Asia sentiment glum although better data out for the US and Europe. NZD seen as ajusting back from December distortions

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Market jitters continued, with another sea of red for equity markets and Yen being the favoured currency.

Market sentiment turned down following China’s unexpectedly weaker currency fixing yesterday afternoon. The PBOC set the Yuan reference rate at 6.5314, an effective 0.22% devaluation, following the 0.21% devaluation the previous day.  This was the weakest back-to-back adjustment since the shock mid-August 2015 devaluation.  The Yuan offshore-onshore gap widened to a record 1433 pips, suggesting that the market expects ongoing devaluations in the CNY reference rate going forward.

The market saw the PBoC’s move as an increasing tolerance of China’s government to use depreciation of its currency as a policy tool to support economic growth.  The move triggered a downward movement in Asian currencies, with the NZD and AUD swept away for the ride.

Sentiment for Asia remained glum following China’s Caixin Services PMI reading, which came in at 50.2, the second lowest reading since the survey began a decade ago.  While analysts generally accept China’s manufacturing downturn, the services sector is meant to be the offsetting growth engine.  These figures raise doubt about China’s growth outlook and rebalancing of its economy towards services.

And just as if things seemingly couldn’t get worse in the Asian session, North Korea decided to detonate what experts believe was probably a hydrogen bomb, under test conditions.

S&P500 futures were well down by nightfall and the market opened on a weak note and that fall has largely been maintained, with the index down 1.3% as I write.  European equities were down in the order of 1%.

Crude oil prices fell by more than 5% to an 11-year low on large volumes. Supplies at the US’s largest hub, Cushing Oklahoma, rose to an all-time high while other data showed a rise in crude output by 17,000 barrels a day to 9.22m, the highest since August.  These data impacted energy stocks, weighing on equity market sentiment.

In economic news, ADP employment rose by a healthy 257k in December, setting the scene for a good non-farm payrolls outcome on Friday night.  The US ISM non-manufacturing index was weaker than expected at 55.3, but the detail was more supportive.  The index was driven down by suppliers deliveries, while the orders, business activity and employment components were all higher.  The Markit Services PMIs were slightly better than expected for the euro area but slightly weaker for the UK.

On currency movements, it was another good day for the safe-haven Yen, which traded as low as 118.25 and currently sits at 118.60.  That said, the point-to-point movements between the Yen, Swiss Franc, Euro and Sterling against the USD over the last 24 hours have all been within 0.4% of the USD, not a big movement in the scheme of things.  EUR was up slightly to 1.076, perhaps a reflection of that PMI services data, while GBP fell modestly to a 9-month low against the USD and trades just above the 1.46 handle.

Most of the action in currency markets was in the Asia-Pacific currencies.  NZD/USD dropped immediately following the PBoC Yuan fix announcement to around 0.6630 and has oscillated around that level since.  AUD/USD has shown a more downward trend and trades close to its low for the NY session at 0.7052.  Thus, NZD/AUD has drifted higher and has climbed back up to 0.94, after dipping as low as 0.9320 yesterday afternoon.

Our short-term NZD/USD model shows that the NZD should have fallen, not risen 3.8% in December and now we are seeing a payback of that move.  Fair-value is currently close to the 0.64 mark so we could see further downward pressure on the Kiwi over the rest of the month.

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Kymberly Martin is on the BNZ Research team. All its research is available here.