Across The Border

Brace for market turbulence as Fed rate rise back on radar

PUBLISHED : Tuesday, 24 May, 2016, 3:53pm
UPDATED : Tuesday, 24 May, 2016, 5:26pm

A market repricing of the risk of tightening by the US Federal Reserve weighed heavily on Chinese shares last week, which could persist through mid-June as fears loom large of a possible currency devaluation and capital outflows as a result of the Fed move.

Last week, A shares extended their losing streak to a fifth straight week, mainly due to the hawkish tone in the Fed minutes that revived expectations of an interest rate rise next month. Concerns over monetary tightening have also driven the US dollar index to a seven-week high while the Chinese yuan has fallen to an 11-week low against the greenback.

“Brace for turbulence,” said Frederic Neumann, an economist at HSBC. “The Fed is back in play. And when it moves, markets in Asia will feel the ripple.”

Analysts mull the effects of possible Fed hike on yuan, China equities

He said any tweaks to the US central bank’s policy stance will reverberate across the region and affect the financial markets, as concerns over a Fed tightening will likely impact the US dollar and cause volatility in the Chinese currency. It may also weigh on oil prices and trigger worries about the energy sector.

Similar factors rattled Asian markets in January, he said.

“After all the fury in January, Asian markets did rather well with the return of the ‘stabilisation trade’. But fundamentally, little has changed. Local demand is still highly credit-dependent and exports wobbly,” Neumann said, noting that the growth prospect for China has turned gloomier.

In the Chinese markets, caution has prevailed due to worries over both further Fed tightening and sluggish growth of China’s economy.

Weekly turnover in Shanghai markets touched a seven-month low of 664 billion yuan last week. The balance of margin loans and securities lending also shrank to 825 billion yuan by Friday, the lowest since late November 2014.

“Investors lack the conviction to act,” said Larry Hu, an analyst for Macquarie Group, adding that sentiment has been dampened by a number of macro uncertainties, including slower-than-expected growth of the Chinese economy.

US Fed signals strongly interest rate hike on the table in June

“Going forward, it’s hard for stocks to stage a solid rebound in the short term, as the market is dominated by a risk-off sentiment, with rising expectations of a US rate hike and new macro uncertainties,” said Zhang Ge, an analyst at Citic Securities Futures.

He added that there is no “significant improvement” in fundamentals, with no sustained signs of a strong recovery in the Chinese economy and the central bank showing less appetite for strong monetary stimulus.

Besides, the possibility of a Fed rate rise has also fuelled expectations of a weakening in the Chinese currency and faster capital outflows from China, which may cause volatility in asset markets, analysts said.

By Friday, yuan’s reference rate against the US dollar had fallen 1.4 per cent from the end of April. Onshore yuan had also fallen 0.9 per cent during the same time while offshore yuan had weakened 1.2 per cent. The spread between onshore and offshore yuan widened up to 400 pips in mid-May, compared with 100 pips at the end of April, indicating mounting depreciation pressure on the yuan in overseas markets.

“Down the road, if the dollar index returns to 100 (currently at 95), the RMB against dollar could depreciate to 6.8,” said analysts from Macquarie Group in a recent research report.

They warned against a scenario in which a stronger dollar will lead to a weaker yuan and higher capital outflows from emerging markets, resulting in lower risk appetite and rising market volatility.

Capital outflows from China persisted in April. The country’s commercial banks sold net foreign exchange of US$24.7 billion in April, the State Administration of Foreign Exchange reported recently. Although April’s figures showed the pace of capital outflow slowed from March – with net sales of US$36.4 billion – the pressure could easily return as the dollar has gained momentum, analysts said.

Why US Fed’s latest stance on interest rate is good news for China

“People have every reason to believe China is facing bigger capital outflow pressures due to the continued depreciation in the Chinese yuan in May, ” said Song Yiwei, an analyst at Bohai Securities.

“For A shares, the fundamentals are unfavourable and the liquidity stress could deteriorate,” he noted, advising investors to stay on the sidelines and wait till the end of the market repricing of the current risk factors.

Neumann from HSBC also cautioned that investors may have to get ready for a more volatile summer.

“With little fundamental improvement, asset markets may turn out to be more brittle than the last

few months suggest,” he said.