By Miguel Ferreyra de Bone
Following the decision of the Chinese government to trim interest rates and adjust the requisites of bank reserves for commercial banks, we are starting to see some improvement from the 20% loss in the Shanghai stock exchange last week. More losses in emerging markets should be expected, however.
The financial turmoil that the Chinese experienced at their primary mainland stock exchange, due in large part to investors placing their positions without appropriate market or industry due diligence, has made the world tremble. Some have compared the crisis to the losses experienced with the dotcom bubble in the late 1990’s. Over $5 trillion has been wiped off of stock prices since the devaluation of the yuan.
Intending to ignite their cooled economy, Chinese authorities have initiated a set of textbook monetary policies that aim to inject huge amounts of cash into the system. Moreover, their intentions are clear: bring some tranquility to the markets, and prove to the rest of the world that China is committed to being a serious player in the world’s financial system.
Since real interest rates sat above the two-digit mark for quite some time, it’s smart to bring the official rates down at this point. Regarding liquidity in the system, the Government has taken the yuan out of the economy, injecting dollars instead to avoid a steeper rise of the American currency.
Although analysts were expecting these monetary policies taking place, they believe that the clipping of the reserves ratio for commercial banks is a positive step towards a healthier economy. Those funds should flow down to individuals and companies in the shape of investment and increased access to credit.
In October, we can expect to see some market recovery in China. The government’s recent decisions improve the short term outlook, making the current market tumbles look like a temporary situation. The bigger problem, however, lies in emerging markets, which are going through a deep plunge.
Emerging Market Turmoil
Money has been flying out of Russia, Brazil, and China since the Fed started to discuss their upcoming rate hikes. A stronger dollar means a headache for importers of goods, particularly from emerging markets. In fact, China accelerated its soybean imports in July (+27% than last year) from South American producers for three reasons: take advantage of the crops downfall in price, pay with a stronger yuan before the expected devaluation, and stock up in order to make sure soybean prices would stay low for some time.
Although buyers have not fully covered their soybean demands for October and November, they are not actively buying the new American harvest, either, according to sources from the industry. South Americans will top sales until at least September given the record harvests they have experienced, particularly in Brazil and Argentina, the first and third largest exporters of soybeans in the globe.
In terms of stocks, more temporary drops can be expected. Shanghai will is most at risk for deeper losses, since most of the local investors place their positions in the mainland exchange. Hong Kong remains an international arena regarding the provenance of the stock holders.
The Shanghai Composite, which lost 37.43% since the second week of June, is still up 40.12% compared to its level one year ago. And following the recent change in the required reserve ratio for banks, we should expect to see a limited and contained drop in the case of a continuance of these stocks’ falling tendencies.
If stocks are not working for investors, fixed income securities definitely are. Bonds in some countries, like Brazil and Argentina, are paying extremely high interest rates, while American and German bonds are receiving more attention due to their perceived security.
With oil prices still at a six and a half year low, and with a continued weak price of gold, we shouldn’t expect any immediate dramatic improvements in the Chinese market. Commodities are widely falling as a result of the global economic slowdown. Prices drop because there’s a strong offer, and companies aren’t buying as freely as they once did.
If companies do decide to buy, it is based on their short-term needs, for a short-term profit; not many investors are looking further to the future.