Global investor sentiment hinges critically on policies in the US and China

The protectionist and nationalist instincts of senior members of the Trump administration pose a serious threat to both the trading relationship between the two countries and China’s own precarious financial position

PUBLISHED : Monday, 13 February, 2017, 9:29am
UPDATED : Monday, 13 February, 2017, 10:41pm

Reports by credit rating agencies and international financial institutions are a dime a dozen and are invariably disregarded by financial markets.

Last week, however, two reports were published which international investors would do well to peruse.

The first was an unusually forthright note published on Friday by Fitch Ratings, one of the three main rating agencies, on the domestic and international risks posed by the new US administration of Donald Trump.

Warning that “US policy predictability has diminished” since Trump’s victory, Fitch said “the prospect of sudden, unanticipated changes in US policies” poses risks to both the global economy and the creditworthiness of countries.

The threats “include the possibility of disruptive changes to trade relations, diminished international capital flows, limits on migration and confrontational exchanges between policymakers that contribute to prolonged financial market volatility”.

Fitch singled out China, Germany and Japan as countries most at risk because of “existing financial imbalances or perceptions of unfair frameworks or practises that govern their bilateral relations” with the US.

The second report, published last Thursday by the Institute of International Finance (IIF), was the latest data on capital flows to emerging market (EM) economies.

According to the IIF, an industry association,developing economies will suffer a fourth consecutive year of capital outflows in 2017, with net outflows set to reach nearly $500 billion this year, compared with more than $600 billion last year. The main culprit is China which, according to the IIF, is forecast to suffer capital outflows of $560 billion this year. The other 24 EM economies tracked by the IIF are expected to attract inflows of roughly $70 billion, nearly twice the level achieved last year.

The IIF report was published just days after it was revealed that China’s foreign exchange reserves dipped below the psychologically important level of $3 trillion for the first time since 2012 due to aggressive sales of dollars by the country’s central bank to stem the decline of the renminbi, a persistent focal point of market nervousness. The yuan has dropped more than 11 per cent against the dollar since the August 2015 surprise devaluation.

The protectionist and nationalist instincts of senior members of the Trump administration and the threat they pose to both the trading relationship between the two countries and China’s own precarious financial position

These two reports reveal the extent to which investor sentiment hinges critically on the policies pursued by the US and China, particularly given the protectionist and nationalist instincts of senior members of the Trump administration and the threat they pose to both the trading relationship between the two countries and China’s own precarious financial position.

Fitch deserves credit for being the first major rating agency to warn of the significant international financial and economic dangers posed by a Trump presidency.

The agency’s warnings stand in stark contrast to the bullish mood in US equity markets since Trump’s victory – the country’s three main stock market indices currently stand at record highs – yet chime with growing criticism of the new administration from prominent international investors.

Ray Dalio, the head of Bridgewater, the world’s largest hedge fund, warned in a recent note to clients that he is afraid of the dangers of “nationalism, protectionism and militarism.”

The tax-cutting and regulation-shredding agenda which investors are banking on has been eclipsed by aggressive measures to restrict immigration and trade

The “moment of truth” for investor sentiment towards the Trump administration is fast approaching.

While markets were buoyed by a pledge by Trump last Thursday that a “phenomenal” plan to cut taxes would be announced shortly, the president’s first three weeks in office have been anything but business-friendly and suggest, at the very least, that investors have misread Trump, as I argued in an earlier column. The tax-cutting and regulation-shredding agenda which investors are banking on has been eclipsed by aggressive measures to restrict immigration and trade.

If this is a foretaste of things to come in US policymaking, then fears about an escalation in trade tensions between America and China are only likely to intensify.

In a note published earlier this month, JPMorgan warns that risks stemming from rising trade tensions between the US and China could contribute to “a re-acceleration of capital outflow pressures” in the world’s second-largest economy. While these strains have eased of late due to tighter restrictions to stem the flow of cash moving offshore, analysts surveyed by Reuters expect the renminbi to fall by a further 4.5 per cent from its current level against the dollar by early next year.

If Fitch’s warnings about the Trump administration prove prescient – and there is a good chance they will – concerns about China’s own policy regime are likely to become more pronounced.

For US and Chinese policy watchers, these are worrying times.

Nicholas Spiro is a partner at Lauressa Advisory

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