China slowdown impacting on health of global economy
Jeremy Stewart is head of wealth management and private banking at Danske Bank
Last week did not see the emergence of a 'currency war'. After the initial devaluation of the Chinese Yuan (CNY), it seemed to be pegged to the US dollar in a range between 6.38 and 6.40. For the past 10 years, the CNY has appreciated against all major currencies but is now closer to what the markets had seen as fair value. Indeed, there are those who think that it could depreciate by a further 5% versus the US$ over the coming year.
Where we did see increased currency volatility was in most of the smaller Asian emerging markets. The beginning of CNY depreciation follows recent commodity price falls and an expectation of rising US interest rates.
There are some serious concerns about the global economy. Although still exceeding 6%, Chinese growth is at its weakest since 2009. Economic data coming out of China suggests that the slowdown is worse than was initially expected and by some measures, China is now the biggest economy in the world. This is clearly important for global growth.
For local investors, the real story last week was about world stock market performance, with descriptions ranging from the drama of a 'plunge', to the more reflective 'correction'. The FTSE 100 index fell 2.8% on Friday, leading to the worst week of the year - and this week has started in the same vein. The Dow Jones Industrial Average was down 530 points, representing a 3% loss for the day and 10% off the market's high in May. The Stoxx Europe 600 Index lost 3.3%, as the sell-off included European markets.
The Federal Reserve (The Fed) has been preparing for the first interest rate rise since 2006, although recent events may delay the Fed action. The minutes of the July policy meeting made it clear that conditions for a rate rise were "approaching", but the minutes also referred to the concerns about China.
The usual drivers for a turn in market sentiment are strong policy responses and oversold markets. A postponement of the first Fed rate rise and more monetary easing from China could give some support.
In the medium term, fears of a bigger slowdown are to some extent priced into markets and any easing of global monetary policy alongside moderate growth would underpin shares in the long run.
On a technical basis some markets still offer value, but sentiment is dominating and we will probably continue to see volatility in the short term.
On a more positive note, while the external environment has become more challenging, economic data in both the US and the euro area economy have been robust this week.
At times like this it is important to remember why we expect higher long-term returns from stock markets than from cash or bonds. Without the volatility associated with risk investments, there would not be the corresponding prospect for higher returns over time.