Stocks finally show some life after days of heavy losses. The S&P gained 3.9% to 1,940 while the Dow added 4% to 16,285. Economic data today was a source of domestic optimism, with a strong durable goods report. New orders were expected to fall 0.4% from the previous month but actually rose 2.0%. The core reading (excluding transportation) beat expectations as well. The VIX drifted downwards and currently stands at 30. Markets in China continued to fall with a 1.3% decline in the Shanghai Composite. Officials at the ECB suggest that the central bank may extend its monetary easing program as the current international economic environment is a headwind for inflation reaching the 2% target. Yields in the US rise even though William Dudley of the New York Fed says that the case for September tightening is “less compelling.” It appears that markets reacted more to his statement that investors shouldn’t overreact to “short-term market developments.” The 10 year yield rose 5 basis points to 2.18% and the two year rose 4 basis points to 0.68%. Similarly the dollar rose 1.6% against the euro to $1.1332.
In the wake of China’s renminbi devaluation and subsequent equity collapse, many are expecting the Fed to delay the course in raising interest rates. One strategist at a global macro hedge fund speculates that the Fed may push back tightening into next year or even further if China’s slowdown has severe negative effects on emerging markets and global growth. China’s devaluation puts upward pressure on the dollar against many currencies, and raising interest rates would only further enhance this effect. Barclays pushed back it’s tightening expectation from September to March and speculates that Japan and Europe may extend their QE programs. One analyst notes that the Fed is stuck in a catch 22 situation, in which both courses of action will be wrong. If it raises rates too soon then it fears shocking the market and leading to further selling pressure. If the Fed does not raise rates it may exacerbate investors concerns about China.
As of now the selloff in emerging market equities and currencies does not seem to have hit the debt market. The JPMorgan’s emerging market sovereign debt index has returned -0.3% this year compared to a loss of 15.86% for the emerging market equity index. One analyst suggests that this difference may be attributed to the idea that debt investors have already priced in and expected slower global growth, while equity investors have remained more optimistic and pushed up prices. While bonds denominated in local currencies have fallen heavily, bonds denominated in hard currency have been stable. This may change as further appreciation of hard currencies against local currencies will make interest and principal payments more difficult to pay for debtors.