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 level (over 1600bps intra-day), 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 1.2% as I write.  European equities were down in the order of 1%.

Crude oil prices fell by more than 5% on large volumes to an 11-year low. 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.

The minutes of the FOMC’s December meeting were seen to be slightly dovish, with some on the committee seeing the December hike as a close call.  Some members also believed that “the risks attending their inflation forecasts remained considerable.” There was no hint of the next move in rates.

On currency movements, it was another good day for the safe-haven Yen, which traded as low as 118.25 and currently sits at 118.45.  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 1.0786, perhaps a reflection of that PMI services data, while GBP fell modestly to a 9-month low against the USD and trades around 1.4630.

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 showed more of a downward trend and traded as low as 0.7049 before ticking up after the FOMC minutes were released to 0.7069.  Thus, AUD/NZD has drifted lower and trades at 1.0630, after reaching as high as 1.0729 yesterday afternoon.

Investors switching out of equities into the safety of the bond market has seen US Treasuries well bid, with the 10-year rate down 5bps to 2.18%, trading close to the lows for the session.  The 2-year rate has dipped below the 1% mark and currently trades at 0.99%.  The Fed’s Fischer was on the wires claiming that 4 hikes in 2016 was in the ballpark, and noting that this was above the market expectations of only 2 hikes.  However, he also acknowledged that China’s slowing economy and other sources of uncertainty made it difficult to predict the path of policy.

There’s not much coming up overnight of note, but during the day Australian trade and building approvals data are released.

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