After the dramatic falls in equity markets in August, stock market volatility extended throughout September. These market falls contributed to the worst quarter in global stock markets since quarter 3 of 2011 and the Eurozone crisis. Confidence in the strength of a global recovery was hit by Chinese data that suggested that their economic activity had fallen. The subsequent official Chinese government intervention in both the foreign exchange and stock markets only exacerbated the situation.
August’s devaluation of the Chinese renminbi was a major event and a significant departure by Chinese policy makers. This devaluation was part of a currency war aimed at supporting the competitiveness of Chinese exports.
Market anxiety almost reached a panic when the Shanghai Composite Index fell by 42% over a horrendous ten week period. Things look quite different now with the index recovering 17% from its August low and up 25% on its value twelve months ago.
The US Federal Reserve also contributed to the uncertainty by putting off its decision to raise the federal funds rate in September. Global jitters and some soft data on US job creation meant that dearer money was postponed. This caused investors to ask questions of whether the Fed knew something that they didn’t, rather than being pleased that near zero rates had been maintained.
Notwithstanding the upturn in volatility in the past six months, the ending of quantitative easing (QE) in the US has been taken relatively well by markets. This reaction is encouraging as the withdrawal of loose money and the December rise in US interest rates further illustrate the growing confidence in the US recovery.
The US economy remains flexible and entrepreneurial with better demographics than many of its Asian and European counterparts. The low cost of oil and the development of domestic shale gas will provide low cost energy and a competitive advantage for many years to come. Countries that control their own energy costs, as Britain did during the industrial revolution, have built-in economic advantages.
Recent actions from the European Central Bank (ECB) as well as the Bank of Japan (BoJ) have provided massive monetary easing on an unprecedented scale for these areas. The respective QE programmes are aimed at currency devaluation to create greater export competitiveness. It remains to be seen if central banks in competing countries, adversely affected by these moves, will respond.
Central banks now have far less ability to respond to adverse economic shocks when their interest rates are at near zero and having already implemented extensive QE programmes. A central bank “put” where monetary policy can underpin growth, is now less credible and less functional.
Since 2008 we have witnessed hundreds of interest rate cuts and trillions of US$ worth of QE. Still, it feels as though all we have to show for it is a fairly underwhelming stop-start recovery.
Since the great sell off in August markets have significantly picked up. It is becoming clear that Chinese growth is due to bounce back and markets are positive about the Federal Reserve interest rate rise in December. The postponement of a US interest rate rise in September and the continuation of BoJ and ECB QE have maintained the loose money conditions that have historically lifted stock prices.
‘Global growth is holding up better than many commentators had expected’
A global manufacturing recovery has started to emerge in Europe, the US and Japan and is starting to shake off the recession scare of the summer. Chinese data has improved after a deep summer slump in industrial output. Fears in August of the world being dragged into a deflationary cycle, which prompted the heavy market falls, now seem overblown and panic driven as global growth is holding up better than many commentators had expected.
The Markit Purchasing Managers Index (PMI) of global factory output has risen to 51.4 in October fuelled by continuing monetary stimulus. The PMI results improved in the UK, Japan, India, Russia and Vietnam. Chinese PMI for October showed signs of bottoming the cyclical trough. The increase in Chinese PMI was the biggest jump for 15 months and the result of the recent fiscal stimulus and interest rate cuts at last feeding through to the real economy. This has also begun to spur on a Chinese housing market revival. The PMI index for the Eurozone rose to 52.3 again lifted by a weaker euro, cheap oil and ECB QE.