Perspective: Morning Commentary, 01/07/2016

Thursday, January 07, 2016

January 7 – It took just 29 minutes this time for China’s stock market to shut down. Circuit breakers closed the markets for the day as the China’s benchmark CSI 300 Index tumbled 7% in early trading. The reason for the tumble was a mystery for some, but all too clear for others. There wasn’t that much fresh news to justify the sharp selling, but rather recent action by regulators created sufficient uncertainty in the markets to spur the panic. Many are beginning to question whether the regulators have a grasp on what needs to be done to restore stability and are liquidating their positions until confidence returns that they can successfully manage the situation.

The triggering mechanism for today’s sell-off was believed to be another devaluation of the yuan, as the central bank again lowered the reference rate. The markets view actions by China’s central bank as a trade war with other Asian competitors to jump-start exports, signaling a desperation by authorities to reverse recent trends of slow economic growth.

Yet, the central bank continues to defend the yuan as well to control the rate of descent. It does so by stepping in to buy the yuan on the currency market with its foreign reserves. However, the problem is that those foreign reserves are in rapid decline. China’s foreign reserves fell a record $108 billion in December, which was four-times the rate anticipated by analysts. The foreign reserves ended 2015 at $3.33 trillion, down a half-trillion dollars on the year. Yet, China’s yuan continues to tumble, falling to a fresh five-year low today. Observers fear that China’s efforts to control the rate of decline are unsustainable, which could lead to more chaos down the road. Ironically, the dollar is actually weaker today after U.S. factory orders and inventories disappointed.

European stocks took their lead from the Chinese rout, and are generally down 2 to 3% at this hour. U.S. stock futures were down more than 2%. Weakness in the U.S. markets finds additional selling interest from the release of the minutes of the December Federal Reserve meeting on Wednesday. The minutes conveyed to traders that the Fed has no clear view of where to go from here regarding interest rates. The Fed appears to be split on both the threats at hand and the best approach for managing those threats. As such, expectations of a second rate hike by April have now fallen below 50%.

West Texas Intermediate crude oil fell to its lowest level since early 2009 Wednesday and is down another 3% this morning. The lead contract fell to a new low of $32.10 overnight before selling interest slowed. We could see increased volatility in this market to close out the week amid Middle East tensions that are on the rise once again as Iran places responsibility on Saudi Arabia for a missile attack on its embassy in Yemen. Global oil supplies are large and getting larger amid slumping world demand and increasing supplies from the Middle East. Yet, escalating tensions could result in supplies being disrupted, creating anxiety for traders holding large short positions in the market at multi-year lows.
The Thomson Reuters CRB Index is again gapping lower to new lows since 2002 this morning, led by weakness in crude oil. That again creates significant head winds for the grain and oilseed markets, as well as many of the other commodities. However, Ag traders are also concerned about positioning for Tuesday’s big USDA January crop report, which is known for its surprises. Sentiment is bearish going into the report, but traders also recall USDA’s tendency to throw a surprise into the January reports.

Market expectations ahead of the report are for December 1 corn, soybean and wheat stocks to be modestly above year ago levels. Projected ending stocks are expected to remain near unchanged for corn and to rise very modestly for soybeans and wheat.

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