What a week. It’s a new year for the world’s financial markets, but it sure didn’t take long for investors to realize that the themes of 2015 are still very much prevalent. The week and the year began with Chinese regulators attempting to maintain control of their currency as the offshore market continues to discount the official rate has seen investors sell Chinese stock markets and prompt fear of further weakness in the world’s second biggest economy. The immediate and pertinent questions as fear of contagion spreads around the globe is, are the events over the previous week indicating some sort of paradigm shift in the global economy like a crisis or is this simply volatility that is to be expected in 2016?
At this point, it seems the latter scenario of increased volatility is more likely. Furthermore, ending the week Friday with strong US job numbers only added credence to this point. As the US labour market created 292 thousand net jobs in December, the year of 2015 topped out as the second best year for job creation since 1999. The US economy continues to moderately advance as the least dirty shirt in an obstacle-ridden world.
The US Federal Reserve remains in their challenged position as the world’s central bank. As the IMF points out, global growth in 2016 will be muted and uneven, but domestically US businesses continue to have a positive outlook and hire. Hence, there is an environment to continue to support a strong dollar. Shifting overseas, part of the fear of the rapid currency depreciation in China, and other emerging markets is linked to local firms holding US dollar debt that inflates with currency weakness. This currency weakness is being prompted by diverging central bank policy between the US and the rest of the world. This has certainly been the dark cloud that has reappeared over financial markets, not unlike August and September of last year.
Chinese equities perhaps tell part of this story as they represent investors fleeing their domestic market, but don’t share a link to their economy that financial markets in more advanced economies may have. This is why they only an incomplete story. Proof of this is in the issues over the past week where circuit breakers and trading halts that failed to restore investor confidence and minimize what was an incomplete emotion-filled rush for the exits. As their equity markets require reform, it will be important for investors to keep this in mind in the year ahead and anticipate further violent moves. Chinese equities, while making headlines surrounding trading halts and selling bans, are only a small part of the story for global markets.
In retrospect, the outlook for the markets circles back to the US Fed and their interest rate policy. Despite the fact that we are now past the point of quantitative easing and emergency level interest rates, it is still the pace at which the US Fed continues to raise rates that will be the focus of investors. The unconventional measures of the past allowed the fed to maintain a liquidity backstop for global markets. This game is now changing as their ultra-accommodative measures are tapered back. Less liquidity prompts more volatility, and that is why in 2016 it is most important investors are tempered and have a plan for when the market sells off, instead of being caught in shock.