The declines were again on the concerns we discussed yesterday which included:
1. The roll out of QE2 and the potential impact that printing money will have on the long term viability of the US economy.
2. The recent moves by China to increase interest rates and jack up the Reserve Requirement Ratios (RRR) of banks in an attempt to manage growth (and inflationary pressures that go with it)
3. Risk of Ireland defaulting on its debt
Overview of market action last night.
- USD (
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- The AUD (
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- There was broad based selling in the commodity market as shown by the commodity index (
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- This was particularly aggressive in Gold (
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Yesterday we discussed the roll out of QE2and the impact of that and other previous stimulatory measures on the US economy. My conclusion was that US economic data is improving so it appears in the short term at least that the programs are starting to work (slowly).
The tightening of monetary policy in China is another concern the market is now grappling with. We had data out last week that showed a sharp increase in pricing pressure in China with the CPI up 4.4% YoY. This was largely driven by a large spike in food costs which were up 10.1% on the year. This is pretty typical of an economy that operates on a low per capita GDP as food makes up almost half of an individuals expenditure.
So far, the Bank of China has raised interest rates by 0.25%, have hiked the Reserve Requirement Ratios for banks 4 times (the last one being by 0.5% last week) and there are now reports from Bloomberg that China;s four biggest banks will stop extending new loans to property developers for the the rest of the year. This story was supported by Reuters who said that the four banks had used up there full year property quotas for property developers and had halted approval of any new loans.
The first issue is interest rates. Forgive me if I'm being too simplistic however an economy that is running with double digit GDP growth and looking stronger by the day will utilise interest rate hikes to ensure growth remains sustainable and bubbles don't develop. Australia is a case in point. To me this is a positive and shows prudent economic management. To give you a better idea of the dynamics driving growth in China, I've attached the report I sent out to clients on the 20th September. It was actually a reprint of a speech given by the RBA Assistant Governor.
Worth a read for those that haven't yet seen it.
Goldman Sachs have raised their China CPI forecasts to 3.2% for 2010 and 4.3% for 2011 - up from 2.4% and 1.3% respectively. They say this will trigger 3 interest rate hikes next year each of 0.25%. It's important to note however their forecast of the Chinese Currency which they believe will only appreciate about 6% for the year.
So, if this does play we'll have a conservative cycle of interest rate hikes to manage growth. The currency will stay at very low levels to offer further support for exports and inflation (although high) will remain manageable.
The other measures that have bee taken to manage growth has been this increase in Reserve Requirement Ratio's (RRR). In other words, the amount of cash a bank has to retain (so it therefore has less to lend). We've seen four hikes here however its estimated that the banks still have excess capital ratio of about 1.7% so they could withstand another 3 increases of 0.5% before this will have any real impact on capacity.
Yesterday we saw Standard Chartered come out with a forecast that China will become the worlds largest economy by 2020. Goldman Sachs suggests this will occur by 2027 and a lot of other economists are there or there abouts. Investors have a propensity to worry about China however my personal belief is that the Chinese Government has done a great job of creating and managing growth so far - why would this change now.
I think we'll probably see some short term weakness in the market. This will give us an opportunity to top on our theme of investing towards the growth in emerging economies.
James Gerrish
(02) 9375 0117
