Large economies are like supertankers. There are no brakes to use if you want to change direction in a hurry. Instead, you have to put the engine into reverse, and hope you can slow down fast enough to avoid the rocks.
That is what happened in China last month, as the new leadership began to unwind the largest lending bubble ever seen. Short-term corporate loans, the lifeblood of small companies, fell by Rmb 236bn ($38bn).
In pre-Supercycle days this would have been called a “credit squeeze”. Suddenly, credit tightens and investors worry about ‘return of capital’ instead of ‘return on capital’. Or as the blog’s major Research Note on China in February was titled:
“China Bank Lending: from $1tn to $10tn and Back Again?”
Elsewhere in NEA, GDP fell 6.8% in Japan. Abenomics, as expected, is coming to an end of its life as a supposed ‘miracle cure’ for the world’s third largest economy. As former Bank of Japan Governor Shirikawa keeps reminding us:
“The main problem in the Japanese economy is not deflation, its demographics. The issue is whether monetary policy is effective in restoring economic recovery. My observation is, it is quite limited.”
Thus the Great Unwinding of the failed stimulus policies since 2008 has now begun.
Over on the other side of the world, financial markets are slowly beginning to rediscover their role of price discovery. For 6 years, central banks have supplied them with endless amounts of free money. This has forced prices upwards in what became known as the ‘correlation trade’.
But now, oil markets are starting to follow cotton and other commodities in refocusing on the fundamentals of supply and demand. And as the International Energy Agency noted in its latest monthly report:
“Oil supplies were ample, and the Atlantic market was even reported to be facing a glut”, whilst Reuters reported that ”implied oil demand in China fell 6% last month“.
In Europe, hopes that stimulus policies will finally lead to a sustained recovery are also unwinding. The Eurozone economy failed to grow in Q2: Germany’s economy declined; France showed no growth; Italy fell back into recession.
Meanwhile in the USA, retail sales were flat in July, whilst housing remains weak due to demographic factors. This is a bad omen for GDP, as consumer spending is more than two-thirds of the economy. Thus we are likely to see a repeat of the pattern described last week by the new deputy chairman of the US Federal Reserve, Stanley Fischer:
“Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back”
Even more alarming, as Nobel-prize winner Prof Robert Shiller warned yesterday, is that the Cyclically Adjusted Price/Earnings (CAPE) ratio for the S&P 500 - the best predictor of long-term stock market returns - is now:
“Above 25, a level that has been surpassed since 1881 in only three previous periods: the years clustered around 1929, 1999 and 2007. Major market drops followed those peaks.”
Of course, nothing is certain in this world apart from death and taxes. But there are clearly signs that the long-awaited Great Unwinding is now underway. The blog will look at the potential impact of this in 4 key areas next week – oil prices, exchange rates, interest rates and equity markets.
WEEKLY MARKET ROUND-UP
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
Naphtha Europe, down 6%. “Softening upstream ICE Brent crude oil prices and slow downstream demand continue to impact, leading to lower prices again.”
Brent crude oil, down 4%
US$: yen, down 2%
PTA China, up 2%. ”Producers continue to have to sell below cost. As a result, lower plant operating rates have halted a drastic price decline in the spot markets despite stable-to-soft conditions in the downstream polyester sectors.”
Benzene Europe, up 5%. “Unclear how September will shape up in terms of pricing and demand in Europe”
S&P 500 stock market index, up 7%
HDPE US export, up 9%. “Prices were mostly steady, with material remaining in tight supply”