Market volatility clouds outlook

• Financial markets swung sharply downward in response to the potential default of Evergrande, a large Chinese property developer. The Hang Seng index in Hong Kong was among the most exposed, falling as much as 4.2% at one point before closing more than 3.3% down. Chinese markets remain closed for public holidays, shielding them for now from any dramatic sell offs. The equity market decline that has been sparked in China may not presage a complete crash or threaten a broader financial crisis but could cloud the outlook for policymakers in both developed and emerging markets if market volatility remains high for an extended period. 
• The pace of inflation in Dubai moderated in August to 0.25% m/m from 0.27% previously but is still on track for the Emirate to move out of multi-year deflationary trend. On an annual basis, price growth fell by 1.9% in August compared with 2.5% a month previously. Food prices were the fastest growing component, up 1.35% m/m while transport and general goods and services also gained strongly. Dubai’s economy continues to show signs of recovery out of the pandemic and is enduring the same input price inflation as other major economies.
• Producer prices in Germany rose considerably faster than expected in August, up 1.5% m/m compared with market expectations of around 0.8% gains. On an annual basis, PPI rose 12% y/y from 10.4% y/y in July. The elevated pace of input prices may give more fodder to policy hawks within the ECB with several policymakers signaling that they believe the bank’s inflation forecasts are too low. However, input prices globally have been increasing albeit with limited domestic catalysts: global supply chains remain disrupted as an enduring legacy of the Covid-19 pandemic and domestic policy responses may have little effect to redress global materials shortages.
• The new government of Lebanon has won a parliamentary vote of confidence, according to local media. Prime Minister Najib Mikati has also said that the government will restart negotiations with the IMF for a bailout and recovery programme.

Today’s Economic Data and Events

11:20 ID 7-day reverse repo: forecast 3.5%.

16:30 US Housing starts (Aug): forecast 1.55m

Fixed Income

• Markets moved sharply to risk-off positions with high-quality government bonds benefitting strongly. A broad index of US Treasuries added 0.4%, its strongest daily gain since mid-August. Yields fell across the UST curve with the long end dropping substantially. The 2yr UST yield was off by less than 1bps to 0.2158% while the 10yr fell more than 5bps to 1.3107%. Downward moves in European markets were generally to a similar degree.
• Emerging market bonds were caught up in the risk off maelstrom with an index of USD-denominated debt falling by 0.24%. local currency bonds were also negative with yields on South African 10yr yields adding almost 8bps to 9.399% while the 10yr Turkish government bond yield added more than 15bps to 16.63%.

FX

• Currency markets reflected the general risk-off tone although they moderated much of their drop in the later part of the trading day. The DXY index faded some of its initial gains in the US session, ending the day at 93.276 near around flat. After some initial heavy selling EURUSD managed to stabilize and hold around flat on the day at 1.1726. GBPUSD fell relentlessly though, closing down at 1.3657, a loss of 0.61%. USDJPY and USDCHF benefitted from the flight to safety with USDJPY closing at 109.44, down 0.45% and USDCHF down by 0.5% at 0.9276.
• Commodity currencies were caught up in the downswing though with USDCAD rising to 1.2822, up 0.45% while both AUD and NZD fell 0.18% to 0.7252 and 0.7027 respectively.

Equities

• Equity markets were roiled by the Evergrande fallout yesterday which brought a confluence of concerns over slowing growth, incipient tightening, rising inflation, and commodity price shocks to a head.
• While some major Asian equity markets were closed for the mid-Autumn festival (the Shanghai Composite, the KOSPI and the Nikkei, with the Shanghai Composite not reopening until tomorrow and the KOSPI on Thursday), the Hang Seng lost -3.3% by the end of the day and is down modestly at -0.1% at the time of writing this morning. It is now down -11.5% ytd. The Nikkei is down -2.0% so far today.
• The contagion spread first to Europe and then to the US. European equity markets were also hit by concerns over sharply rising gas prices and had their worst day since July. Positive news around easing travel softened some of the blow, but the FTSE 100 still lost -0.9%, the CAC -1.7% and the DAX -2.3%.
• The US was not immune, as the S&P 500 suffered its worst day since May, dropping -1.7%. The index is now down -1.9% m/m. The Dow Jones lost -1.8% and the NASDAQ -2.2%.

Commodities

• Oil prices dropped sharply to start the week in line with other risk assets. Brent futures fell 1.9% to USD 73.92/b while WTI sank more than 2.3% at USD 70.29/b. The financial market sell-off may not prompt any immediate shift in the demand outlook but will nevertheless represent a near-term downside risk for oil.
• Gold was the standout among the metals markets as the only climber, up 0.56% to USD 1,764/troy oz. Across the rest of the precious metal and industrial metals complexes there was a sea of red. Copper forwards fell 3% to USD 9,033/tonne while aluminium was off by 0.8% to USD 2,863/tonne. Iron ore continued to drop, off by almost 1.13% to USD 113/tonne.

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