FX Year Starts with Massive Risk Off Move

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Market Drivers Jan 04, 2015

Shanghai down 7% creates massive risk aversion in market
EZ, UK PMI bit lower than expected
Nikkei -3.06% Eurostoxx -2.43%
Oil $37/bbl
Gold $1071/oz

Europe and Asia:
CNY Caixin PMI 48.2 vs. 48.9
EUR Markit PMI 53.2 vs. 53.1
GBP UK PMI Manufacturing 51.9 vs. 52.8

North America:
USD ISM Manufacturing 10:00

The currency markets started the New Year off on a sour note today as the 7% decline in the Shanghai equity market triggered waves of risk aversion in FX with both euro and yen strengthening while the carry trades suffered steep declines.

Initially in early Australian dealing the dollar opened well bid rising to 120.46 against the yen while EUR/USD dropped to 1.0825. But the rally did not last for long as the panicked selling in the Chinese markets spilled over into FX and quickly flipped the flow around as Asian indices dropped across the board and investor sentiment grew more panicked by the minute.

There was no single event to precipitate the selloff but certainly macro economic data and global tensions contributed to gloomy mood in capital markets. In China both the official and the Caixin PMI’s missed their mark dropping further below the 50 boom/bust level with Caixin printing at 48.2 versus 48.9 eyed while the official data released over the holiday weekend showed that Chinese PMI has slowed to 49.7 from 49.9 forecast.

Chinese manufacturing remains in a slump and is likely to be a drag on growth this year. That in turn could reduce the 7% GDP target for China and decelerate global growth in general putting Fed’s tightening action in doubt. The capital markets are clearly concerned about such a scenario and the geopolitical tensions between Iran and Saudi Arabia which ruptured diplomatic relations over the weekend only helped to exacerbate these fears.

Whether this risk off move will continue for rest of the day will depend to a large extent on the US equity open. If the panic selling picks up in North American trade USD/JPY will likely make fresh lows as the day proceeds testing the 118.50 level while EUR/USD could push to 1.1000 as risk aversion flows continue to cause carry trade unwinds.

The US calendar only carries the ISM Manufacturing report and given the bleak results from the regional releases the prospect of a miss is quite high, The market is actually looking for a pop to 49.1 from 48.6, but any further decline could only add to the stock selloff and push the dollar lower against the low yielders as risk off sentiment persists.

For now currencies appear to have stabilized at lower levels, but all eyes will be on the North American open as traders watch for the second wave of selling to hit risk assets on the first trading day of the year.

Boris Schlossberg
Managing Director

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