Macroscope | Why China’s woes matter less to Wall Street than US labour market and interest rates

In financial markets, the narrative around China is unrelentingly bleak. While sentiment towards the world’s second-largest economy had been deteriorating steadily since the reopening rally fizzled out in February, the mood has darkened considerably in the past month.

Concerns about financial contagion from the liquidity crunch in the property sector have focused attention on links between property developers, local governments and the vast shadow banking industry. These fears are exacerbated by worries that China is falling into a deflationary trap akin to the one Japan found itself in during the 1990s.

In a report published on August 20, Morgan Stanley – which has been relatively bullish on China this year – said “until we get a significant easing in fiscal policy, the economy is likely to lose momentum. This will keep the risk of China entering a debt-deflation loop alive.”

There are also signs China’s problems are starting to weigh on global asset prices, particularly in developing economies. According to data from Bloomberg, emerging market stocks are on track for their worst August since 2015, when the surprise devaluation of the yuan sent shock waves through global markets.

The big question when it comes to China is the policy response. Much of the investment bank research and commentary suggests the problem is the absence of large-scale stimulus, especially measures to boost consumption. There is a supposition, moreover, that such support is the key to turning sentiment around.