What’s the Worry?

We look at the myriad of reasons that sentiment has deteriorated and whether it's justified. Oil fell 6% on Wednesday and commodity currencies were beaten up again while the yen led the way. Australian building approvals are due later. There are currently six Premium trades in progress, three in profit and three at a loss.

The magnitude of negativity caught virtually everyone off guard to begin the year as aggressive selling roils markets.

China

The most-widely cited problem is China and the worries kicked off with a 6.8% opening day decline in the Shanghai Composite. Officials have spent the past three days shoring up markets with various interventions and selling bans and Chinese shares have risen modestly. Concerns about yuan weakness are prevalent but it's not a shock to see it softer.

China scares come and go. The past two episodes have shown that the rest of global markets are increasingly affected. That's a scary thought for the future because big swings in Chinese equities are the norm.

In the near-term, there is no reason for sustained risk aversion. The PBOC and government both have plenty of firepower to shore up the economy and it could be unleashed any time.

Broader emerging markets

This is a genuine worry. The World Bank released its semi-annual report Wednesday and downgraded global growth in 2016 and 2017 with a softer trajectory for the US, Japan and China envisioned. None of that is a big surprise but what caught our attention was a forecast for a 2.5% contraction in Brazil. Other commodity-producing emerging markets are taking heavy hits as well and if there is crisis in 2016, they're a good bet.

The Fed

The FOMC minutes were a tad on the dovish side Wednesday but they're old news. In the past two weeks several influential Fed members have been talking about 3-5 rate hikes in 2016. The market has been largely humoring the Fed's tough talk and doesn't believe it's coming but Yellen has now proved she can hike. The market could probably swallow 2-3 hikes but any more would show the Fed is needlessly dominated by hawks.

Geopolitics

Tension in the Middle East and exaggerated military claims from North Korea are nothing new. Perhaps the headlines have added to the sour mood but until the bullets start flying (and that won't be any time soon) then any fears are overblown.

Overall

We're through three days of trading in 2016. Nothing in the global outlook has materially changed. It's the time of year when flows dominate. Like everyone, we've been surprised by the magnitude of worries and we will continue to watch closely but the ADP numbers were strong today and the ISM non-manufacturing index remained healthy.

The jury should stay out at least until the second week of the year.

In the short-term, the focus is on the Australian dollar, which is down 4.4% against the yen already. The main releases are at 0030 GMT with Australian trade balance and building approvals. It's tough to envision either number being strong/weak enough to overcome the swings in sentiment at the moment.