The shock of the VW scandal has affected European sentiment as well. The global growth shock has permeated Russia where sanctions and oil’s weakness are hurting. Latin America is notably weak where in Brazil there is wide current political uncertainty, as the Real and the country’s commodity-orientated exports suffer. Even major capital investment markets, such as North America, are dull. This is despite a generally strong economy, as oil and gas investment weakens and, more surprisingly, corporates opt to divert cash flow to stock buy-backs rather than into capital plant - a curious distortion of the prolonged zero interest rate environment. This much of a global growth shock has now been priced in.
Markets have been volatile with several notable casualties in the commodity space, from Glencore, the trading house, to the indebted Peabody coal operations in the US, still a major supplier to its domestic energy market. Affiliated sectors are seeing capital expenditure vanish and dividend flows cease. The crucial data point remains whether the ultra cautious Yellen is able to fulfil the Fed’s stated policy of a rate rise in 2015. Events in China will be carefully managed by the Communist regime, with graduated easing of rates and studious management of the renminbi peg.
International support from such bodies as the IMF ought to be brought to bear to assist. The Chinese authorities will surely try to manage the unwinding of a leveraged property bubble that has rolled over into its stock market. The quantum and manageability of the resulting bad debt situation is what concerns central bankers. If the Chinese situation causes a serious recession, global growth may suffer further. It may be that continued and concerted devaluation by China is forced on them by domestic pressures.
It was noticeable in the Fed’s last minutes that Chinese events were referred to as a factor influencing the failure to hike. However, Yellen must avoid getting boxed in by not having any rate influence over any policy response should there be a deflationary downdraught in 2016, which could affect international economies. Whilst there is the undoubted danger of extreme volatility and further market squalls in the immediate future – the autumn has a preternaturally high correlation with such market storms – there is an equal likelihood that much of the deflationary concerns are increasingly baked into markets, unexpected setbacks aside. Should China’s economic data stabilise from its current dire levels, the Fed might still well be able to hike in late 2015 and establish the expectation of a shallow path of rates out into 2016.
At present, the Fed’s narrative of forecasts is not believed by the futures bond curve – it has not since we noted this phenomenon in the Spring edition of our client newsletter, Prospects. Nevertheless, anything other than a fracturing of markets by weakness in China may permit the Fed to restore a stabilising pattern. The forthcoming data flow of the next few weeks will be critical and leaves markets naturally nervous. The Fed, under Yellen, will be anxious to raise rates if international conditions allow them to, if only to avoid being identified as having given the markets terrible guidance into 2015 and having committed a significant policy error. One has to await the data flow of coming weeks to see which fork in the economic road events go down.