Major bout of risk aversion ahead? It is more than just Greece

The financial markets begun the week on a relatively calmer note, however, the picture has turned sour today. A look at the performance of the equities, currencies, commodities and bonds indicates we are heading towards a major bout of risk aversion in the markets. 

It is not just Greece, Markets reacting to China – As pointed out yesterday in the report â€œThree events to watch out for in next 24 hours”, the trend in the Shanghai composite index did set the tone for the commodity currencies. The index turned lower despite the slew of measures announced over the weekend by the Chinese authorities. The rout now appears more serious and threatens the stability in the world’s second largest economy, that is already struggling with decade low growth rate. 
 
The sell-off or rout or crash, whatever one may call, is a more serious issue than Grexit. If not halted somehow, it could export deflation across the globe, triggering another round of currency wars. The first to go would be central banks of commodity exporters – RBA, RBNZ, BOC, followed by retaliatory actions from other major central bankers (including Fed – delay in rate hike) and it is unlikely that interest rate cuts could bring back risk appetite in the markets with immediate effect.

Signs of Risk aversion written across markets

Resilience in Yen – After a long time, we have witnessed the Yen remain relatively stable with moderate gains against the USD, while other major currencies being ditched aggressively against the USD. Take a look at GBP/JPY; down more than 200 pips and EUR/JPY; down more than 150 pips. It has been a long time since we saw the EUR/JPY and GBP/JPY pair drop as the Yen hardly showed resilience amid broad based US strength. Such a resilience in the Yen usually preceds bouts of risk aversion. 

The benchmark bond yields drop across the globe – Once again after a long time, we are witnessing losses at the long-end of the bond market curve across the globe. The 10-year German yield is down more than 12 basis points, while the 10-year treasury yield is down more than 6 basis points. Except Greek yields, all other periphery nation bond yields are trading in the red. Canadian yields are down as well. 

Commodities punished – Energies, Base metals have suffered losses. Crude prices are down more than 4%. Sharp losses indicate its more than Greece. Commodities are reacting to Chinese concerns more than Grexit fears. As mentioned earlier, a major trouble in China could export deflation across the globe, which could trigger another round of currency wars as the central banks would go on the loose to achieve famed 2% inflation target.

Equity markets across the globe have suffered losses too, except Nikkei, which ended with 1% gains. The drop once again underlines the fact that it is more than just Greece. European equities may be down due to Grexit fears, however, the US and Asian equities, are certainly responding to Chinese concerns. 

At the moment, the only asset that contradicts signs of a major risk aversion is Gold. The metal is down 1% to USD 1150/Oz. An easy explanation for that is the prospect of an interest rate hike in the US. However, the rate hike bets are likely to fall if we do have a major risk aversion as indicated by the markets. In such a case, Gold could be the biggest beneficiary since– 

• The sentiment is overtly bearish on Gold
• Rate hike bets in the US could fall, with a possible delay till late 2015/early 2016
• Most undervalued safe haven asset at the moment 

The risk aversion could get intense leading to a rise in Gold, if the Fed minutes due for release tomorrow put more emphasis on the overseas developments.