China has replaced Greece as the main worry for financial markets

China has replaced Greece as the main worry for financial markets and it is fundamentally a much bigger deal. The problem? Investors are losing faith in the ability of Chinese policymakers to control their markets. What could break the damaging spiral? Moving quickly and decisively to shutter excess capacity in state- owned steel and coal companies would be a game changer. Imagine the effect on commodities, for one. We see 1:5 odds for such bold action in the near term but do detect a greater appetite for tackling supply-side reforms.

Global equities have sold off, but U.S. Treasury yields are roughly unchanged since last May. We see U.S. Treasuries becoming less effective as portfolio stabilizers for three reasons: 1) The Fed is in hiking mode (albeit gently); 2) The low level of rates does not leave much upside. 3) Supply-demand dynamics have changed. There is heavy bond issuance as investment-grade companies lock in cheap financing, while price-insensitive buyers such as China and petro states have turned into sellers as their currency reserves shrink.