Stock markets around the world fell hard at the end of last week and it will be a nervous Monday for traders and investors around the world.
The coming days should give an indication of just how far this fall may have to go.
It might turn out to be a bog-standard correction. Many market observers, including optimists, have believed that stocks have been due a reality check and this may be it.
But in recent months the nasty data coming out of China – and there was more on Friday – has been spooking people. The prospect of a harder landing than anticipated for the world’s second-largest economy cannot be easily dismissed. And this has the potential to trigger problems far beyond China.
While the spectacular losses on the Shanghai stock exchange are of themselves of little consequence to China’s vast economy, the crash and the surprise decision to start devaluing the currency has raised questions about something potentially more troublesome: whether Beijing is losing its command over important aspects of its plans for economic reform.
The brutal reality is that the world is looking to China to continue with its impressive record of economic reforms which has unlocked new productive capacity for the global economy and also created new demand by the rapid creation of a vast new urbanised population and a new middle class which will be about the size of the entire U.S. population by 2030.
But in China’s political dynamic, continuing the path of the Xi Jinping reforms requires Xi and his offsider, Li Keqiang, to retain the authority necessary to implement their agenda.
With remarkable reliability, authorities in China have deployed various stimulus measures to counteract a softening of the economy, giving the appearance that China’s policymakers don’t quite have a grip on the situation. Without that China’s growth trajectory becomes unpredictable. And markets hate uncertainty.
Soc Gen’s Global Head of Economics Michala Marcussen has noted the risks in a note to clients and it makes for grim reading.
Here’s Marcussen with two sentences that may cause you to take a sharp intake of breath (the ellipses are as they appear in the note):
Critical to our outlook is global market confidence; should equities, bond spreads, commodities and emerging currencies suffer further sharp and significant losses across the board from here, then a self-fulfilling vicious circle of default, forced asset sales, further price declines … and ultimately recession … could result. Moreover, policymakers may struggle in such a risk scenario to respond, given that much of the ammunition was exhausted on the previous crisis.
With interest rates already at record lows and government budgets in advanced economies around the world already looking threadbare after all the stimulus used to absorb the shock of the GFC, the usual response tools to a global recession are simply not available. However, Marcussen adds, one positive is:
the still-large level of FX reserves in several major EM economies. This is one reason that a new crisis is not our baseline scenario. To our minds, the gradual recovery taking shape in the advanced economies can weather what we expect will be a prolonged period of weaker growth in a number of the major emerging markets and this was a key feature already in our previous (global economic outlook).
Marcussen adds Soc Gen still believes the U.S. Federal Reserve will start raising rates in the coming months. But clearly, the sell-off in global markets and the anxiety this is triggering is exercising the very top economic minds in the world’s biggest investment banks.