20 February 2019
China's central bank could undertake more monetary easing next year if economic growth fails to pick up. Photo: Bloomberg
China's central bank could undertake more monetary easing next year if economic growth fails to pick up. Photo: Bloomberg

Financial markets: Some more trends to watch for in 2016

Last week, I outlined four major trends for 2016. They are: 1) the dollar strength is set to continue and even post one-way rally, 2) commodity prices will remain under pressure, 3) global economy will be under stress or even face the risk of recession; and 4) global inflation will continue to slide and could even lead to deflationary risk.

The financial market is likely to be fairly volatile next year as the four above-mentioned trends could form a vicious circle.

Now I will lay out another three trends that we could see in 2016.

Emerging markets could spark a financial crisis

Emerging markets are likely to be the weakest point of the financial world. As many of the emerging economies rely heavily on raw materials export, plunging commodity prices have weighed on their growth.

Meanwhile, many Asian and Latin American nations have ramped up leverage ratios over the last seven years after the 2008 financial crisis. They would see even greater capital flight as the Fed normalizes its monetary policy.

The aggregate bank loans in emerging markets have kept growing, and exceeded the total loans in non-emerging markets by end of 2011, according to BIS data. The loans have maintained double-digit annual growth for most of the time.

The incremental bank loans in emerging markets have reached US$27 trillion from the end of 2008, around US$670 billion less than the figure from non-emerging markets.

Henceforth, money flowing into emerging markets may decline further, which might trigger another financial crisis. In fact, China has already experienced severe capital outflow over the past year. As of end of November, China has reported more than US$1 trillion of capital outflow in last 12 months.

Also, accelerating capital outflow from emerging markets may further drive up US dollar, and make the greenback register one-way appreciation. That could add more fuel to market chaos.

Chinese yuan may depreciate by 10 percent

Amid such degree of yuan depreciation, Beijing may seek to launch massive monetary stimulus measures. The Li Keqiang Index and capital outflow both hit record levels in November, in a sign that China is facing higher risk of hard landing. In this case, the Chinese central bank is set to cut interest rates and reserve requirement ratios further next year, or even resort to Chinese-version monetary easing measures.

How about the room for further yuan devaluation? The ADXY-XCNY and JPM FX indices have dropped by 12.4 percent and 25.4 percent respectively since mid-2015. Meanwhile, offshore renminbi only lost 5 percent against the US dollar. The offshore yuan might weaken another 7.5 percent or 14.4 percent, or yuan may tumble to 7.0 or 7.4 against the dollar, if the redback moves in line with other emerging market currencies.

The US Fed may eventually launch QE4

The Fed is very likely to face a dilemma of financial market turmoil and slowing global economic growth, which could reverse the US economic recovery.

The US rate hike is likely to be slow and gradual. In fact, the market widely expects there will one to two rate hikes next year. The Fed might cut rates again in late 2016 or even launch QE4 if the US economic growth lags behind expectation.

I’ve said earlier that the unwinding of QE3 may open up a Pandora’s Box, exposing the global economy and the emerging markets in particular to recession risk. That could cause heightened volatility in the financial markets.

In this case, QE4 might be the only option to end the vicious cycle. The timing should be around mid-2016 as the US presidential election process gathers steam. The move would help reverse dollar strength.

This article appeared in the Hong Kong Economic Journal on Dec. 17.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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