Stocks rise as a risk on attitude takes hold over global markets. The S&P500 rose 0.8% to 1,995 and the Dow Jones added 0.7% to 16,912. The risk on sentiment is reflected in the continuing downward trend in the VIX which fell to 18.34. China’s foreign exchange reserve data was not as bad as expected which helps investors get a better sense of the situation in that economy. A $43bn drop in reserves was less than the previous month and leaves the country with $3.5tn to manage capital outflows. This leads to support in emerging markets which have been the hardest hit by China’s woes. The Indonesian rupiah rose 3.1% against the dollar, the Malaysian ringgit 3.6%, and the Turkish lira 0.6%. The dollar also fell against the Yen to Y119.96 as the Bank of Japan made no changes to monetary policy however further easing is still expected by analysts. Weak data out of the eurozone sent the euro falling 0.2% to $1.1243 after German and Spanish industrial output disappointed. The US 10 year yield rose 4 basis points to 2.07%. S&P500 earnings are forecast to fall 5.1% from last year in 3Q. Earnings releases over the next few weeks will be an indication of just how badly US companies are affected by the global economic downturn.
The IMF issues a downbeat report on the risks to the global economy. The outlook comes as part of the assessment of global financial stability and risks that comes twice each year. The IMF sees defaults picking up around the world coupled with less investor demand for risky investments. As a result Jose Vinals of the IMF asserts that the outlook “does not rely on extreme assumptions.” A material downturn would result in falling growth rates to a point that would indicate a global recessionary period. There are downside risks to shocks that may originate in either developed or emerging economies including the Fed raising rates or a sudden drop in liquidity. The report calls on policymakers to address financial stability. On a global level the debt market is in a late stage of the credit cycle and the report notes $3tn in “over borrowing”. The main question associated with this trend is how quickly will bad loans flare up and how it will be handled by authorities. The report notes that banks are holding less capital which puts them in a dangerous spot if they begin to take losses on bad loans. Emerging markets are seeing heavy outflows as commodities fall and interest rates rise. Current market prices do not adequately reflect these downside risks. Lastly, the IMF report expresses that it wants the Fed to hold off until it sees more signs of inflation.
China along with other foreign central banks and governments are selling US Treasuries. The biggest sellers are China, Russia, Taiwan, and Brazil. Net foreign purchases of US Treasuries was -$120bn in July according to Deutsche Bank. This extensive selling has been met with demand which has kept yields at lows due to uncertainty. Countries around the world have amassed Treasuries as Foreign reserves over the last decade. Now given current turmoil they are forced to sell in order to defend currencies and meet capital outflows. China has been buying yuan and selling USD in the open market in order to prevent its currency from fluctuating beyond Rmb6.40 against the dollar. The country spend 120bn in August alone in order to defend the peg. This trend could make Treasury markets more volatile in the future. Central banks and foreign governments are typically very stable investors. Their selling has been met by investors that may have different buy and hold characteristics which may very well lead to larger swings in the future.