The global economy is precariously balanced.
On the one end of the spectrum the US economy is surging with unprecedented economic growth, rising employment, increasing inflation and monetary contraction on the cards.
In the Asia-Pacific region, China is undergoing a paradigm shift away from an export-driven market to one which has turned inwards.
The World’s #2 economy has sharply contracted with massive declines year-on-year for September and October imports, and equally concerning pullbacks in export figures.
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Given all the analysis of late, it is apparent that the data lends credibility to the assertions of an economic slowdown in China, even with state-sanctioned data making its rounds. As it stands the following performance figures have been posted for the Chinese economy:
- September imports declined by 20.4 percent year-on-year, while exports declined by 3.7 percent year-on-year
- October imports declined by 18.8 percent year-on-year, while exports declined by 6.9 percent
These figures are startling, given the sheer size of the Chinese economy and the importance of trade with China for emerging market economies like Brazil, Russia, India and South Africa among others.
In fact, for the vast majority of EM countries, it is the Chinese export market that is the most significant in terms of generating revenues for the mining and energy sectors. For the most part, EM economy performance dovetails precisely with what is happening with the commodity price rout vis-à-vis China weakness. The numbers themselves are alarming, but it’s the disparity between actual numbers and consensus estimates that has so many analysts perturbed.
Disparity Between Estimates and Reality
For example, in September 2015, the consensus forecast for Chinese imports (year-on-year) was -15 percent but the actual figure was sharply lower at -20.4 percent. In October, the consensus forecast for imports (year-on-year) was -16 percent, but the actual figure came in at -18.8 percent. A similar story is true for export data, but with a difference.
Analysts were bamboozled by the lack of clarity in China’s economic performance so they forecast an export decline of -6.3 percent for September while the actual number came in at -3.7 percent. For October, the consensus estimate was -3 percent but the actual number came in sharply lower at -6.9 percent. This all lends itself to a clear contraction in the growth of the Chinese economy. It has been corroborated by a GDP decline to below 7 percent for the first time, with GDP growth now coming in at 6.9 percent.
These figures, coupled with the $5 trillion rout of the Shanghai Composite Index and the Shenzhen Index are proof enough that the Chinese economy is in decline. This has been further validated by the sharp reduction in output for the Chinese steel manufacturing industry and the shuttering of mines across the developing world. We are seeing companies like Anglo American, BHP Billiton, Glencore PLC and Rio Tinto looking towards temporarily shuttering mines and operations of business units that are unprofitable. Already Glencore PLC (the worst performer on the FTSE 100 index) has closed up several operations throughout Africa. These include the Eland Platinum mine and others in the DRC and Zambia.
What It's Affecting
Everything is being done in an attempt to shore up the prices of commodities by reducing output to raise the equilibrium price. Copper has been particularly hard hit by China weakness and the prices of metals and energy are so low that high-cost producers are being forced out of the market, one after another.
We are likely to see a consolidation of the industry as the bigger firms restructure their operations, manage their debt profiles and divest from poorly performing business units in attempt to stay afloat. Glencore PLC has put in place plans to shave off billions of dollars in debt within the next year or two. It has opted to forego dividend payouts this quarter and instead will focus on profitable actions to restore investor sentiment and keep the company afloat. Much the same is being done with Anglo American and other major mining companies.
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The Fed Rate Hike is Looming Large in the Background
It is against this backdrop that the Fed FOMC will be making important decisions on December 15/16, 2015. Already we have seen all signs pointing towards a Fed liftoff for the first time since the 2008 financial collapse. Janet Yellen, Stanley Fischer and other policymakers are setting the stage for what is expected to be a historic decision for the US economy.
Presently, the short-term lending rate is 0.25 percent but if analyst forecasts are to be believed, we may see the Fed raise rates to 0.50 percent by the middle of December. There are substantial implications for a Fed rate hike for the US. Firstly, a higher interest rate will make the USD inherently more attractive to foreigners. A higher yield on dollar investments (US Treasuries, CDs and fixed interest-bearing accounts) will lead to an exchange of foreign currencies for the relatively more valuable (and stable) USD.
This has already led to sharp declines in the exchange rates of EM currencies like the Turkish lira, the Russian ruble, the South African rand, the Brazilian real and the Venezuelan Bolivar among others. As a matter of fact, US dollar strength has made it difficult for these EM countries to import from the US and other developed countries but it has facilitated their export markets. The changes to balance of trade figures are evident in EM countries.
The Big Picture: Putting Things Into Perspective
However, the implications of a strong USD on dollar-denominated commodities is less clear cut. Analysts are of the opinion that higher prices will lead to lower demand, but that’s only in the long-term. Short-term, higher prices will be followed up by increased entry of mining and energy companies into the markets.
As prices rise, the potential for profitable operations will be an attractive factor for companies that have had to close up operations owing to lack of profitability, This is especially true for shale oil companies across the US and mining companies across the developing world. But as more entrants appear, supply will increase and with increasing supply and falling demand we will see inventory levels rise and manufacturing data declining.
Ultimately, the long-term implications of a stronger USD will not bode well for multinational conglomerates or the commodity sector in general. A December rate hike will also cause a shift away from equities markets and gold to 2-Year Treasury notes and fixed-interest bearing securities. Gold and precious metals lose favour too since they are incapable of earning interest.
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The good news is that the markets have been appropriately primed for the Fed rate hike and the implications have been factored in. Unfortunately capital flight from emerging markets will continue at an accelerated rate and a further weakening of these currencies will continue.