Correlations are acute as the Dow meltdown triggers a forex crash

Correlations are acute as the Dow meltdown triggers a forex crash

Because this is one of the busiest trading weeks of the year, stock market volatility, as measured by the CBOE Volatility Index, has reached its highest level in four months. The Dow Jones Industrial Average dropped over 900 points in one day, settling around 600 points down. The S&P 500 index fell 1.7 percent, its lowest level since May. While the Federal Reserve will make an important monetary policy announcement on Wednesday, the decrease was not caused by the meeting. Following the central bank’s dovish inflation and employment figures, economists did not expect the central bank to make any bold announcements. Fears about China and the debt ceiling, on the other hand, drove stocks and currencies to plummet. Evergrande (HK:3333), China’s property behemoth, is on the verge of a $300 billion default, and investors are concerned about contagion due to huge Western bond fund exposure.

September is historically a bad month for equities, and after focused on COVID-19 for more than a year, Evergrande is a new shock that could result in huge liquidation in the coming weeks. The sell-off in equities drove currencies, bond rates, oil, and cryptocurrency substantially lower, tightening market correlations that had broken down throughout the year. The scope of risk aversion is mind-boggling.

The top performing currencies in FX were the Japanese Yen and Swiss Franc, which is to be expected when stocks fall substantially. Except for the euro, which remained steady; the Japanese Yen; and the Swiss Franc, the US dollar rose against all major currencies. If stocks continue to collapse tomorrow, with the Dow plunging 500 points or more, any notion of a Fed taper on Wednesday is effectively cancelled. The Evergrande debacle is, in many ways, a larger deal for the financial markets than the FOMC. We foresee significant currency depreciation in the next 24 to 36 hours as China refuses to bail out the property behemoth. The US dollar is particularly vulnerable to Yen and Franc depreciation. Housing starts and permits in the United States are coming out on Tuesday, and the Chinese housing disaster could prompt a stronger reaction to housing weakness in the United States.

There are four key central bank monetary policy announcements this week, as well as an election and a long list of important economic statistics, amid all of the turbulence. Today, Canadians will vote on whether or not to keep Prime Minister Justin Trudeau in power. The prime leader called a sudden election a month ago, two years ahead of schedule. The contest is now far tighter than he could have predicted. Although changes in leadership do not usually have a long-term influence on currencies, if Trudeau loses, the uncertainty will cause the Canadian dollar to weaken in the short term. We should know shortly after the last polls close at 7 p.m. Pacific time, but paper ballot counting could delay the results a few more dates.

The RBA minutes are due out this evening, which will keep the Australian dollar in the spotlight. At its most recent meeting, the central bank opted to go forward with its taper plans, which came as a surprise, but also stated that rate hikes are unlikely to occur until late 2024, which is later than most economists predicted. Although the NZ PMI services survey released last night revealed a considerable slowdown in activity, the government’s decision to ease restrictions in Auckland helped to keep the currency from falling too much.

Stronger inflation data and a safe-haven bid boosted the euro. One of the biggest losers was Sterling. With no adjustments expected from the Bank of England on Thursday, the pound is trading solely on risk appetite. Although the Bank of England is one of the most dovish central banks, with stocks tumbling and the Delta variation spreading, it will be hesitant to even discuss hiking interest rates. Its furlough program is also coming to an end this month, which could cause some economic hardship.