"I'm confused, but still buying stocks. I trade only from my own account, I'm slightly long - a little discouraged when I see the action we've seen overnight in China. But, I think I'll stay that way and my propensity shall be to a quiet modest buyer of more on today's weakness.

Yesterday, the FT triumphantly proclaimed: "Beijing abandons large-scale share purchases", and that instead of manipulating stocks directly as China did last week on Thursday and Friday, China would instead focus on punishing sellers, shorters, and various other entities. We snickered, especially after the Shanghai Composite opened down 2% and dropped as low as 4% overnight. Just a few hours later we found out that our cynical skepticism was again spot on: the moment the afternoon trading session opened, the "National Team's" favorite plunge protection trade, the SSE 50 index of biggest companies, went super-bid and ramped from a low of 2071 to close 140 points higher, ending trading with a last minute government-facilitated surge, and pushing the Composite just 0.8% lower after trading down as much as -4.0%.

The stability of global capital markets, the ECB meeting and US employment data are highlights.   Risk seems to be greater than discounted that Sept rate hike is still a distinct possibility.

Having recently explained (in great detail) why QE4 (and 5, 6 & 7) were inevitable (despite the protestations of all central planners, except for perhaps Kocharlakota - who never met an economy he didn't want to throw free money at), we found it fascinating that no lessor purveyor of the status quo's view of the world - Citigroup's chief economist Willem Buiter - that a global recession is imminent and nothing but a major blast of fiscal spending financed by outright "helicopter" money from the central banks will avert the deepening crisis. Faced with China's 'Quantitative Tightening', the economist who proclaimed "gold is a 6000-year old bubble" and cash should be banned, concludes ominously, "everybody will be adversely affected."

Many were stunned at the pace of the v-shaped recovery in US equity markets this week after Monday and Tuesday's carnage. However, as the following chart makes very clear, there was good reason for it... Having overshot to the downside of "Fed-Balance-Sheet-Implied" levels but around 100 S&P points, the broad index ripped back higher to almost perfectly settle at "Fed Fair Value" - between 1980 and 2000. But, there is a rather ominous event occuring in 2016 that is out of The Fed's control that implies S&P 1,800 unless QE4 is unleashed.

"As soon as people sense the government is withdrawing from direct intervention, there will be lots of investors starting to dump stocks again."

Overnight's start attraction was as usual China's stock market, where trading was generally less dramatic than Thursday's furious last hour engineered ramp, as stocks rose modestly off the open only to see a bout of buying throughout the entire afternoon session, closing 4.8% higher, and bringing the gain over the last two days to over 10%. This happens as China dumped a boatload of US paper to push the CNY higher the most since March, strengthening from 6.4053 to 6.3986, even as Chinese industrial profits tumbled 2.9% from last year: this in a country that still represents its GDP is rising by 7%. Expect much more Yuan devaluation in the coming weeks.

"Price insensitive" flows are starting to materialize, and our goal is to estimate their likely size and timing. These technical flows are determined by algorithms and risk limits, and can hence push the market away from fundamentals.  The obvious risk is if these technical flows outsize fundamental buyers. In the current environment of low liquidity, they may cause a market crash such as the one we saw at the US market open on Mondaay"