Disturbing rumblings from China

For now, investors can forget the Federal Reserve; the bigger worry may be China, with the latest downward lurch on the Shanghai Composite index only the most recent indication that all is not well.

Bears on the loose

A hawkish signal from the People’s Bank of China (PBoC) that it would continue with its credit tightening policy has helped to boost risk-averse sentiment across markets this morning. Beijing appears set on a policy that will see credit conditions become less conducive for financial institutions. In a country the size of China, it is debatable to what extent the PBoC can really control the financial sector, but it can send signals that will cause major ructions.

Markets in China duly suffered their worst day in around three years, pushed lower by financial shares. Having fallen 21% from the top in February, the Shanghai Composite is now officially in bear market territory, putting even the recent volatile trading on the FTSE 100 in the shade.

The bigger question for us is what it means for global financial markets. The knee-jerk reaction has been one of elevated concern, although we haven’t yet strayed into panic mode. We in the west will not be immune, however, if China has to go through a credit crunch of its own.

In 2008/2009, it was China’s massive infrastructure stimulus that provided a useful crutch for the global economy, taking the strain as economies in the west underwent a sharp contraction. Regardless of the Fed meeting last week, economies in the developed world are not out the woods yet. Without China, the recovery will be much harder.

Further ramifications

China may even have a bearing on the dormant eurozone crisis. Germany’s seemingly-invulnerable economy was built on exports, with China being one of the key destinations. Yet if we see a sustained downturn in growth in China then Germany will be one of the main casualties.

If Germany feels the economic pinch then expect it to become even less amenable to further demands for financial assistance from its southern eurozone brethren. We have seen peripheral eurozone yields rise (with Italian and Spanish 10-year yields seemingly on the way back to 10%) in the wake of Wednesday’s Fed meeting, and concerns about a new phase in the eurozone crisis could see those yields go higher still.

The Fed meeting might have sparked off the latest sell-off, but, for a worrying story that is going to keep coming back, you need look no further than China.

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