US Open Note – China's potential domino effect spooks stocks; dollar up

Stocks plunge as China's Evergrande causes risk-off

While the week was supposed to be all about the Fed and its tapering signals, increasing fears that Beijing will let its giant property developer Evergrande default on its $305 billion liabilities over a looming deadline for payment obligations brought another headache to global markets on Monday.

The jitters popped up at a time when investors are growing sensitive to high valuations in stock markets and monitor signs of a slowing global economic recovery amid the spread of the delta variant. Hence, unless China’s authorities intervene to ease the liquidity stress, a major default in the real estate sector could become an imminent risk.

European indices were in the sea of red following the plunge in Asian markets, with most sectors tumbling by more than 1.0% on the day, especially in basic materials as China is a heavy consumer of global metals.

The pan-European STOXX 600, having erased August’s impressive rally, is currently trading near a fresh two-month low and comfortably below the record of 475.73 at 453.17. Perhaps the surprising pickup in German producer prices, which hit a new all-time high at 12.0% y/y in August, added extra nerves to investors today. UK'S FTSE 100 sank below the 200-day simple moving average (SMA) for the first time in almost a year.

Wall Street may not be an exception when US markets open, with US futures signaling a 1- 1.45% dip at the start of the session.

Note that Chinese markets will be shut for holidays today and tomorrow.

Dollar outperforms ahead of FOMC; risky currencies in the red

In the FX space, the US dollar was outperforming a basket of major currencies during the European session, extending last week’s rebound to a one-month high of 93.41, probably gaining from the risk-off trade. Although the Jackson Hole symposium reduced the case for a taper announcement in September, traders believe the Fed will keep up the talk on the issue at this week’s FOMC meeting. Yet, if China risks prove to be something more serious, it would be interesting to see if Powell can push the tightening plans further into the horizon this year or cancel them all together for the sake of safety.

Separately, the traditional safe haven yen managed to find some buying traction against the US dollar near the 110.00 level, and achieve an even larger share of gains against the aussie and kiwi, which tend to decelerate on China’s doldrums. The swissie recouped a smaller share of gains after the peak at 5 ½-month high of 0.9332 versus the greenback.

Turning to European currencies, the pound surrendered to the bears despite speculation that the Bank of England could adopt a relatively hawkish tone on Thursday as inflation in the UK has notably strengthened. Companies tend to build their energy inventories months ahead of winter, but soaring gas prices may slow this process, likely causing a domino effect of supply constraints in several industries. The UK government is currently seeking to provide state-backed loans to cover the rising cost of production.

Pound/dollar is heading to test the 1.3600 number, which is the lower boundary of its range area, after slumping below the 1.3700 level. Pound/yen was a bigger victim, falling at a faster pace below the 200-day SMA and to a one-month low of 149.41.

In the Eurozone, ECB executive board member Isabel Schnabel, underlined that the timeline of when asset purchases will end becomes more important as inflation picks up steam, though her remarks did little to help the euro, with euro/dollar stretching its two-week-old bearish run slightly below the 1.1700 bar.

Election day in Canada

In Canada, it will be an election day for Prime Minister Justin Trudeau, who is slightly in front of the polls relative to Conservative Erin O’Toole. The voting process is said to close around 02:00 GMT, but the final results may not come out before Tuesday. Yet, a weaker support on the east coast, where Trudeau dominates, could signal his defeat. For now, China’s property trouble and falling oil prices may keep weighing on the loonie. Dollar/loonie is thriving for the third consecutive day, set to close above the key 1.2824 resistance.

In commodities, WTI oil futures dropped to an intra-day low of $69.96/barrer, while gold is neutral overall on the day despite a flash decline to a fresh low of $1,742.

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