Heightened Volatility Continues as China and North Korea Spook Markets

Financial markets extended their volatile start to 2016 off the back of lingering concerns out of China and heightened geopolitical tensions in North Korea and the Middle East.  The PBoC allowed the yuan to fall to its lowest level in nearly five years, while the Caixin-Markit Services PMI showed China’s services sector expanded at the slowest pace in 17 months, adding to fears of a prolonged slowdown for the world’s second largest economy.  Demand concerns and fading hopes of export cuts due to rising tensions in the Middle East caused oil prices to fall more than 5%, dropping below $35/barrel for the first time since 2004.

News that North Korea successfully conducted its first hydrogen nuclear bomb test added to a growing list of geopolitical worries for the markets to absorb.  Experts cast doubt on the legitimacy of Pyongyang’s claims that it was a full-fledged hydrogen device, but regardless, the test threatens to further destabilize the region and will likely become a key topic during the US presidential campaign.  The test drew condemnation from the international community, including from China and Russia, who are considered North Korea’s primary allies.  The flight to quality trade was on in full force, with most major US stock indexes down 1% while Treasuries rallied 1-5 bps across the curve. Swap spreads and swap rates also declined along with Treasury yields, as new swaps of new public debt issuance has pushed swap spreads lower too.

While largely overshadowed by events abroad, US economic data surprised to the upside.  Trade data for November pointed to a smaller drag on growth from net exports in the fourth quarter, while the ADP Employment report showed service sector hiring was robust in December.  The ADP payrolls report showed the US economy added 257,000 jobs, the most since 2014, easily surpassing the 198,000 jobs economists were projecting.  Aside from the data, investors will get some visibility into the Fed’s recent thinking with the release of the December minutes at 2pm ET today.  The ADP data also increases the anticipation of this Friday’s release of Dec. Nonfarm payrolls (exp. +200,000) and Dec. Unemployment rate (exp. 5.0%).