Downgrade Torpedoes Market, China Data on Tap

The US debt downgrade and ongoing sovereign crisis sparked the worst stock market selloff since 2008 on Monday. In FX, CHF was the market leader while AUD and NZD lagged. The focus now switches to China's monthly data slate including CPI, industrial production and retail sales.

The S&P500 fell 6.7% to 1119 in the worst one-day decline since Dec 2008. Volume was nearly double the one-year average. At this point, the panic seems overdone. The US downgrade certainly wasn't a shock and the market moves appear to be more sentiment driven than news driven.

The forex market hasn't displayed the same type of panic as stocks, primarily because the knee-jerk reaction isn't as clear. The obvious safe havens like JPY and CHF are already at extreme levels and the risk of intervention looms. The set-up has left precious metals in an enviable position. Gold hit a record on Monday and silver rallied. We remain upbeat on precious metals, see Ashraf's latest thoughts in the Premium section.

The turmoil in markets has sent a strong signal to the FOMC demanding action at tomorrow's meeting. Policymakers are likely to commit to lower rates for longer or lay the groundwork for QE3. Something along those lines is likely to send risk assets rebounding while total inaction would compound the pain. We note that the Bernanke Fed has always been extremely responsive to stock markets so we have little doubt the Fed will take some action.

In any case, there is little the Fed can do for the economy. With 10-year yields falling to 2.22% today, borrowing rates are already near historical lows. The most the Fed can do is inspire confidence. Given that, we would turn outright bearish on risk assets if the Fed takes action and the market is not impressed. This would signal a loss of faith in the Fed.

Asia-Pacific Preview

Up first are the minutes of the July 17 BOJ meeting at 2350 GMT. This was not the meeting where officials decided to intervene in fx but it may contain hints about the role of JPY appreciation on the economy.

The monthly Chinese data slate will be a major focus at 0200 GMT. China's stock market has fallen into a bear market on fears of interest rate hikes and a slowing global economy. The CPI is expected to remain steady at 6.4% y/y; industrial production up 14.7% y/y compared to the 15.1% prior; and retail sales steady at 17.7% y/y.

Given the prevailing negativity, we believe a 1-2 percentage point beat in IP and/or retail sales will be necessary to improve sentiment. The CPI reading will be most important with a rise above 6.5% seen as the precursor to a rate hike.

Later, at 0600 GMT, Japan releases preliminary data on machine tool orders. The prior was 53.3% y/y.