The first two trading days of this week have been marked by the return of some positive risk appetite. While one can cite many factors for this – bargain-hunting, positive US economic statistics the previous week, promises of more stimulus, a rebounding oil price – one factor probably stands out – China.
The reopening of markets in China following the Lunar New Year holidays was surprisingly uneventful given the volatility of the previous week when the country’s markets were closed. The lack of big knee-jerk moves during the beginning of the China’s new Lunar trading year was something that was welcomed and something that also shows that global financial markets need Chinese markets to calm down in order to regain their composure.
Specifically, China’s Shanghai Composite lost only 0.63% after it reopened following the week-long holiday on Monday, while it managed to gain 3.32% in Tuesday’s trading. Similarly, the yuan was also relatively well-behaved versus the US dollar; helped also by a bout of US dollar weakness it strengthened to as low as 6.48 yuan per dollar from the 6.57 level before the holidays. The yuan subsequently stabilized around the 6.51 levels in Tuesday’s trading.
Further depreciation of the yuan could be coming however as the Chinese authorities have been pumping liquidity in the Chinese economy as monetary aggregates data revealed on Tuesday. China may not have cut its key interest rate or reserve ratio requirement lately but is taking other measures to keep its economy well-lubricated with liquidity. Cutting interest rates for example could aggravate capital outflows. Maintaining the value of the yuan stable in foreign exchange markets while pumping liquidity in the economy is going to be a tricky affair and may call for some very strict capital controls. Attracting investment into the country might be a challenge under draconian capital controls but this is the path the authorities have chosen and many outside China are wishing that the country’s problems are gradually resolved.
Another interesting observation was that the markets overall did not appear overly concerned by evidence of economic weakness. For example China’s trade data was disappointing as both exports and imports fell much more sharply than expected during January. Of course seasonal patterns and orders before and after the Lunar New Year holidays always distort the data and makes conclusions difficult around this time. In Japan, disappointing GDP numbers in the form of a larger-than-feared economic contraction of 0.4% in the fourth quarter were accompanied by a spectacular 7.2% daily gain in the Nikkei; its biggest such gain since 2008. However it was a day when the yen lost ground and this represented a significant relief to Japanese exporters. Speculators buying the yen may soon find the Bank of Japan on the other side of the trade as the Japanese Premier warned against excessive movements in currency markets on Monday.
Overall the market turmoil so far in 2016 has not been as affected by key economic releases – instead selling has tended to create its own momentum and has fed off through developments in the oil market, China’s currency and stock markets and more recently pressure on (mainly European) banking names. However it could be possible that the market enters a “bad news is good news” phase if it believes that bad economic data will strengthen the case for additional monetary stimulus, which would then allow risk assets to retain high valuations.
In other developments, the US dollar staged a strong rebound – which started after the release of positive January US retail sales. Even though US markets were closed on Monday, the dollar extended its gains. Therefore one could say that the US dollar is also a beneficiary of positive risk appetite together with assets like stocks and oil. This could also be the result of the dollar’s major counterparts - the yen and the euro - playing the role of safe havens. The positive risk appetite also hit gold which quickly returned to $1200 after topping the $1260 level the previous week.