For all the hopes of healing world markets, it’s hard to see how a ‘jarring January’ suddenly becomes ‘feel-good February’.
‘Febrile’ might be a better descriptor.
Tension is now growing between central banks and governments, urging calm, and global investors nursing heavy losses from one of the worst starts to the year on record.
Unnerved by the oil collapse and its fallout, China’s yuan ‘trilemma’ and growing fears of world recession, for many money managers this will be at best a long haul with no easy fixes.
“Central banks, although remaining vigilant on financial stability, are progressively losing effectiveness, and may fail to effectively curb market volatility in the medium term as they did after the Great Financial Crisis,” said Giordano Lombardo, Group Chief Investment Officer at Pioneer Investments.
So do policymakers go up a gear or stand back a little and hope warm words and small monetary tweaks limit the shakeout?
So far, they are sticking to the script. Measures mooted over the past two weeks are all consistent with G20 finance chiefs, meeting in Shanghai on Feb. 26 and 27, reading straight from last year’s playbook.
Sticking to standing G20 communiques, central banks have so far been true to the pledge “to monitor financial market volatility and take necessary actions.”
The Bank of Japan went furthest by adopting negative interest rates last week for the first time. The European Central Bank continues to stoke expectations of another cut in its already negative deposit rate as soon as next month.
Both the U.S. Federal Reserve and the Bank of England have cited the fresh market ructions as major policy considerations and, in doing so, pushed back market expectations for planned interest rate rises there into late 2016, or even 2017 in the case of the United Kingdom.
Again, this is straight from G20 texts: “In an environment of diverging monetary policy settings and rising financial market volatility, policy settings should be carefully calibrated and clearly communicated to minimise negative spillovers.”
China, the G20 chair for 2016, has insisted it can and will hold the yuan steady. Premier Li Keqiang phoned International Monetary Fund chief Christine Lagarde last week to pledge Beijing would keep the yuan “basically stable” and improve communication with financial markets.
For that, read G20 texts saying: “We reaffirm our previous exchange rate commitments and will resist protectionism.”
What’s more, alarmed by the relentless oil rout, major energy exporters, including G20 members Saudi Arabia and Russia, have at least started talking about draining the crude glut even if they’re still far from agreeing on how and when.
Prior communiques have been clear here too in stating that relentless oil price falls are not an unambiguous positive and can be deeply destabilizing. “There are important challenges including volatility in exchange rates and prolonged low inflation, sustained internal and external imbalances, high public debt, and geopolitical tensions.”
So far, so good. But is that enough?
The big concern for many investors and governments is that even though projections for aggregate global economic performance still look reasonable, a loss of financial market confidence in itself can catalyze a crunch.
So some reckon a more forceful ‘Grand Bargain’ is needed.
Strategists at Bank of America Merrill Lynch reckon something akin to a 1985-style Plaza Accord may require a large one-off devaluation of China’s yuan to lance speculation fuelling capital flight. They also talked of quid pro quo measures such as fiscal boosts from Germany, France and the UK.
But “our deep concern is that the macro and the markets may first need to worsen to inspire the correct policy response,” they added.
Reality for many in the marketplace is that the attrition is not just about sentiment or even monetary settings, it’s now about real distressed selling from sovereign funds and emerging market central banks, as well as blue-chip corporate hits or asset writedowns and fears for junk credit or dividends.
The full extent of the hit to leveraged U.S. shale companies has yet to be felt. Oil majors such as BP are only starting to register the scale of their losses as their credit quality deteriorates and dividends across all firms in the natural resource sector come under intense pressure.
With trillions of dollars now changing hands as a direct result of what looks like a sustained 70 percent drop in oil prices over 18 months, there are many shoes yet to drop.
Using publicly available models from oil exporters’ reserve managers and sovereign funds, and assuming only liquid assets were sold, JPM Morgan estimates they dumped about $90 billion of government bonds, $50 billion of public equities, $7 billion of corporate bonds and $15 billion of cash instruments in 2015.
Even if oil prices stay about $35 per barrel this year, it reckons on at least another $220 billion depletion of FX reserve and sovereign wealth fund assets this year. Western European equities and financials are most exposed, it said.
Selling from reserve managers and sovereign funds in China, where hard currency reserves are estimated to have dropped about $700 billion from the peak in 2014, is another pressure point.
As for more illiquid assets, such as high yield bonds or property and private equity, “to the extent that this liquidity risk triggers solvency risk, we need to be very nervous in certain areas,” wrote Axa Investment Managers’ Mark Tinker.