Risk remains out of favour following yesterday’s big drop in global stock markets. In FX markets, the US dollar has fallen further thanks to slightly lower US bond yields after President Donald Trump shockingly announced that the Federal Reserve was making a "mistake" and described the path of rate hikes as being "crazy." The weakness in the dollar and yields have helped to underpin lower-yielding and noninterest-bearing assets such as gold, which until yesterday had hardly responded to the recent stock market weakness. But the main focus will be on Wall Street again when trading gets underway later this afternoon. Will there be further sharp losses to come, and if so could safe haven gold and yen rise further? Or will we see some bargain hunting following the steep falls? It is impossible to say which of the two outcomes will play out today, but things aren’t looking great at the moment.
Brutal sell-off in stock markets
Just before the big stock market drop, we thought that there was a slim chance equities were trying to rebound yesterday, but didn’t get the confirmation we were looking for on the German DAX index as it never went to that 12000 level. Instead, it broke down as too did the other major global indices, leading to further technical follow-up selling. As the selling gathered momentum, panic took hold which eventually saw the Dow Jones Industrial Average shed more than 1,000 points from its high. On a closing basis, the Dow fell more than 800 points, or around 3%, which was its worst fall in eight months. Similar losses were seen for the other major US indices and Asian markets overnight. The negativity has followed-through to European indices which were going to open sharply lower anyway.
Trade war concerns, rising borrowing costs undermine equities
We have been banging on about it that a brutal sell-off was coming, but few had expected such a steep one-day drop. The recent drop in equity prices has been due to a number of factors that had been building up in recent weeks, not least concerns over trade between the two largest economies in the world – the US and China – and its potential impact on global growth. On top of this, the rising levels of government bond yields have been diverting attention away from assets that had been offering the most attractive returns for investors in recent years. Chief among them have been the stock markets. While we are not necessarily calling this the top, the fact that central bank stimulus is slowly being withdrawn bodes ill for equities in the long run.
Gold rises to test key resistance again ahead of US CPI
In another “risk-off” sign, gold finally found support yesterday and has risen further today as yields and dollar eased back after US President Donald Trump said the Fed was making a "mistake" and described the path of rate hikes as "crazy." The safe haven metal had hardly responded to recent stock market sell-off, as investors found better yields in the fixed income markets. But now that the dollar and yields have eased back, gold is finding some solid support, especially given that the stock markets are selling off. The metal could extend its gains further should it finally crack that $1205-$1215 resistance range, which was being tested at the time of writing, on a daily closing basis. We want to wait for it to do this before turning bullish on gold. After all, it could easily turn lower in the event the dollar rises again, say on the back of a surprisingly strong US CPI report later on today. A close above $1205-$1215 could pave the way for a rally to the next potential resistance at $1238. However, if that $1180/3 support area gives way first then all bets are off.