China’s stock markets saw huge volatility last week, with major falls followed by strong rebounds when the authorities weighed in with policy easing. In contrast, central banks elsewhere are tightening policy in the face of soaring inflation, which could yet accelerate further.
Last week saw energy prices vacillate as Brent crude oil rose by 10%, while natural gas prices in Europe fell by a similar amount. Even though prices dipped from their early March peaks, Brent and natural gas are still 25% and 40% higher, respectively, than before the onset of the conflict in Ukraine.
Chinese stock markets capped their most volatile week in decades, with 14 and 15 March seeing day-on-day declines in Hong Kong’s Hang Seng and China’s A-share indices totalling 11% and 8%, respectively. A rebound followed of more than 16% and 6%, respectively, over the rest of the week after the Chinese authorities weighed in, on 17 March, with assurance of policy easing.
In contrast, many other central banks started tightening policy on the back of rising inflation. This could rise yet further due to upward price pressures from new supply bottlenecks.
The Chinese market rout arose from a host of negative catalysts. Aside from the Russia-Ukraine crisis, investor uncertainty flared over the delisting of Chinese equities in the US, China’s shutting-down of major cities in response to the Omicron Covid surge – with the implications of this hitting domestic growth and global supply chains – and the continuing regulatory crackdown on China’s tech sector.
Despite this raft of negative factors, there was no spill-over of heightened volatility to other major markets (see Exhibit 1).
What prompted China to ease?
China’s financial markets reversed course mid-week when Beijing made a sweeping set of statements about policy moves to stimulate GDP growth, ease its regulatory crackdown and support the battered property market.
It remains to be seen how China’s stringent anti-Covid policy will bear up while other countries are easing restrictions thanks to high vaccination rates. Even Hong Kong is starting to relax some of its stringent measures.
Although Chinese data for January/February beat market expectations (industrial output +7.5% year-on-year, fixed-asset investment +12.1% and retail sales +6.7%), this did not yet reflect the negative impact of the new lockdowns imposed to control the Omicron outbreak.
Meanwhile, the credit impulse in February broke the recovery trend of the previous three months, falling by 7.3%, and the emerging industries purchasing managers’ index (PMI) dropped to 49.5 in March from 53.5 in February.
It is rare for Chinese officials to explicitly avow support for financial markets. Last week’s verbal intervention suggests that slowing growth, together with the weakening market confidence as seen in the sharp falls in stock prices, breached Beijing’s pain threshold. Consequently, the authorities acted to keep the market rout from getting out of control.
Escalating downward pressures on growth are threatening China’s 5.5% GDP target for 2022 – an objective that has particular political significance in this year of leadership change. It suggests more policy easing could be on the cards if Beijing wants to achieve the target and political stability.
Hawkish tilt elsewhere
Elsewhere, central banks remain on a hawkish path, prioritising concerns about rising inflation over the downside risks to growth in the near term.
Eurozone headline inflation came in at 5.9% YoY and core inflation at 2.7% in February, with broad-based price pressures due to rising energy prices, supply constraints and strong demand. January’s 5.1% headline rate was revised up to 5.9%.
The ECB is sticking with its decision to exit its accommodative policy by ending the pandemic emergency purchase programme (PEPP) this month and reducing monthly purchases under its asset purchase programme (APP). The market now expects the first rate rise to come at the end of Q3 2022 or early in Q4.
Meanwhile, the US Federal Reserve was loud and clear about its policy, raising the fed funds rate by 25bp, as expected, and strongly signalling that it will begin to wind down its balance sheet after the May meeting of the Federal Open Market Committee (FOMC).
The Fed’s new ‘dot plot’ indicates that officials now think monetary policy will be about 100bp tighter than they had expected in December. Fed Chair Jerome Powell has noted repeatedly that the central bank could raise rates in steps of more than 25bp if inflation does not align with the FOMC’s expectations.
In response, US Treasury yields have risen sharply, putting Treasuries on course for their worst month since 2016. The yields of the 10-year US Treasury has risen by 48bp so far in March to above 2.3%, the highest since May 2019.
The Treasury yield curve is flattening with the yield on the 2-year note up by 69bp month-to-date, its largest monthly increase since April 2004. Market pricing now anticipates the Fed will raise fed funds to above 2% by December, a major reappraisal after expecting them to end 2022 at near-zero at the start of this year.
The Bank of England has lifted its policy rate by 25bp. Despite its downbeat view on growth, the BoE decided to maintain a policy-tightening bias that would leave the door open for another rate rise in May.
The BoE said ‘monetary policy will act to ensure that longer-term inflation expectations are well anchored’. Inflation, as measured by the UK consumer price index (CPI), rose at an annual rate of 6.2% in February, up from 5.5% in January and marking the highest rate since 1992.
The forces driving the BoE’s rate rise appear to differ from those motivating the Fed. In the UK, there looks to be a larger contribution from supply-side, cost-push inflation (which could weaken demand by eroding real income and profits), whereas in the US, demand-pull inflation is stronger.
The Russia-Ukraine conflict could inflict more damage from supply-side, cost-push inflation in the eurozone than in the UK, while the US is relatively insulated from its effects. On that basis, the Fed will likely be the most hawkish in its policy action, with the BoE less so and the ECB the least so.
Their hawkish tilt has spread to the emerging markets, first to Latin America and more recently to Asia. Taiwan’s central bank raised its policy discount rate by 25bp last week. This was twice the size of its more usual 12.5bp increases and marked its first rate increase in 11 years.