Bad Economic News from China Sets Negative Tone for First Week of Trading

Bad news swept the markets at the opening of trading for the new year on January 4, fueled by weak manufacturing news from China. China’s official manufacturing Purchasing Managers’ Index (PMI), a measure of factory activity, stood at 49.7 in December, in line with market expectations, but the Caixin December manufacturing PMI was down 48.2 compared with 48.6 in November. The Caixin PMI is more closely watched by investors, so the weaker-than-expected number had a major impact on the global market-place.

Chinese stocks plunged on Monday, January 4, dropping 7% before a government and exchange circuit-breaker stopped the trading. The move, however, had already set in motion steep drops in markets all over the world with some major indices like the FTSE-100 reaching their lowest levels since late August. Japanese, European and U.S. equity indices also fell sharply in a trend that would last all week.

Throughout the week, China created additional trouble for traders with its decision to push the value of its currency lower in an effort to make its goods and services less-expensive for foreign buyers. The news was considered bearish because it would likely put a damper on global growth expectations in neighboring countries such as South Korea, Singapore and Taiwan. There were also lingering fears at the end of the week that India would become a casualty of the People’s Bank of China’s devaluation strategy.

Compounding the problems out of China was a geopolitical situation in the Middle East, which reached a point of concern for investors. Over the long holiday week-end, Saudi Arabia severed diplomatic ties with Iran after Iranian protestors stormed Saudi Arabia’s embassy in Tehran following Saudi Arabia’s execution of Shite cleric Nimr al-Nimr last Saturday.

Crude oil prices initially spiked on the news, but eventually concerns over the global supply glut drove the WTI crude oil futures contract to a multi-year low at $32.10. Initially, traders reacted as if the situation between Iran and Saudi Arabia would bring turmoil to the Middle East and a possible disruption in supply. However, by mid-week, traders realized that a disagreement between the two OPEC members would likely mean that an agreement to cut production later in the year would be nearly impossible to achieve.

Also pressuring crude oil prices was an unexpected jump in gasoline and distillate inventories. According to the U.S. Energy Information Administration (EIA), total motor gasoline inventories increased by 10.6 million barrels the week-ending December 31. Distillate fuel inventories increased by 6.3 million barrels. Although crude oil inventories fell 5.1 million barrels during the same time period, it was not enough to offset the huge surge in gasoline stockpiles.

The U.S. Dollar Index had a volatile trade last week. First driven higher, by the turmoil in the global equity markets then lower on concerns about the timing of the next Fed rate hike. The Fed said in its latest minutes that FOMC expressed worries about whether inflation would be strong enough to warrant future rate hikes, nevertheless, they did vote unanimously to raise rates on December 16.

The Fed minutes helped boost the EUR/USD at one point during the week, however, sellers took over on worries about the divergence between the European Central Bank and U.S. Federal Reserve monetary policies. Last week, the Euro Zone reported lower than expected inflation, which likely means additional stimulus is coming. The Fed, on the other hand, is still on track to hike rates as early as June 2016.

Sellers continued to drive the GBP/USD lower. The two main drivers of the sell-off are worries that lower oil prices will hurt the U.K. economy and further delay an interest rate hike by the Bank of England, and worries over the timing of the referendum that will determine whether the U.K. remains a member of the European Union.

Lower oil prices and concerns that a weakening Chinese economy will lead to lower demand for commodities, helped drive down commodity-linked currencies like the Australian Dollar, the New Zealand Dollar and the Canadian Dollar.

There were bright spots in the markets last week. February Comex Gold prices rallied sharply higher on speculative buying fueled by the news that North Korea successfully tested an H-Bomb. Stock investors who took money out of the equity markets also bought gold as a hedge. Gold investors at times paid more attention to outside events this week than to the movement in the U.S. Dollar, which was a little unusual.

Finally, February Natural Gas futures also posted a strong gain on reports of colder weather threatening key demand areas and on a larger-than expected drawdown in supply.