One more sleep to Fed Day.

European stocks are rallying off 10-week lows after a small bounce in oil prices and easing concerns over the high-yield debt market helped Wall Street reverse initial heavy losses ahead of the Federal Reserve’s policy decision this week, writes Jamie Chisholm.

The dollar is softer, while core sovereign bonds are mixed as copper leads losses in base metals. Gold is up $1 to $1,064 an ounce.

Following a soft performance in Asia, the pan-European Euro Stoxx 600, which closed the previous session at its lowest since early October, is up 0.6 per cent with resources groups attracting buyers. Underpinning Europe’s advance is Wall Street’s late recovery on Monday. US index futures suggest the S&P 500, which at one point in the last session hit a two-month intraday trough of 1,993, will open flat on Tuesday at 2,022.

Analysts and traders are unsure how much the recent volatility reflects caution ahead of the Fed’s imminent decision on whether to raise interest rates for the first time in nearly a decade — and how much related issues around commodities and credit are taking a toll.

“The Fed’s widely anticipated rate hike on Wednesday has been largely discounted in the markets,” said foreign exchange strategists at Deutsche Bank. The bigger fears are the effect of cheap oil, unsteady credit markets and worries that the People’s Bank of China will let the renminbi slide further against the US dollar.

“We consider renminbi fears overdone, but the worries underline the nervousness of the markets,” they added.

Fed futures are still pricing in only a 76 per cent probability of the Fed delivering “lift off” on Wednesday, according to Bloomberg calculations, though, as Deutsche notes, market sentiment has a hike pretty much nailed on.

Still, the US central bank’s expected tightening is impacting the three other interlinking factors that have been exercising investors of late — though the angst seems to be waning a touch on Tuesday.

First the commodity sector. Copper is slipping 1.3 per cent to $4,619 a tonne and Brent crude is off 0.9 per cent to $37.58 a barrel having touched overnight $36.33, just a dozen or so cents above it cheapest since 2004.

Chronic oversupply concerns — particularly in the energy space — are being exacerbated by a recently stronger dollar, in which such resources are denominated.

The dollar index is down 0.3 per cent to 97.34 on the day, but sits only about 3 per cent shy of a 12-year high, underpinned by the policy divergence between the Fed and its eurozone, Chinese and Japanese peers.

US 2-year yields are 0.94 per cent, near a five-year high, and 10-year Treasury yields are easing 2 basis points to 2.21 per cent, ahead of inflation data due later on Tuesday.
Equivalent longer-term maturity German and Japanese paper are yielding 0.58 per cent, up 2bp for the session, and unchanged at 0.30 per cent, respectively.

Second, credit. As energy prices fell — warm weather also has helped push US natural gas futures to a 13-year low — and as US short-term bond yields rose, the riskier end of the credit spectrum, where some heavily-indebted commodity-focused borrowers lurk, has been getting hit.

Closely watched US investor Carl Icahn last week tweeted that “the meltdown in High Yield is just beginning” after Third Avenue Management said it was halting redemptions from its high-yield mutual fund, sparking selling across the sector. That pace of that exodus appears, for now, to have died down.

Finally, China. Soft commodity prices speak of worries about waning Chinese demand. Beijing’s is allowing the renminbi to weaken, a strategy likely to help China’s exporters, but one which highlights concerns about slowing activity in the world’s second biggest economy.

Additional dollar strength following a Fed hike might hasten the renminbi’s decline. Emerging markets, vulnerable to perceptions of Chinese economic health, are feeling the pressure.

The People’s Bank of China set the mid-rate around which the renminbi is allowed to trade another 0.1 per cent softer on Tuesday to Rmb6.4559 per dollar, a new four-year low. That marked a seventh straight weakening, and since the mid-August devaluation — when the fix was suddenly softened by 1.9 per cent — the fix has been weakened by 5.55 per cent, an unusually swift move for the tightly controlled currency.

Meanwhile, among other currencies, the Australian dollar rose swiftly after minutes from the central bank’s last meeting highlighted “positive” domestic data, making the case for further easing more difficult. But the Aussie gave up its gains and now sits up just 0.1 per cent at US$0.7250.

The Sydney stock market slipped 0.4 per cent to close at its lowest since 2013, encapsulating a downbeat display for many bourses in the region.The exporter-sensitive Nikkei 225 in Tokyo lost 1.7 per cent as the yen strengthened to near Y120 per dollar.
Hong Kong’s Hang Seng index edged up 0.1 per cent, but the Shanghai Composite lost 0.3 per cent after Monday’s 2.5 per cent climb.

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