If we could summarise market movement over the past week in one word, jittery would best fit the bill. Amidst investor expectations of further quantitative easing to be announced by the ECB tomorrow, in hand with a continued rally in crude oil prices, equity markets performed strongly, reflecting reignited investor confidence to risk-on sentiment. Weak trade balance data out of China yesterday, however, was enough to force investors to retreat and flee back into safe haven assets such as government bonds.
Chinese trade balance data yesterday disappointed global markets, as China reported the sharpest monthly drop in trade balance figures since 2009. Weak exports demand in hand with lower import numbers for the period continued to show weakness across the world’s second largest economy.
As demand for Chinese exports are directly correlated to the demand for Chinese currency, the news bears further woes for the Renminbi as foreign reserves continue to be depleted against the efforts of the People’s Bank of China to stabilise the currency.
Investors’ concerns are not irrational, the higher possibility of depleted foreign reserves increases the value of Dollar denominated debt China owes to its creditors in real terms (the lower the depreciation of the Renminbi, the more expensive it will be for China to afford USD) possibly resulting in a higher Debt to GDP ratio which has been constantly increasing for China since 2011. In theory, a higher Debt to GDP ratio for a country is a negative signal as it signifies a higher default risk on repayment of debt.
In the Eurozone, focus is set on Thursday’s ECB meeting, where Mario Draghi is highly expected to announce further quantitative easing (QE) measures to stimulate Eurozone growth. Despite markets already pricing in QE expectations, upon announcement we could expect to see the most consequential gains in European cyclical equities and risky bonds. Should Mario Draghi not disappoint investor expectations this time around, the EUR could lose further ground against the USD and bring a EUR/USD parity scenario closer to reality.
The Bank of England (BOE) meanwhile has been busy planning out liquidity auctions as part of a damage control strategy for UK banks. As Brexit fears intensify ahead of a June vote, the BOE is exceptionally allowing UK banks via auction unlimited borrowing amounts to offset any potential future run on banks. Until a certain outcome of a vote is known, I believe GBP denominated assets for foreign investors should be avoided for the time being, in light of potential outflows of capital and a depreciation of the currency should the Yes camp win the Brexit vote.
We’ll see what the week ahead brings, however one thing is for sure, the past week’s positive data in the U.S will not make rate hike decisions any easier for the Federal Reserve as the weak data out of China almost certainly brings further credibility to weak global demand. Any further hikes given the bleak market environment would undermine not only the U.S recovery but a global recovery. The best course of action for the Federal Reserve would be to hold-off and wait on further positive economic data to emerge out of the U.S and meanwhile wait and observe the global volatility play out.
This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.