Stocks Around the World Sell off While Worries About FX Tensions and European Sovereign Debt

Yesterday's decision by LCH.Clearnet to require an additional 15% of margin on positions of Irish sovereign debt has been a catalyst to the downtrend in place for a while in risky assets, and we saw bourses in the red around the world, with Asia being a rare point of strength. North and South America, Europe, and most emerging markets saw significant declines in share prices. In contrast, Japanese, Australian, Chinese, and HK bourses were higher, with the strongest gains seen in Chinese markets, while Thailand, and Korea (-2.7%) were lower with the rest of the world with energy firms and banks reported as the main source of strength. On data front, China data released today in Japan has shown machinery orders falling by about 10 percent in September following two months of strong increases, yet Nikkei was higher after the USD rose around the world on negative risk sentiment.
As expressed here before, we believe that the Fed decision of last week is in fact going to be the starting point of a sharp correction in markets, on the basis of the familiar concept of "buy the rumor, sell the fact". However at this point it is almost impossible to adopt a bullish posture on the U.S. with both the Treasury and the Fed clearly committed to depreciating the USD. Geithner's recent comments that the U.S. never aims to manipulate the currency are but exercises on definitions and theory, with QE2 a dominant concern in the minds of traders and authorities. At the same time, we doubt that the FX market presents the most suitable environment for dollar-bearish positions, since most nations have very little to gain from a rapid depreciation, and will not hesitate to take drastic action at times to reverse or slow the trend, resulting in costly mistakes and misunderstandings among traders. Commodities are not regulated or controlled by anyone, so speculators have far greater freedom in drawing them in any direction they desire. In particular, gold, among all commodities, has the added benefit of being regarded as an alternative currency, and presents an exceptionally good choice for the exploitation of the USD trend.

Eurozone debt market in crisis mode, turmoil spreads

As readers are probably aware, the spreads of Irish, Portuguese, Italian, Spanish, Greek and Belgian bonds against German bunds were all wider today. To reduce tensions, the ECB is known to have bought some Eur711 billion of Eurozone debt, which is still small in comparison to peak numbers of May, and there is ample room for further bond purchases before the market is cowed, if at all, to stop shorting the periphery.

In other developments, correlation among various Irish banks has been rising, with today's reports showing that Allied Irish, and Bank of Ireland reaching similar CDS levels to those suffered by the embattled Anglo-Irish.
3-month Euribor was back up at 1.050% today after falling for the past few days.

PBOC watching inflation closely

Vice Governor of the Chinese central bank, Hu XiaoLian, has said today that the bank is carefully watching inflation trends, and that they will use monetary policy tools "flexibly" in order to control them. Today's numbers which showed inflation jumping to a two-year high of 4.4% last month from the previous 3.6% lie behind the decision of the PBOC to raise the reserve requirement ratio yesterday, and news sources also report that about CNY30 billion has been removed from the market in monetary operations during this week. Nonetheless, unless they are implemented in the framework of a tightening policy that will accompany the rise of the currency, they are unlikely to lead to a meaningful improvement in the excess liquidity situation of domestic markets. After all, with the USDCNY pointed lower, any small amount withdrawn through traditional means will be more than made up by aggressive inflows created by appreciation expectations. We doubt that inflation is a serious problem for China for now, but the real estate market, and the continuing rapid growth of credit (with M2 rising at 19.3% in October) pose issues that must be tackled decisively if China hopes to avert a costly and unpredictable downturn.
Meanwhile, Asian markets got a significant boost from Moody's decision to upgrade China's long term sovereign credit rating to AA3, and maintaining a positive outlook. In yet another highly aggressive fixing, the yuan was set at 6.6242 from 6.6450 yesterday, while In Korea, large state-owned corporations are reported to be active in the FX market as the government attempts to prevent the rapid appreciation of the won.