Five points on the current situation
1 – Global level: the expected growth for the world economy is low, no strong drivers in the US, Europe and China. That’s our scenario (we had before the current crisis see my blog)
The Chinese move on its currency a week ago is a signal that after having done a lot to support their internal market (large SOE indebtedness, stock market bubble) they have tried to improve the situation by depreciating their currency.
It’s a signal that says that the situation is worse than expected
2 – On market the message is: the world economy will have a longer period of low growth without inflation. It means that investors have to rescale their expectations to this trajectory. By itself it’s not a contagion from China to the rest of the world by mechanical means, it’s the fact that growth prospects are persistently lower than thought
3 – Chinese authorities have a role here: they didn’t accept the convergence of the equity market to a kind of fair value after the burst of the bubble. What we’ve learned from 1987 notably is that , in order to reallocate resources, it’s better to let the market to adjust by itself with an accommodative monetary policy
The Chinese authorities have blocked the adjustment by forbidding sales and by imposing investment to brokers. The market is probably still far from its fair value and this will imply further adjustments. This will lead to uncertainty as every Chinese investor will try to exit from the market.
4 – The good point associated with this situation is the fact that oil price drops dramatically. This will be positive for European economies as consumers’ purchasing power will be boost.
So the impact for western countries will be limited:
a- Because if growth is weak in China, the equity market adjustment is not the sign of a recession
b- Equity markets will adjust downward with volatility in Europe but if the sequence is not too long it will not affect behaviors. It is just if the crisis lasts that we could have an impact on confidence
c- Lower oil price will have a positive impact – The price could go lower (remember 1998 )
5 – This situation will lead to lower interest rates. This is what we currently see with 10Year TBonds at 2% but the probability of a non-action from the Fed at its next meeting (16-17 September) is increasing. The global monetary stance is still accommodative and will remain for an extended period
Philippe Waechter, Natixis Global Asset Management
