Why Risk Rebounded and Why China's Done Hiking By A. Button?

When the Fed didnt save the market on Tuesday, the market decided to save itself. Risk assets initially fell after the Fed downgraded the economy and pledged to hold rates low until mid-2013 but the trade reversed in spectacular fashion. We explain the rally and explain why China is likely done hiking rates.

Its clear that the US government is now on the sidelines, so the sharp fall in stocks in the past two weeks put tremendous pressure on the Fed to do something to stimulate the economy at Tuesdays FOMC meeting. The knee jerk reaction was to sell risk when the Fed only offered minimal stimulus in the form of a pledge to keep rates low until at least through mid-2013.

USD/CHF fell by as much as 5.6% to a low of 0.7066. The S&P 500 fell to 1101. The market then pulled an amazing turnaround as USD/CHF rebounded to 0.7236 and the S&P 500 to 1171. Other risk assets followed a similar pattern.

Two reasons for the market rebound:

1) Lack of alternatives

Traders were upset when the Fed failed to deliver but where else is there to go? Ten-year Treasury yields touched a record low of 2.03%. Dividends on 22 of the 30 stocks in the Dow yield more than 10 years and the average yield is 3.26%. The market tried to bully the Fed into QE3. The Fed didnt bite so the market took a second look at where it could stash its money and decided risk assets were still a good bet.

2) The Fed hinted at more possible action.

The Fed did not deliver the QE3 silver bullet but the statement noted that the FOMC discussed the range of policy tools available to promote a stronger economic recovery and is prepared to employ these tools. Its a reminder that the Fed is creative and powerful.

In the upcoming Premium Piece, Ashraf will offer NEW TRADES and note that both the S&P500 and Dow-30 avoided technical panic as they closed above their respective 200-week moving averages of 1155 and 10740 respectively after both indices sank below these levels intraday. Had they closed below these their 200 WMAs, it would have been the first such decline in exactly 3 years (since August 2008). The last time before that happened was in 2002.

China Likely Done Hiking

Chinese data yesterday on CPI was at touch high but industrial production (14.0% vs 15.1% prior) and retail sales (17.2% vs. 17.7% prior) were soft. Even with higher inflation PBOC has likely come to the end of the rate hiking cycle. Since Oct. 2010, there have been nine hikes in the reserve requirement and five interest rate hikes. In the past eight weeks there have been no hikes. With the turmoil in global markets and falling commodity prices, its hard to imagine them hiking now.

Sentiment and momentum should continue to dominate Asia-Pacific trading but one data point to watch is Chinese trade balance. For us, THE MOST OVERLOOKED ECONOMIC DATA POINT ANYWHERE is Chinese imports. This is an excellent, early indicator of global demand. If the Chinese are unwilling to import raw materials it shows that they are seeing low demand and/or expect global economic growth to slow. The consensus is for a 22.0% y/y rise after the 19.3% prior.