Dollar Turns Mixed, Chinese Shares Tumble

The US dollar is mixed after making new multi-year highs against the yen near JPY124.30 in Asia, while month-end positioning appears to have helped fuel an extension of the euro's recovery that began in the North America yesterday.  The lack of an upward revision to UK Q1 GDP kept sterling's upside correction muted.  

There are two main talking points today.  The first is the dramatic break of the seven-day rally in Chinese stocks.  It ended today with a 6.5% slide in the Shanghai Composite and a 5.5% drop in Shenzhen.  The drop in Shanghai is the second largest daily decline this year, while Shenzhen's loss is the third largest in the past five years.  Shanghai shares stop trading after losing 10% intraday drop.  Reports suggest that more than a quarter of the 1083 hit the circuit breaker today. 

Accounts attribute the sharp decline to increased margin requirements though this story first emerged several days ago.   There were also some reports indicating that regulators asked banks to report their equity investments.  In addition, the PBOC drained liquidity via targeted repo operations.  The PBOC had appeared to refrain from open market operations for the past several weeks.    Others cited that a new wave of initial public offerings set to begin next month (at least 23 new IPOs and in preparation could lock up almost CNY5 trillion, according to some estimates). 

Even with today's losses, over the past year the Shanghai Composite has risen 125% and the Shenzhen Composite almost 160%.  It may not require a major fundamental development to spark profit-taking, which under such conditions, can easily build momentum of its own.  There was record turnover today.  

While some sectors may be stretched on a valuation basis, the main factors driving the Chinese shares higher have not changed.  These include official efforts to push wealth management products from the shadow banking system to an exchange.  Companies are being encouraged to raise equity capital over debt.   There is also speculation that MSCI will decide as early as next month to begin including "A shares" in its global indices, which is anticipated to attract large sums of foreign capital.    In addition, many expect the government to provide additional economic stimulus. 

The second main point of interest today is the official push back against the Greek optimism reported yesterday.  News wires carried reports implying that an agreement had been struck and that "an accord" was being drafted.  Throughout these past several months, Greek officials have consistently been more optimistic than the official creditors, and this seems more of the same.  The IMF's Lagarde was crystal clear, saying there have been no substantial results.   Greek bonds are paring yesterday's gains.  In fact, the peripheral bonds are all lower.   Greek stocks are fractionally lower. 

The euro itself seems unperturbed.  It rose above the previous day's high for the first time this week.  At the end of last week when the euro last traded above the previous day's high, it peaked in front of $1.1210.  Given the slide to about $1.0820 yesterday, the first retracement objective is seen near $1.0970.    The euro appears to be running out of momentum in the European morning around $1.0950.   If month-end adjustments, and some profit-taking ahead of what is expected to be a sharp downward revision to US Q1 GDP tomorrow, a move toward $1.1020 cannot be ruled out. 

The dollar’s breakout against the yen continued, with the greenback taking out the 2007 high near JPY124.15.  The peak has been JPY124.30, but pullbacks have been shallow and limited to the JPY123.60 area.  The importance of resistance is that it is supposed to signal where supply comes I, but these levels have been seen more many years, and it is difficult to talk a price trigger for supply under such conditions.  That said, the next price target is in the JPY125.00-60 area.  The dollar’s appreciation will impact investing strategies.  One large Japanese life insurance company indicated today that given the dollar’s strength, it will not continue to buy dollar bonds on an unhedged basis. 

The Nikkei extended advancing streak to ten sessions today.  Over the past week, its 1.7% makes it the best performer in the G7.  The FTSE is in a distant second at 0.4%.   Sterling itself is finding it difficult to sustain even modest upticks.  It has not taken risen above the previous day’s high since May 21.  Today’s excuse was that Q1 GDP was unrevised at 0.3%.  Stronger industrial output and construction data have fanned hopes of a small upward revision.  Between April 14 low to the May 14 high, sterling rallied 8.5% against the dollar.  That move is being corrected/unwound.  The convincing break of $1.5345 signals a move toward $1.5200. 

The dubious honor of the weakest major currency today, however, goes to the Australian dollar.  Capital expenditures in Q1 fell twice as much as the consensus expected (-4.4%), though Q4 14 was revised to -1.7% from -2.2%.   The key here is that the non-mining sector is not picking up the slack from the mining sector.  This is encouraging speculation that the RBA will be forced to cut rates again, though probably not at next week’s meeting.  With today’s losses, the Australian dollar is off 6.25% since May 14.  The next level of support is pegged near $0.7635 and then $0.7600. 

The features of the North American session include US weekly jobless claims and pending home sales.  The Fed’s Kocherlakota, one of two Fed presidents who do not think the Fed ought to raise rates this year speaks on monetary policy.   Canada reports its Q1 current account balance (the consensus looks for a shortfall of $18.6 bln after $13.9 deficit in Q4 14).   The G7 finance minister and central bankers continue to meet.  No statement is expected, but headline risk remains. 

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