A slump in the Chinese stock market overnight and an abrupt end to a string of government and corporate orders for durable goods helped turn sentiment sour on Wall Street and boosted demand for the dollar. The euro has fallen through $1.41for the first time in at least 10 days, while the dollar is also gaining against that other supposed safe haven, the Japanese yen at ¥94.84. While the Wall Street Journal and New York Times are busy trumpeting a potential end to the housing market gloom, today's data shows a conflicting episode to this saga with a dive in demand for mortgage refinancing, while demand for new loans was flat.


Wednesday is turning out to be an interesting day for trading the macro view. The 5% slide in the Shanghai Composite index is the largest fall since last November and was triggered in part by a fear that the government may yet attempt to curb further inflows into a market where asset prices have risen 79% this year. Of course if it isn't going any higher, then perhaps investors think now is the time to make a sharp exit.

Global bourses are of course taking a cue from the performance of the Chinese index. The government's attempt to reach an 8% growth target is on track, but only at the cost of heavy stimulus and shotgun lending practices. By that we mean that banks are held at ransom by the government in a threat to make them part with their money to customers. Many economists have raised a red-flag over prospects for a bubble in lending, which is clearly also playing out in stocks.

If China's policies are responsible for digging the global economy out of a hole earlier this year, then what happens next in China is unlikely to go unnoticed. With signs of rising copper inventories and slowing imports at a time of only limited improvements in export demand, a Chinese meltdown becomes the epicenter of a nasty seismic event, whose Tsunami waves could yet have lasting repercussions on foreign markets. While Tuesday's decline in a reading of U.S. consumer confidence may have been an early catalyst, the spiral has begun in what many people felt was overdue in terms of an equity market rally losing its head of steam. As fears over the core health of China grow so does the sustainability of the commodity price rally. Crude oil and copper prices are lower and that's also helping shore up the value of the dollar today. The dollar index is 0.5% higher at 79.38.

Wednesday's macro drama continues. Risk-on plays are indeed getting harmed. Bothe the Australian and Canadian dollars appear to have had a capitulation with a price frenzy occurring Tuesday morning and that rally now seems a long way off in the rear-view mirror. Today the Aussie buys 81.98 U.S. cents have achieved almost 83.50 yesterday, while the Canadian's decline is gentler to 92.09 from approximately 93 cents yesterday.

Most curious about today's risk-aversion trading is that it appears to be the dollar alone that's winning the day. As we noted above, the dollar is outpacing the Japanese yen, but it's also beating up an already suffering Swiss franc at Chf 1.0826. Earlier, a domestic economic magazine carried colorful commentary from Swiss National Bank member, Thomas Jordan, who continued to wield the bat against any further franc appreciation. The previous scope and scale of SNB intervention clearly sent those daring enough to face the wrath of the central banker scurrying like cats with tails firmly between its legs. The Swiss franc fell to its lowest point versus the euro for July.

That brings us back to the role of the Japanese yen, which traditionally has done well when crisis reemerges. However, saddled with potential political risk from national elections at the end of August, investors might be thinking twice about buying Japan. But we think there is another factor brewing that could see a longer-term appreciation of the dollar versus the yen as events unfold.

As investors concentrate on the global outlook it's possible that they may indeed fear the potential for a double-dip recession, with the second leg-down less ugly than the full-blown financial crisis that we're currently emerging from. With investors pawing at the theory that interest rates my go up sooner rather than later - we noted yesterday RBA's red-flag on this issue - investors might feel a lesser need to reach for the yen given the prospect that the carry-trade is pretty high on the agenda once the hurdle of recovery is licked.

That leaves the dollar isolated as the sole flag bearer at times when risk-aversion pops up. Macro events are morphing once again to leave analysts stretching to explain away their last prediction was wrong. Here's the latest episode.