Wall Street slumped with DJIA and S&P 500 plummeting -5.55% and -6.66% respectively as recent selloff accelerated after S&P's downgrade of US-linked assets. The volatility index (VIX) jumped to 48, signaling market sentiment has plunged to a 2-year low. Commodities, with the exception of gold, tumbled. The front-month contracts for WTI and Brent crude oil lost -3.26% and -5.15% respectively. Both contracts extended the decline in Asia today with the former at one point diving to 75.71, a level not seen since September 2009, while the latter to 98.74, the lowest level since February 2011. The ultimate safe-haven gold kept its strong momentum. After ending the day with a +3.71% gain, the benchmark Comex contract advanced further to a new record high of 1756.8 in Asia today. As talks of Fed's QE3 gets hotter, demand for the yellow metal should be higher.
S&P followed through on its downgrade activity by cutting the AAA ratings of a number of US-backed bonds, including Fannie Mae and Freddie Mac, by a notch to AA+. The agency said the downgrade was due to their 'direct reliance on the US government. In a statement in the midday, S&P also warned about the Asia-Pacific outlook, citing 'uncertainties in the global financial market and weakened prospects in the developed economies have further undermined confidence. The potential longer-term consequences of a weaker financing environment, slower growth, and higher risk aversion are negative factors for Asia-Pacific sovereign ratings '.
Inflation in China continued to overshoot government's target. Headline CPI rose to +6.5% y/y in July, from +6.4% in June. Yet, core inflation moderated slightly to +2.9% from +3% a month ago. It's expected that inflation is starting to peak as PBOC's tightening measures take into effects and commodity prices eased.
The next crucial event is the FOMC meeting. Speculations of QE3 have intensified, especially after disappointing GDP report for 2Q11 and recent downgrades by the S&P. However, we do not expect the Fed will announce a new round of outright bond purchases at the August meeting. Rather, it will deliver a more dovish tone in the accompanying statement, acknowledging higher downside risks on the economy and committing to keep interest rates low for a longer period of time than previously anticipated. The Fed may also pledge to keep the balance sheet large for an extended period. Ultimately, the statement should give the market a sense the Fed is stepping in further quantitative easing so as to stimulate economic growth.