Market ructions not all about China
Oil price being driven by fears of a long-lasting supply glut
For an indication of just how worried financial investors are about China, look no further than the sudden improvement in sentiment on Tuesday following the publication of better-than-expected gross domestic product data for the fourth quarter.
While figures for Chinese industrial production, retail sales and investment were all a tad softer than anticipated, producing a full-year growth rate that was the weakest since 1990, investors were encouraged by the fact that the data was not as bleak as some had feared – but still sufficiently bleak to make further stimulus measures more likely.
Global equity markets, which have had their worst start to a trading year in recent memory, rose following the release of the data, while the price of Brent crude, the international oil benchmark which has fallen more than 20 per cent since January 4, increased 2.5 per cent to just over US$30 a barrel.
Yet the rally was short-lived.
On Wednesday, equity markets fell sharply, with euro zone shares hitting a 13-month low and Japanese stocks entering a bear market. Oil prices, meanwhile, resumed their slide.
Investors are starting to fret about a wider range of issues.
Although developments in China are a crucial determinant of market conditions, there are other factors shaping sentiment.
The most conspicuous one is the oil price which, although heavily influenced by investor perceptions of China’s slowing economy, is being driven by fears of a long-lasting supply glut.
On Tuesday, the International Energy Agency (IEA) fanned these concerns further by warning that oil markets “could drown in oversupply”, with an overhang this year of at least 1 million barrels a day for the third year in a row.
The IEA warned that while supply from non-Opec countries is expected to fall in 2016, the decline is likely to be offset by a sudden burst in supply from Iran following the removal of sanctions associated with the country’s nuclear programme.
A second major concern is economic weakness – particularly in emerging markets (EMs) but also, more worryingly, in developed nations.
On Tuesday, the International Monetary Fund unveiled a fresh set of forecasts in which it revised down its GDP estimates for both advanced and emerging economies in 2016 and 2017 and warned that “global growth could be derailed” by a number of “downside risks, particularly prominent [in] developing economies” which “could generate broader contagion effects”.
The IMF also lowered its GDP forecasts for the US economy, which it now expects will grow 2.6 per cent (as opposed to the previously assumed 2.8 per cent) this year and next.
Indeed the US manufacturing sector is already in recession, weighed down by the resurgent US dollar and the collapse in oil prices. Private consumption, moreover, which accounts for over two-thirds of GDP, is slowing, with retail sales contracting in December.
This raises serious questions about the merits of further increases in US interest rates, especially in view of the recent decline in inflation expectations. Instead of the four additional increases forecast by the Fed, futures markets are now anticipating only one more rate increase this year, widening the gulf between the Fed’s expectations and those of financial investors.
A third major concern is that central banks are fast running out of ammunition and can no longer be relied on to steady markets at times of severe stress.
While the Fed is now in the process of tightening monetary policy, the European Central Bank (ECB) and the Bank of Japan are reluctant to provide further stimulus – partly for political reasons but also because the limits of monetary policy have been reached, with the euro zone requiring much looser fiscal policy in Germany and Japan’s economy in need of more aggressive supply-side reforms.
Without effective central bank “puts” in place – ultra-loose monetary policies which keep bond yields and interest rates at artificially low levels and encourage investors to take risks – economic fundamentals become more important to investors.
The recent surge in volatility in financial markets partly stems from a loss of confidence in central banks’ policies at a time when investors are still relying on (and indeed are addicted to) monetary stimulus measures to offset economic and financial risks in both developing and advanced economies.
The combination of all four of these vulnerabilities – China’s woes, tumbling oil prices, economic weakness and the increasing ineffectiveness of monetary policy – has the makings of a perfect storm for markets.
China may be dominating the headlines, but there are plenty of other risks for investors to fret about.
Nicholas Spiro is managing director of Spiro Sovereign Strategy