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It was clear by 8am Thursday that the day's trading session was going to be unpleasant. The loonie was down a cent and a half, crude lower by 1.3 per cent and gold had plummeted $45 (U.S.) to challenge the $1,300 mark.
Why did the market sell off? The professional traders that dominate my Twitter feed are still searching among the usual suspects – Ben Bernanke, China's liquidity crisis or leveraged hedge fund position unwinding – for the (most) guilty party responsible for the ongoing rout.
The obvious answer is that it's all Ben Bernanke's fault, but that's too simple. After all, North American markets had over an hour on Wednesday to get their panic selling over with after the Chairman's remarks.
I'm guessing, too, so readers should take the following theories with a big grain of salt. But I suspect the realization of a serious financial crisis in China had far more to do with Thursday's weakness than most investors are aware.
The Fed's proposed withdrawal of monetary stimulus doesn't worry me that much. Yet. There is positive economic news behind the Fed's intentions – U.S. wages are finally rising and the U.S. housing market has, at the very least, stabilized.
Whether or not the Fed actually slows asset purchases this year, and ends them in 2014, will depend on the U.S. economy. If data weakens, the end of open market support is likely to be postponed. This borders on a win-win for investors. The end of stimulus will imply the U.S. economic recovery is self-sustaining which would be great news for markets. Otherwise, the Fed will stay involved.
Where Fed policy is concerned, the one possibility that should make investors nervous is a complete rout in the crowded high-yield debt trade as Treasury yields rise. If that were to occur, investment assets could move back into money markets and away from equities.
China is another matter. Bloomberg reported interbank lending rates in China had reached 10.77 per cent (annualized) – the highest since at least 2006 and almost four times the level from the beginning of February 2013. There were rumours floating that some smaller, less financially healthy banks could not borrow overnight money for less than 25 per cent.
Those ubiquitous "unidentified industry sources" have also told Bloomberg that the PBoC is negotiating with banks to provide 50 billion yuan ($8.5-billion) in emergency liquidity. Nonetheless, it is clear at this point that the People's Bank of China is deliberately starving the banking system of capital.
The central bank's intention, according to regional economists, is to reign in the shadow banking industry, particularly the estimated $2.5-trillion (U.S.) worth of wealth management products. After trying unsuccessfully to tame shadow banking through regulation, the PBoC is now executing an extraordinarily dangerous plan. It is akin to treating heroin addiction by stopping the patient's heart while standing by with a defibrillator.
I'd suggest watching the U.S. Treasury market as a primary indicator for the next week. Stabilization in U.S rates will suggest that markets have regained equilibrium. The Treasury market also functions as a thermometer for global risk aversion. Sustained decline in rates would, in part, indicate a dive toward safety, and away from risk-on assets like emerging markets and commodities.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .
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Scott Barlow