South China Morning Post
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Pedestrians and motorists are reflected in an advertising billboard in the central business district in Beijing. In 2016, an aggressive fiscal stimulus package helped get the Chinese economy back on its feet after the blow of the 2015 devaluation of the renminbi. In 2019, however, the government’s deleveraging campaign is limiting the scope for more forceful measures as China’s manufacturing sector slows. Photo: AP
Opinion
The View
by Nicholas Spiro
The View
by Nicholas Spiro

China’s economy and Fed policies are again unsettling markets. But don’t expect a turnaround like in 2016

  • Nicholas Spiro says that, now as then, concerns about the health of the global economy dominate, but the confluence of factors that stabilised, then lifted, the markets in 2016 is unlikely to come about this year
Nicholas Spiro
Nicholas Spiro
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Is this 2016 all over again? If international investors are having flashbacks to the early months of 2016, one can understand why. Many of the drivers of asset prices three years ago are strikingly similar to the ones that are influencing financial markets today.

Then, as now, there was a surge in volatility in stock markets. Then, as now, China’s economy and policy regime were a focal point of anxiety. Then, as now, the Federal Reserve had to reassure investors that it was not hell-bent on raising interest rates aggressively. Other obvious parallels with the start of 2016 include a weakening US dollar, a recovery in commodity markets and an improvement in sentiment towards developing economies.
The similarities have taken on significance partly because of mounting concerns about the health of the global economy. As I argued previously, the sharp slowdown in China has become a more important determinant of sentiment in the past several weeks, amplified by the recent warning from Apple about slowing iPhone sales in the world’s second-largest economy.
The other main reason why the parallels figure prominently in market commentary is because the Fed appears to be in a similar position to the one it found itself early in 2016. Then, as now, the Fed raised interest rates in December and signalled further tightening in the coming year in the face of a China-driven loss of momentum in the global economy. Asset prices plunged and, as is the case currently, the Fed swiftly moved to dampen expectations that further rate increases were imminent, contributing to a sharp rally in markets.

The similarities with early 2016 have not been lost on policymakers themselves. In remarks at the annual meeting of the American Economic Association on January 4, Fed chair Jerome Powell cited the China-induced shift in US monetary policy in 2016 as evidence that the central bank can react quickly if external headwinds endanger the US economy. Powell’s dovish comments have been the main catalyst behind the sharp recovery in stock markets since the end of last year, with the benchmark S&P 500 index enjoying its strongest 10-day rally since 2009, according to data from Bloomberg.

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The big question, however, is whether the parallels with 2016 will persist in the coming months, which would mean that China’s economy recovers, the Fed keeps rates unchanged and markets enjoy a spectacular rally for the remainder of this year.

While the Fed-China nexus will undoubtedly be a key driver of asset prices this year, there are reasons to believe that 2019 will not be a repeat of 2016. Not only is it unlikely that the two main underpinnings of the 2016 rally – a Fed that refrains from tightening policy and an aggressive stimulus package that quickly turns around China’s economy – will fall into place simultaneously once again, the geopolitical landscape is quite distinct from the one three years ago.

First, it is still unclear whether the Fed will halt its rate-hiking cycle this year. America’s economy, although having recently shown signs of slowing, is expanding at a significantly faster pace than in 2016. What is more, even if the Fed does pause, it will continue to tighten policy by unwinding its balance sheet, a crucial element of stimulus that had yet to be withdrawn in 2016.

Second, China’s economy is in a race against time. By the spring of 2016, manufacturing activity, which had been contracting for several months as part of the fallout from the shock devaluation of the yuan in August 2015, had already begun to recover, powered by an aggressive fiscal stimulus package. Today, the deleveraging campaign, which began to bite in late 2017, is limiting the scope for more forceful measures. China’s manufacturing sector, moreover, only entered contraction territory last month and looks set to decline further, increasing the threat of deflation.
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Third, and perhaps most importantly, Donald Trump is now America’s president. In 2016, investors did not have to contend with the damaging effects of a full-blown trade war. While Beijing and Washington have at least returned to the negotiating table, resolving the underlying problems bedevilling US-China relations will prove exceedingly difficult. What is more, America’s response to a severe downturn in the global economy is now in doubt. Not only have Trump’s protectionist policies (and, more recently, his assault on the Fed) undermined sentiment, his deep hostility towards multilateralism is exacerbating financial tensions.

Three years ago, the world economy benefited from a purported “Shanghai Accord”. This was the apparent quid pro quo that emerged from the G20 summit in February 2016 in which the Fed agreed to be patient in raising rates while China launched a major stimulus programme. The agreement brought about a sharp fall in the dollar and triggered a fierce rally in markets.

Investors are clamouring for another Shanghai Accord. The absence of one this year is another reason why 2019 is unlikely to be a repeat of 2016.

Nicholas Spiro is a partner at Lauressa Advisory

This article appeared in the South China Morning Post print edition as: No turnaround this time
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