Stock markets, exchange rate volatility, commodities shakeout and shifting economic landscape
Almost eight weeks ago, this author in – Update 9, Global economies heading for turbulence, watch out China - warned the global economy has turned red from amber. What was seen then by Singapore Finance Ministry as remote of possibility of yet another global financial melt-down , has now come to the contrary of fruition, with a degree of increasingly uncomfortable visibility that this is indeed the case .
It is already in the works last week. The Dow has its biggest one weekly fall since 10 October 2008. http://www.marketwatch.com/story/us-stocks-gain-dow-suffers-worst-week-since-08-2011-09-24?link=MW_story_latest_news. US 10-year Treasury yields closed at 1.81% after dipping to a record intra-week low of 1.67%. http://www.marketwatch.com/story/treasurys-gain-as-stocks-head-lower-again-2011-09-23-839350. The US dollar index, DXY was up 2.3% last week, last traded at 78.37 on Friday 23 September against a basket of six major currencies. http://www.marketwatch.com/story/dollar-slips-back-after-g-20-statement-2011-09-23.
European stock markets did not fare any better. The DAX and FT indices were trading below their 24 –month low and the CAC were trading about 300 points shy of its 2009 low. The steep sell-off in equities saw global stocks “officially” entered its bear market as the MSCI index encompassing the equity performances of 24 developed countries declined by more than 20% from its 2011 peak. http://www.cnbc.com/id/44640754. That includes China, India, Japan, Taiwan., South Korea and Australia. Germany, France and Hong Kong have already sunk deeply into the bear market territory, having slipped much closer to nearly a 30% fall. The sell-off in equities was brutal last week.
Commodities, too, were caught in the rout. Crude oil fell 9%, reflecting the tensions in Europe and global outlook. http://www.theaustralian.com.au/business/markets/crude-oil-rises-along-with-us-dollar/story-e6frg91x-1226145131219. Spot gold also slumped 9% in the market carnage. And contrary to BHP-Billiton’s recent confident assertion that the near-term outlook for its products “remained robust” in the wake of global slow-down, http://myresources.com.au/index.php?option=com_content&view=article&id=3022:bhp-outlook-bright-after-105b-profit&catid=52:stories&Itemid=113 industrial metals, in fact, were worst hit in that week ended 23 September. Spot nickel, copper, zinc, lead, and aluminum prices plummeted by 14.1%, 13.2%, 8.8%, 16.6% and 6.6% respectively. This was despite the fact that in recent months, wet weather conditions have negatively impacted on supply for iron-ore, coal and copper in Australia, Brazil, Columbia, Indonesia and South Africa. The slide in industrial metals was much steeper than the 2.5% rise in the US dollar against a basket of currencies: EUR, JPY, GBP, CAD, CHF (Swiss franc) and SEK (Swedish Kroner). Compared against month beginning, the US dollar measured by this DXY index rose by a mere 6.5%. Commodities prices and their demand - specifically LME-traded metals, were proven flaccid. Besides Freeport McMoran’s re-scheduling of customers’ order deliveries, Rio Tinto has advised of the same from its customer this weekend. http://www.smh.com.au/business/buckle-up-for-apocalypse-dow-20110924-1kqsq.html That signals industrial metal demand is weakening suddenly. The strength of Asian demand could not withstand the eroding demand weakness of developed economies. Commodity-based currencies like Canadian Loonie, Australian dollar or the Brazilian Real could be vulnerable to steep falls in the weeks ahead as volatility of industrial metals escalates.
Chinese market represented 59 per cent of global seaborne iron ore demand, 39 per cent of copper demand, 38 per cent of nickel demand, 41 per cent of aluminum demand, 42 per cent of energy coal demand and 10 per cent of oil demand, according to BHP’s latest annual report. The strength and the overall size relevance of Chinese demand for nickel, copper, aluminum and oil could not sustain the spot prices of these commodities last week which BHP-Billiton is a leading supplier along with Rio Tinto and CVRD. The biggest fear now must be either a steep fall in iron-ore price or coal or both next. That, if eventuate, would tell global economy is screeching to a stalling slowdown, not just seen in developed economies but also a much slower pace of growth in China and emerging economies as well - in effect, a catastrophe worst in 2009 meltdown repeating and worst of global impact. George Soros warned of risk consequences that the euro debt crisis could be worse than the US experienced in 2008. http://www.cnbc.com/id/44653617
Against US dollar, Asian currencies depreciated since month beginning - the Korean Won by 9.6%, Indian Rupee and Singapore dollar by 8%, Thai Baht by 3.1%, Taiwan New Dollar by 4.9%. The US dollar, however, remained largely unchanged against Chinese Rmb and Japanese Yen. Capital inflow into Asia reversed direction last week as financial assets on the eastern side of Pacific were offloaded to buy US Treasuries - all in the chase of imaginary “safe haven” that won’t last. For such razor-thin yield of near zero returns in short-term US Government-backed treasuries, money from Asian zone was flowing back into US dollar-denominated Treasuries, even climbing a tall wall of currency reversal risk worry to the magnitude of 3% to 8% range. Such risks to return ratio looks appalling unattractive unless one assumes that the US dollar is in permanent ascend. It is most unlikely to be the sustainable case when Asian economies are performing stronger relative to North American economies in general and the US in particular. There is a noticeable qualitative sign of fear current in this “hot” money outflow but the panic proportion of tsunami has yet to incubate and evolve into visible capitulation. One can clearly sees the global wobbles have put a lid on corporate takeover surge. http://www.theaustralian.com.au/business/mergers-acquisitions/global-wobbles-put-a-lid-on-takeover-surge/story-fn91vdzj-1226146151398. Filings in the US Securities Exchange Commission disclosed of August strong insider buying of their own stocks have all but disappeared. Corporate insiders of cash-rich corporate sector are no longer confident of their own business outlook and that is telling of their assessment of more headwinds and uncertainty confronting global economies awaiting resolution.
Industrial metals are a proxy for economy and gold is a proxy of exchange rate volatility and inversely correlated to fiscal stability in developed economies. As prices for industrial metals fell far deeper than gold and both volatility on the downside way exceeds volatility of US dollar exchange rate, there must be deep soul-searching concerns of economic fundamentals have shifted away from fragile cyclical recovery into full-blown recession mode probably. At least this is what this author believes in. A bumpy journey of slow crawling growth lies ahead even in the best of bailout supports of re-energized globally coordinated efforts. Sovereign indebtedness in developed economies are structural weakness cannot be resolved by even more debt-funded stimulus of limited duration impact. Battered commodity prices triggered by the steep momentum loss of economic activity in developed countries will most likely hammer the economic lifeline of emerging economies. Global economies are heading for a deep slowdown.
Are global economies plunging headlong into a recession?
Not all economists agree on this point – at least not in the minds of mainstream institutions like the World Bank, IMF, ECB and sovereign governments, publicly at least. Or perhaps they are attempting to talk up market confidence and buying time to string together a bailout package of 440 billion Euros to stave off the imminent Greek insolvency default without triggering a global banking crisis and catastrophic contagion similar to or worst than the 2008 episode. Barclay Capital Managing Director, Larry Kantor, even see the US economy as likely to stage a rebound in the second half of this year – thanks to falling energy prices, late rebound in auto manufacturing. Moreover, US trade deficit unexpectedly declined to US$44.8 bln in July as compared to US$51.6 bln in June. A 3.6% surge in exports helped by a lower exchange rate was the contributing factor. September’s sudden reversal of US exchange rate upward might reverse this favorable terms of trade and US export performance for the rest of current year. http://www.cnbc.com/id/44442250.
Professor Michael Spence, of New York University, 2001 Nobel laureate economist, rates the world has 50% chance of going into a recession; the US as currently not in recession but evolving debt crisis in Europe is the wild card which could tip the balance. http://www.bloomberg.com/news/2011-08-31/brics-no-cure-for-global-economy-this-time-as-avon-to-siemens-shares-sink.html.
Nouriel Roubini is more pessimistic. He takes a view that there is a 60% chance of the world slipping into a recession worst than 2008. http://www.cnbc.com/id/44368995
Singapore’s Finance Minister, Mr Tharman Shanmugaratnum, despite earlier cautious optimism, now thinks that, on balance, the world economy is sliding into a recession. He believes that the world have now “entered a self-reinforcing cycle” of lost consumer confidence discouraging investment and Asia is not immune from the downturn.
http://www.smh.com.au/business/world-business/global-recession-likely-singapore-says-20110906-1jv8e.html
The confronting reality, however, is that the US has continually been plagued by consumer spending lethargy, massive and increasing government debt, Fed ‘s money printing in failed repeated quantitative easing, exacerbated lately by narrowing of policy option choices and political paralysis in making changes. Latest data shows manufacturing slowdown continued in most districts. Manufacturing has been the strongest engine and driver of US recovery from the GFC low. New housing starts decreased by 5% last month and US consumer confidence sank to the lowest point since June 2009. George Soros thinks the US is already in recession. US Federal Reserve Chairman Ben Bernanke gave a stark warning on the downside risks to the health of the US economy. Bernanke spoke of ““significant downside risks to the economic outlook, including strains in global financial markets.” Operation “Twist” failed to convince stock markets as equities were sold off aggressively across the globe since his public announcement. http://www.marketwatch.com/story/fed-decides-on-400-billion-bond-swap-2011-09-21. Republicans were publicly opposed to further Fed’s easing, politicizing the Fed’s independence of action adds to the growing dismay on Wall Street. The political dimension and platform of economic agenda tighten, further intensifying political bargaining on Capitol Hill. That is worrying of dysfunctional economic management in the exigency of fast deteriorating economic contingencies the Fed has warned.
Robert Zoellick, World Bank President warned the world is in a “danger zone” even though it is still not in recession at this moment. IMF, in similar stark warning, said that the world economy has entered a “dangerous new phase.” http://www.theaustralian.com.au/business/economics/global-recovery-stalled-says-imf-but-australia-well-placed-to-weather-economic-turmoil/story-e6frg926-1226142190157
Adding to the latest chorus of gloomy forecast is Royal Bank of Scotland’s prognosis. They forecast Europe entering into recession in the next quarter extending at least into the first quarter of 2012. And it could lead to very damaging consequences. The ECB could be forced into crisis management of containing the expected severe economic fallout as the inter-play of both mutually-reinforcing sovereign and banking crisis trigger widespread turbulence. http://www.cnbc.com/id/44667622. Whilst some relief could be afford by the record cash holdings in the hands of both corporate and individuals, the downside of a Greek default is cascading defaults, bank runs sweeping Europe and that catastrophic repeats reverberating across the world’s weaker economies. G 20 leaders are scheduled to meet in Cannes on the 3-4 of November to map out a rescue strategy or at least some kind of barrier relief to permit an orderly default of Greece. Will financial market display further tolerance to wait for another 6 weeks? It is anybody’s guess until that fateful date.
There is a confluence of economic activity shrinkage in all developed economies as there is unity of burdensome debt-ridden paralysis. European banks riddled with bad sovereign debt investment on their balance sheet as much as American banks trapped by households’ bad mortgage – both reinforcing each other of crisis of confidence, curbing demand and investment, employment and consumer spending. The world is right on track for a recession and China can’t help to any measurable extent of global growth stimulus support as it did in the last GFC – even in the false calming benign holding back of a Greece sovereign default and the risks of Italy contaminated perilously by this adversity contagion if Greece defaulted instead.
A BANKING CRISIS IN WAITING IN EU, USA AND CHINA TOGETHER?
Besides the vulnerable countries like Greece and Italy, there are crisis bystanders who could be badly hurt. Europe and US are two biggest markets for Chinese exports and therefore highly vulnerable to turbulence in both economies and systemic risks in their banking sector, worst still together. In current climate of sovereign and banking crisis in developed economies, banking everywhere operates in difficult terrain and China is NOT excluded – both of its banks and economy. While the European sovereign debt crisis threatening to spin out of control, the Chinese remained deeply and resolutely focused on containing inflation. Over the weekend, PBOC actually fixed the Yuan/Dollar reference rate to its highest level since the currency peg in 2005. Zhou Xiaochuan spoke in no uncertain terms of “high inflation remains the top concerns in China” and that will influence some flexibility of the Yuan. In other words, credit tightening is priority and any economic fall-out from European sovereign debt/banking crisis takes the background consideration of policy determination or any changes there from. China won’t be too aggressive in any stimulus similar to 2008/2009 to boost its economy and supporting global growth. http://www.theaustralian.com.au/business/world/china-signals-comfort-on-yuan/story-e6frg90o-1226147505085 Banking credit has all but dried up within China except for the largest state-owned enterprises and smaller property developers are at risks of liquidity crunch and sudden insolvency if property prices continue to drop and stay at those levels for the next few months.
Banking runs could start from either Europe from sovereign debt exposure or in China from a loss of confidence in real estate bubble burst and would reinforce each other in cascades. China is fearful. That explains why, I believe, the Chinese Premier in Europe (and repeated in China by the PBOC’s Deputy Governor Yi Gang) stated publicly that it could only help Europe “at the margin” and PBOC’s Zhou said it is “too early” to assess correctly what the risks of European sovereign debt and banking crisis and its impact. http://www.quamnet.com/newscontent.action?request_locale=en_US&articleId=2046279&view=NEWS. Chinese listed banks are also cash strapped in the property sector and also trapped in state-directed policy lending to municipal authorities. There are reports that Liaoning defaulted on 85% of its debt service payment last year. Now operating with tighter regulatory framework of capital adequacy ratio, Chinese banks either have to look for market funding to grow its business or curtail their lending growth. Question must be asked – who is feeding China’s cash hungry banks?http://www.marketwatch.com/story/chinas-capital-hungry-banks-2011-09-11
The Chinese have enough distress on their plate and presumably waiting for the rest of G20 leaders’ forthcoming November meeting to throw in their shoulder support before committing its own share of contributory efforts.
If European banks are forced to accept “haircut” from sovereign debt holdings, many European banks could go under. The implications of that are huge and damaging. http://www.cnbc.com/id/44397053. Italy credit rating was downgraded even as ECB struggles to manage a seemingly orderly default of Greece. Credit Agricole & Societe Generale, two of three largest French banks, had their credit ratings downgraded by Moody’s for their risks exposure to Greece sovereign indebtedness. British and US banks, bailed out in the GFC for their exposures to derivatives linked to subprime mortgages hardly made any progress on their lending front. http://www.theaustralian.com.au/business/markets/don-argus-looks-for-answers-after-the-debt-binge/story-e6frg916-1226139357596.
Right now, there are as much political paralysis in Europe and as there is also in Washington. High leverage is as damaging for corporate as for sovereign. Where is the quick fix except for one stumbles from one crisis after another in seemingly endless succession?
Bank of America, Well Fargo, Morgan Stanley and a host of investment bankers are on a non-interest cost cutting drive to improve their cost to revenue efficiency ratios. This is how tough of margin banks now operate and cannot afford another big haircut for bad loans, past and present continuing.
http://www.theaustralian.com.au/business/world/bank-of-america-to-cut-30000-jobs/story-e6frg90o-1226135371818
American banks are adjusting to new regulatory framework and still restructuring their lending portfolio. With very little top-line growth in revenue, the concern now is falling real estate prices could erode bottom-line and jeopardizing capital adequacy ratios as well going forward – at a time when financial markets are increasingly skeptical of this sector’s investment outlook to be supportive of new capital raising initiative.
SO WHAT IS THE CURRENT STATE OF GLOBAL ECONOMY NOW AND THE RISKS FORWARD?
Provided the sovereign debt crisis does NOT deteriorate further, there is a real prospect that a mild recession would visit Europe before the end of this calendar year. Any bailout rescue effort, even if effective, that could be formulate in Cannes on 3-4 November will be too little and too late of relief of positive economic impact for Europe. The biggest nightmare is the coincidence of deep recession risks in Europe just ahead of America’s is heading toward a major fiscal tightening in 2012, ahead of the Presidential election. A combative US Congress, majority-controlled by Republicans, is unlikely to be sympathetic to Obama’s re-election prospects to permit another round of quantitative easing spending and money printing by the Fed. Such an eventuality could either trigger another recession in the already weakened US economy, corrodes any recovery prospect in Europe or even aggravating it. http://business.financialpost.com/2011/09/26/developed-world-growth-will-slow-to-a-crawl/
That will leave China again to be the last bastion of defense, but this time, China itself is also weakened by its own worrying fiscal indebtedness, seemingly uncontainable domestic inflation threats and risks of fiscal instability after that orgy binge of poorly co-ordinated and loosely-managed stimulus spending boost of 2008/2009.
China’s official PMI has been steadily declining since March and in August was barely above the expansion/contraction divide at 50.9 after hitting a 28-month July low of 50.7. http://www.cnbc.com/id/44350776. Its August sub-index for new export order plunged into contraction of 48.3 from July’s 50.4. China’s export-oriented manufacturing declined for three consecutive months. These are first hint of its export market is faltering. Chinese trade surplus shrank since January as imports rise faster than export growth Its September trade figures will be closely watched. Chinese trade surplus over the 8 months period shrank 10% to US$92.7 bln compared to year preceding. http://www.theaustralian.com.au/business/economics/demand-in-china-remains-strong-as-imports-surge-30pc-in-august/story-e6frg926-1226133733677. Latest PMI read for South Korea, Taiwan and Singapore all contracted – increasing signs that global slowdown is taking effect.
Spending cuts to rein in budget deficits have cooled the German economy to slower growth. New export order fell for the 2nd consecutive months for German manufacturing. Manufacturing PMI for the 17-nation eurozone fell into negative territory of 49 in August from July’s slightly expanding read of 50.4. Markit Economic also reported first manufacturing contracted in both France and Italy since June and September 2009 respectively. Consumer confidence in Germany and France – the two strongest pillars of the GFC recovery – are now wallowing at a two-year low.
http://www.bloomberg.com/news/2011-09-01/europe-manufacturing-shrinks-more-than-initially-estimated-1-.html. Manufacturing, the pillar of European recovery story, is faltering into contraction. Eurozone dominant services sector registered a shock contraction in September – the first in 2 years. http://business.financialpost.com/2011/09/22/europe-china-slowdowns-stoke-recession-fears/
PIMCO, the world’s largest bond fund manager, forecast Europe will be in recession next year. http://www.bloomberg.com/news/2011-09-25/pimco-s-el-erian-sees-rich-economies-stalling-amid-new-european-recession.html
Growth has stalled in US and EU and China slowing. Most countries cannot simply borrow more. And developing countries will be badly battered. There is no decoupling from the resurgent economic woes confronting Europe or the US. Both major economic blocks together support 40% of the exports-dependent GDP’s of emerging economies. The writing of impending risks to emerging economies is already on the wall of commodity prices last week. Look no further than Canada and Australia whose economies escaped almost unscathed in the GFC of 2008/2009. Canada recorded negative growth in the June quarter and poised to be the first G20 countries to hit the recession patch this time as inflation corrodes consumer spending. The same is happening in Australia, all thanks to strong commodity prices and import costs, retailing are going through the worst times not seen for decades and housing mortgage distress is escalating despite the mining boom. A collapsed mining export sector will be a double blow and might force the Reserve Bank of Australia to cut interest rate just as inflation stubbornly refused to ease downwards. Another commodity-based economy – Brazil – is lowering its growth forecast to 3% to 4% after having cut its interest rate suddenly last month, taking cue from similar example in fast growing Turkey. And this is in spite of a noticeable quickening pace of inflation afflicting its economy.
http://www.businessweek.com/news/2011-09-27/world-s-biggest-rate-cut-forecast-on-global-slump-brazil-credit.html Israel trimmed its key interest rate on Monday, the 26 September, its first in two and a half years. Speculators are now betting that Brazil will soon cut its interest rate by the most in two years to boost domestic consumer spending in an effort to cushion its economy from a banking crisis slowing global growth. The message seems to be that emerging economies are more concern about slower growth than inflation threats looming. And for commodity exporting countries like Canada, Australia and Brazil, slower global growth will leave a far more telling impact and possibly longer in wait for the next recovery cycle. This impending economic downturn is different – it is structural, not cyclical. That is why cheap money of low interest rate has no positive impact on demand growth in developed economies. Debt-laden consumers are tired and no longer have any propensity to further addiction to debt-loaded spending.
IT IS RECESSION AND/OR LONG SLOW RECOVERY FROM TURBULENCE.
The world has changed – particularly the consumer behavior- post the GFC - among the much-battered baby boomer generation and national economic mindset in Governments. With economies of Europe and US are stalling in conjunction, China slowing and emerging economies waiting for the chill winds to blow in, tough times are ahead. Global demand will be decidedly weak and cautious. Without or without the pains of another deep global recession, we are, at best, in for a long, slow crawl of a recovery path going forward, maybe for years to come before sustainable balanced growth returns. The longer our wait of necessary adjustments and medication intake, the more bitter will be the curing (if effectively so) pills to swallow.
Anyone disagreeing?
Zhen He
28 September 2011.
