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Bad News Finally Have an Effect

Even though the market moves in the U.S. were fairly large and volatile, the action became a great deal more pronounced when Japan started trading. At first there was such a heavy sell-off in JGBs that the market was (once again) briefly halted. The Nikkei did its usual thing and tried to move higher.

Then the HSBC 'Flash' PMI for China was released (details here - pdf) and showed that manufacturing in China has slipped back into contraction, to a 7 month low of 49.6.

This is what the China PMI chart with the latest flash estimate added looks like (keep in mind that HSBC only measures private sector activity, its PMI data therefore differ from the official data, which include the state-owned sector).


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China flash PMI - a decline to 46.9 in May, a 7 month low


That was not what traders in the Japanese stock market wanted to hear apparently. The Nikkei, which is always more volatile than the U.S. market, produced a huge 1,125 point intraday swing, a move of roughly 8% on the day.


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The Nikkei, hourly. Now that's volatility


The JGB market in which yields had initially spiked to 1%, recovered its losses as traders moved into bonds in the usual knee-jerk fashion (in contrast to what happened earlier in the U.S.).


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JGB overnight: first a big sell-off, then a full recovery.


Conclusion:

This market action is what is known as a 'warning shot'. In all likelihood stock markets won't just go straight down now, although it is certainly high time that a sizable correction occurred. Usually though a first sharp break in a persistent uptrend tends to get bought, at least initially

However, there was valuable information in the Nikkei's behavior. Hitherto stock markets have ignored weak macro-economic data and have moved solely on the promise of more central bank liquidity (Ambrose Evans-Pritchard had a few interesting remarks on that). The swoon in the Nikkei however only began in earnest after the Chinese PMI data were released - that was the 'trigger' for the long awaited correction.

In other words, for the first time in many months, a stock market has reacted negatively to weaker economic data. This could be very significant in our opinion, even while conceding that the market was more than ripe for a correction and would likely have found a different excuse to sell off if this one hadn't come along.

Nevertheless, our experience is that often when a trend reverses, data that have been ignored for a long time are suddenly viewed as very important. It is therefore likely that the time when weak economic data points could be safely ignored by stock market traders is coming to a close.

Charts by: Finviz, Markit/HSBC, FX Empire

Source: Market Volatility Spikes: Part II- Japanese Markets Go Wild