Developments in China, disappointing US economic data, the introduction of negative interest rates in Japan, and falling oil prices made for a volatile mix in January 2016.
After cruising into the end of the year on a reasonably positive tone, markets commenced 2016 in a volatile and uncertain mood. Early in the month, markets were focused on developments in China, where data showed a continued weakening in the economy.
Chinese GDP for the December quarter offered something for everyone – pointing to a slight slowing in growth (on the back of a stronger services sector), while at the same time that the ongoing rebalancing of the economy away from investment to consumption driven growth was on track. As we have noted previously, this rebalancing is no easy task and there are likely to be many speedbumps along the way, but progress has been steady.
Two policy moves by Chinese authorities during January added to the market’s uncertainty. Early in the month, markets were closely watching daily changes in the Chinese Yuan fix, as two relatively large decreases to the mid-range set by authorities on a daily basis prompted fears that authorities were seeking a competitive devaluation to boost exports and growth. While the fix barely moved for the remainder of the month, many investors remain wary that authorities may either intentionally seek to devalue their currency, or otherwise make a policy faux pas. Then, later in the month, continued equity market weakness twice led to the triggering of the Chinese equity market “circuit breakers”, where trade is suspended if the market falls more than 7% in one day. Then without warning the authorities moved to scrap the circuit breaker. The Shanghai Composite Index subsequently finished the month 23% lower (though it is worth bearing in mind that the index has little correlation with real economic developments).
Elsewhere in the month there was plenty to keep investors occupied. Economic data from the United States was generally disappointing, further weighing on investors’ minds, as the US economy felt the effects of a rising US dollar, higher debt costs and softer external conditions. The key exception to this was employment data, which showed that non-farm payrolls rose a whopping 292,000 in December, ahead of expectations for 200,000. The key change in the month was that rather than emerging markets being weaker than expected as seen in 2015, it was the developed markets that were apparently seeing softer growth early in the New Year. Oil prices also continued to fall, with WTI spot prices declining 9% as supply continuing to exceed demand, and the imbalance likely to get worse before it gets better as international sanctions against Iran are lifted. Interestingly, lower oil prices continue to weigh on equity markets despite most companies, individuals and economies being net oil users or importers, which intuitively suggests that they should benefit as oil prices fall. While we still expect this relationship to hold in the medium to long term, it doesn’t appear to be doing so in the short term.
Just to make sure investors had enough to think about, on the last day of the month the Bank of Japan (BoJ) shocked markets by announcing the introduction of negative interest rates, despite Governor Kuroda claiming on a number of occasions that the BoJ would not introduce negative rates. In reality, the policy as not as radical as the headline, as excess reserves that banks have deposited at the BoJ will continue to receive 0.1% interest, required reserves receiving no interest and only reserves in excess of banks’ current reserves receiving -0.1% interest. Nevertheless, it is likely that further cuts to interest rates will be on their way in the coming months, with Kuroda pointing to the low rates in Denmark, Sweden and Switzerland as examples.
Back home, events were overshadowed by global developments. Data indicated that inflation remained low, providing further scope for easing by the RBA, while another strong employment release showed that job gains in 2015 were the largest since 2006 despite the domestic economic picture remaining quite weak. The resolution of this contrasting pictures is likely to be the key determinant of whether the RBA decides to cut the cash rate in the coming months.
Market returns were weak in January, probably more than what is justified by fundamentals as fear took hold. Global equities returned -3.2% and -5.4% in unhedged and hedged terms, respectively, while Australian equities returned -5.5%. Australian sovereign bonds returned 1.4%, while global sovereign bonds returned 2.5%, as investors sought safety.