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This Summer's Biggest Risk Factor

This Summer's Biggest Risk Factor

Boris Schlossberg, Technical Strategist

The apparent divergence between the US and Chinese economies is a likely focal point for world equity and currency markets this summer, and it could cause increased risk aversion or even full-on investor panic.

Asian markets were destroyed on the first trading day this week, and the Shanghai index was particularly hard hit, as it dropped by -5.3% while investors continue to worry that Chinese policymakers will maintain their hawkish bias about tightening credit supply further. Short-term interbank lending rates in China have surged as the government continues to appear unmoved by the liquidity tightening.

The rise in risk aversion during the Asian session took its toll on AUDUSD once again, with the pair making fresh lows and testing the 0.9150 barrier. The one-way Aussie trade continues, with the shorts now eyeing the psychologically important 0.9000 level. If the selloff in Chinese assets continues this week, that ominous target may be reached within the next several days.

The economic slowdown in China is now acting as the key counterpoint to the improvement in US economy activity, and the imbalance in growth between the world’s two biggest economies is likely to become the key market theme as the summer months unfold.

It is simply impossible to imagine sustained global growth with the US acting as the lone locomotive for demand. Therefore, this divergence in performance between the US and Chinese economies is likely to cause more panic among investors, accelerating risk-aversion flows unless some improvement is seen.

The best-case scenario for global growth would entail a soft landing in China, a quickening recovery in Europe, and an acceleration of activity in the US. However, such a bullish outcome is clearly being doubted by the market, and if the US begins to falter this summer, risk assets will come under enormous pressure as investors pare back their bets.

The threat of a Chinese slowdown was even evident in the EURUSD today. The German IFO sentiment survey was generally in line with expectations, with the forward component even beating consensus by a bit. Still, EURUSD failed to rally on the news, as investors remain concerned about German exports to China.

With exports still acting as the key driver of growth in the economy, market participants are greatly concerned that the German recovery could sputter badly if demand from China begins to collapse. EURUSD made a half-hearted attempt to rally through 1.3125, but the pair has met selling at those levels throughout the morning European session.

In North America today, the economic calendar is barren and equity markets may see some selling pressure on the open as traders digest the overnight activity in Asia. The EURUSD also remains under pressure, and any further selloff could create a test of the 1.3050 level as the day progresses. However, if there is little follow through to the selloff in Shanghai, the pair could stabilize and try to stage a short-covering rally towards 1.3150 as consolidation continues.

By Boris Schlossberg of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.