Tuesday 22 May 2018

Daily Market Update: Chinese stocks plunge again and trigger more global volatility; Irish economic news continues to impress

Beijing's central business district.
Beijing's central business district.

Simon Barry

European investors are this morning digesting what was another session of extreme volatility in Chinese equity markets overnight.

The market was for the second time this week shut early after the threshold for its new “circuit breaking” mechanism was breached within the first half hour of trading, leaving the benchmark Shanghai Composite down around 7%, following on from similar declines in Monday’ssession. One catalyst for last night’s weakness was the news that the Chinese authorities again guided the yuan lower, allowing its fixing vs. the dollar by to decline by the most since August which served to amplify concerns about financial stability locally and beyond.

While the change in the yuan’s official fixing has been described in many news reports as “sharp” (or variants thereof), in fact the 0.5% decline announced yesterday is very modest indeed by the standards of daily movements in other major currencies where moves of such magnitude are pretty routine and would certainly not trigger any major systemic concerns. But China is somewhat different in fairness, in that the fx regime (and indeed the wider economy) is the subject of some pretty large‐scale reforms including greater allowance for market forces in exchange rate determination.

But investors clearly don’t feel fully comfortable with the new regime and the transparency and strategic intent which underpins its operation, with last night’s asset market moves partly reflecting a nervousness about a the threat of the possibility of a larger devaluation in time. And other factors also continue to weigh on investor risk appetite for Chinese assets including rules which restrict stock sales by large shareholder (which were due to be lifted this week but have now been extended further), as well of course as persisting concerns about the trajectory of the economy and associated downside risks (not to mention elevated geopolitical risks in and outside Asia).

The scale of the moves in China is triggering associated volatility in advance economy markets, with equity markets in Europe and the US generally showing losses of around 3‐4% over the past 24 hours as advanced economy data points simply take a back seat in the current risk‐off climate. One data reading that is of note from yesterday was a stronger than expected ADP jobs report which showed the US private sector generated 257k jobs in December – a very positive signal about the performance of the US jobs market ahead of tomorrow’s important official employment report. A solid US jobs report has the potential to exert a calming influence over what is clearly a fraught markets landscape at present but it is clear that Chinese policy makers have some important work to do to address the apparently mounting investor concerns about their domestic macro and policy environment.

In the meantime, in something of a re‐run of what happened in August, the euro is a curious beneficiary of the latest bout of Chinese‐led turmoil, with the single currency up 1.5% against sterling (to 74.35p) and 1.1% against the dollar (to $1.0850). As in August, this looks to be at least partly linked to the re‐pricing of interest rate expectations which the volatility has sparked: the market is pulling back noticeably on its prior expectations for rate hikes in the US and UK (yields on interest rate futures are in places down over 10bps in each case) but because there are no hikes priced into European interest rate markets there are no hikes to price out, with the resulting moves higher in relative euro interest rates generating some upward pressure on the single currency, for now at least.

Meanwhile here in Ireland, the run of very positive economic news continued yesterday. Retail sales accelerated sharply in November, with headline sales advancing 9.4% y/y and core (ex. motors) sales increasing 8.9% y/y – the strongest core sales growth since May 2007. This is consistent with the solid labour market improvements experienced in 2015 and the consequential rise in consumer confidence. On the jobs market, the IDA (the state agency responsible for attracting FDI) announced yesterday that client companies created 12,000 net jobs in 2015, representing an advance of 66% y/y, further evidence that the labour market is exhibiting ongoing solid improvement.

The NTMA also announced that the Irish sovereign will begin funding activities for 2016 by raising somewhere in the ballpark of €3bn on the 10 year bond market. Irish government benchmark 10 year bond yields have returned to levels around 1.0%, helped by recent market turmoil, which has push down government bond yields more generally. Interestingly, the 10 year spread versus Belgium (regarded as a key comparator country) has continued to tighten from ca. 50bps in mid‐2015 to 14bps – its lowest level since 2008 – reflecting Ireland’s absolute and relative improvement in important fundamentalssuch as growth, deficit levels, and debt trends.

Looking to the day ahead, the Eurozone unemployment figures are published for November. Expectations are for the jobless rate to remain at 10.7% in November. Unemployment has been trickling down at about 0.1 percentage points per month and survey indicators(most notably the employment component of the composite PMI) suggest that this trend is set to continue as we look ahead. Subsequently, an improving labour market may underpin an advance in retail sales, which are expected to grow 0.2% m/m in November following a 0.1% decline in October, which would leave the annual growth rate at a reasonably healthy (by Eurozone standards at least) 2.0% pace. The European Commission economic confidence index (also known as the ESI) is also announced, and is expected to tick down from 106.1 in November to 106.0 in December, still representing levels far above the historical average of 100.8.

In the US, the initial jobless claims will round out the leads‐into tomorrow’s payrolls report and investors will show some interest as to whether they corroborate the strong signals that came through from some other indicators earlier in the week. Expectations are for a continuation in the recent healthy trend in initial jobless claims – the four week average has been under 280k since July 2015.

Finally, Fed members Lacker and Evans will deliver speeches on the US economy.

Sponsored by: Ulster Bank

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