After gapping up a few hundred pips on news of the gajillion euro bailout, the euro is back near its lows against the dollar with pervasive selling into strength. Europe is China’s biggest export partner, and with talks of rampant asset bubbles and consequent monetary tightening coming out of there, things look increasingly bad for China. The Shanghai Index is indeed down over 20% off its highs, putting it in technical bear market territory, by some definitions. This weakness is spreading to commodities, for which China has been showing record demand in recent quarters, with crude and copper both down 12% off their highs. And this, of course, has spread to the Aussie Dollar, with the AUD/USD down close to 400 pips off its high and approaching a definitive 200DMA breakdown, which has been what I’ve been calling for as a terrific short trigger for various risk assets, including equities.
During the flash crash last Thursday, JPY and gold got the safe haven bids as investors fleed risk assets. Gold is a rational safe haven, considering the central bank policies of today, and indeed gold just made a new closing high today in terms of USD, after making new highs in EUR, CHF, GBP, and various other currencies recently. The yen, on the other hand, is less obvious of a choice as far as safe havens, considering Japan’s ballooned debt-to-GDP, which finally will put pressure on JGBs as the next wave of the financial crisis hits. The JPY’s strength as equities declined on Thursday reveals the carry trade nature of this market, as the JPY is the lowest-yielding of currencies and most apt to be carried for risk assets. Indeed, the selloff in EUR/JPY on Thursday preceded (and in my opinion, catalyzed) the risk asset crash. With the EUR back to near lows and commodities selling off, the EUR/JPY is close to breaking back down to crash levels, and in the process, close to catalyzing another wave down in equities in my opinion.
The charts will tell but things are once again getting interesting, and the huge volatility in the euro, especially with the massive selling into the bailout gap-up, could be a harbinger of worse to come, especially considering the record bid-to-cover in the recent 3yr Tsy auction. Risk aversion is here and even if we get a short-term bounce on some sort of political event/reactionary policy, it will be short-lasted and by the end of the summer/beginning of the fall, it should be clear that the next wave of the financial crisis has arrived.
And sovereign debt crises are much more political and have worse economic and social consequences (trade wars, revolts, riots, civil wars, and even world wars) than financial/private debt crises.