Expect Stocks to Gyrate More in Months Ahead

Discussions of economic issues in policy circles often suffer from a “which way is up?” dilemma; it’s not clear what the problem is that needs to be solved.

Chinese stock markets fell sharply in the final hour of trading after investors were rattled by fears about the withdrawal of government support for shares and further capital flight following the devaluation of the yuan last week.

All of this should be fairly straightforward.

Over the last decade many African countries that had fallen out of favor with the west have been betting heavily on China as their economic savior.

China may reduce the reserve requirement ratio at banks, the China Securities Journal reported, citing unidentified analysts. Traders immediately re-priced the probability of the Federal Reserve raising US interest rates next month, reducing it to 40% from about 55% previously. The interest rate remained the same at 2.5%.

“The market will be most interested in where U.S. inflation comes in, because this is something that will determine not just when the Fed begins to normalize policy but also the pace at which they tighten, going forward”, said Barclays FX strategist Hamish Pepper in London. To make matters worse, the dollar shortage is actually global, as the Fed’s move to stop quantitative easing reduced worldwide money flows to emerging markets.

In addition, China has wanted its currency to be accepted internationally.

“Front-end rates have been edging up, likely resulting from tighter liquidity conditions amid intervention”, said Frances Cheung, head of Asia ex-Japan rates strategy at Societe Generale SA in Hong Kong. The Fed has kept the rate at zero since December 2008.

Tighter regulation, increased automation, greater competition, and a global market-rigging scandal all suggest its glory days are over. “With weak sentiment we will continue to see unstable moves in the market”.

The American political backlash in response to China’s devaluation to date has primarily been concentrated in states reliant on manufacturing of such things as automobiles and steel.

The transfer has strengthened the dollar worth, which has negatively impacted main world currencies together with the Indian rupee. Thus, by pegging to the dollar, China’s currency was appreciating nearly as fast as the dollar was. Investors are also anxious about how a weaker yuan will affect exporters in other countries.

“When we talk of a currency war, there must be competition in the third market”.

Asian shares fell on Tuesday, with Shanghai hit by fears a pick-up in the property market will stymie government stimulus while a deadly blast in Bangkok sent Thai shares plunging. After sustaining further losses, the currency has since shown signs of stabilizing. This doesn’t sound very plausible. The yuan held little changed at 6.3902 to the dollar in the onshore trade. Is there nothing that President Obama could have offered China to persuade it to not devalue its currency?

“All the news out of China recently has done nothing to restore confidence in its financial markets”, said David Madden, market analyst at IG, “and the ripple effect can be felt in Europe“. How about if Obama said that he would not push for respecting Pfizer’s drug patents or Microsoft’s copyright on Windows?