28 October 2016
Extreme volatility in global stock markets has sparked concern that it could herald another major financial crisis. Photo: Xinhua
Extreme volatility in global stock markets has sparked concern that it could herald another major financial crisis. Photo: Xinhua

Is a global financial crisis coming?

China’s latest interest rate cut and reserve requirement ratio (RRR) reduction have resulted in a limited boost for the stock market so far.

That shows market confidence is stretched and market sentiment is pessimistic.

It could be a prelude to a broader and more alarming financial crisis.

The Chinese central bank released the long-awaited double-barreled easing in an attempt to reverse the market slide and inject more liquidity into the system.

However, the US market reacted calmly to the move, and the three US market benchmarks fell Tuesday, which also weighed on the rebound in Hong Kong and mainland markets.

The outlook is quite worrying if global markets fail to reverse the drop in the near future.

Will governments and central banks have capacity to turn the trend and avert further financial disaster?

The recent market turmoil across the world all stems from US and China issues.

The US Federal Reserve started to pave the way for unwinding monetary easing since early last year, and the US dollar started to rally in mid-2014.

The US dollar index even surged to a 12-year high of over 100 early this year.

The strong US dollar has created a domino effect.

The unwinding of quantitative easing has prompted investors to pull money out of emerging markets.

At the same time, US dollar strength has resulted in plunging prices of commodities like oil and metals and triggered deflation and disinflation pressure.

That has caused economic woes for commodity exporters in the emerging world and even accelerated capital outflows from these regions.

The JP Morgan Emerging Market Currency Index has already slumped by more than 20 percent since mid-2014, which could be part of the motivation for yuan devaluation.

That is to say, the Fed’s tightening move has resulted in a strong US dollar but exerted pressure on the economies of various emerging markets, including China.

Why have financial markets witnessed increased volatility in the last couple of months?

Apart from continuous US dollar strength, various economies have increasingly felt the pain from declining economic growth and deflation.

And the expected Fed “lift-off” this year has worsened market sentiment.

Meanwhile, the stock market crash in emerging markets like China has also weighed on developed markets like the US.

So, how to resolve the current financial difficulties?

Will all the problems be fixed if the Fed decides not to raise the interest rate?

As I predicted late last year, the Fed may need to launch QE4 on a bigger scale.

If not, it might not reverse the strength in the US dollar and alleviate pressure on emerging markets.

Until that happens, global market turmoil is set to continue.

The global and Hong Kong markets faced extremely heavy sell-offs in recent days, in a sign that the markets are worried about a looming, big financial crisis.

The Fed has opened Pandora’s Box since it started to wind up QE3 in early 2014.

That has exposed emerging markets to deflation and recession pressure and created heightened market volatility.

QE4 is the only option, which is likely to be launched in the first half of next year.

This article appeared in the Hong Kong Economic Journal on Aug. 27.

Translation by Julie Zhu

[Chinese version中文版]

– Contact us at [email protected]


Hong Kong Economic Journal chief economist and strategist

EJI Weekly Newsletter