China and interest rates are among the issues weighing heavily on the minds of investors and economists. Global markets have been in turmoil and some are wondering if the Fed raised rates too soon.
Equity markets, which are viewed as a leading indicator of the economy at least in the U.S., are reflecting an underlying concern about the global economy. After all, after the Great Depression ended in 1933, there was a second recession in 1937-38. It’s been eight years since the banking crash and Great Recession, but no parallels are perfect. This time, the two engines of the world economy bears watching.
And those risks are evident in the stock market. Of course, the record highs in equity markets were always likely to deflate with the end of QE and a rate rise in America. Still, it’s a more complex time now with such great global integration.
Concerns about a slowdown in the Chinese economy amplify the sell-off of commodities. In addition, new U.S. energy production adds to the downward pressure on oil. Yet, in economic terms, there are positive fundamental changes to the world’s biggest economies.
China just unveiled its blueprint for growth for the next five years and it remains focused on re-balancing and slowing down as befits a middle income country. For instance, services are now more than half of GDP for the first time and outward investment to Europe has hit a record high.
In other words, China has moved away from just being the factory of the world to relying on growth based on domestic demand and launching multinational companies. This slower growth will require global adjustment and that’s likely to be bumpy.
Dealing with debt and innovation remain challenges that will weigh on investors’ minds but that will not be quickly resolved through any government announcements but rather what they do in the coming years.
The other sector that has dragged down equity indices is banks. Negative interest rates across Europe and also in Japan weigh on bank stocks as they’re designed to force greater lending through penalizing cash deposits in central banks. Concerns about lending to slowing emerging markets, hit hard by China’s slowdown and some by the end of the commodity boom, are another reason.
NIRP or negative interest rate policy also indicates that central banks don’t have many conventional tools to stimulate the economy when they already inject cheap cash via QE. So, if there was another recession, there’s now less capacity than when interest rates were at previously normal levels of around 5%.
So, there was always going to be volatility when the Fed normalized interest rates. It’s compounded by the slowdown in China and continued easing in Europe and Japan. Each country is doing what they believe to be best for their economies. The sum total though is a risky period in the global economy.