It's been a wild week for financial markets, dominated by concerns that the Delta outbreak will put the brakes on the global economic recovery. Even though many of the major economies are protected by a vaccine shield, the fear is that the virus could cool demand in unvaccinated developing markets, which ultimately comes back to bite everyone.
Adding fuel to the pessimism has been the relentless regulatory crackdown in China, where Beijing continues to tighten the screws on the tech sector. The nation just passed a strict data protection law, the latest in a long series of moves to align the Chinese economy with the party’s social values.
All this is playing out against the background of a slowing Chinese economy, amid a fading credit impulse and new restrictions to battle the Delta variant. As a result, commodities and commodity-linked currencies have been taken to the cleaners, with the loonie, aussie, and kiwi all headed for a weekly loss of around 3% against the mighty dollar. Crude oil and iron ore prices tell the same story.
While most charts are painting a scary picture right now, past episodes of covid-fueled panic didn’t last very long. This is almost a self-correcting mechanism. If virus fears escalate enough, there comes a point where investors begin to anticipate greater liquidity injections from central banks and more fiscal firepower from governments, which ultimately calms market nerves. That said, it might get even uglier before we reach that point.
Wall Street fights back
The volatility in equity markets is starting to reach a crescendo. Wall Street managed to hang on for dear life on Thursday, with the major indices erasing some early losses to close virtually unchanged, propped up by tech heavyweights like Microsoft. However, futures are pointing lower again on Friday.
While indices like the S&P 500 haven’t fallen much, there is a major sector rotation taking place under the hood. Small caps and many unprofitable ‘growth’ stocks have been demolished lately whereas tech titans have stood their ground, highlighting that quality tech has almost transformed into a defensive play during this crisis.
The overall message seems clear. Small caps will either suffer from a global slowdown or from a withdrawal of Fed liquidity, as investors move higher along the quality spectrum. Neither will be as damaging for mega-cap US tech. Of course, China is a different beast. Tech stocks have taken heavy damage lately as Beijing continued its regulatory crusade, with the pain now spilling over into other sectors like healthcare and alcohol producers amid concerns the hammer will fall on those next. Hong Kong’s Hang Seng index lost almost 2% today to touch new lows for the year.
Dollar awaits Powell’s signals
The calendar is almost empty today, with the only noteworthy release being Canada's retail sales for July. It has been a tough week for the loonie despite the nation’s inflation rate rising further, as the currency realigned itself with suffering oil prices.
On the other hand, all this pessimism has put the wind back into the dollar’s sails, which won the battle against some crucial technical levels across multiple charts and is now headed for a healthy weekly gain.
Whether this lasts will depend on next week’s speech by Fed Chairman Powell at the Jackson Hole economic symposium. Will he lay the groundwork for a September taper announcement or will he play it slow? The answer will likely drive the dollar for now, even though in the big picture, it doesn’t matter much whether tapering is announced in September or November.