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The current Market Volatility january 2016

JAN 20, 2016

The current volatility in global markets has precisely the same cause as had the major bout of volatility in August 2015.

The Chinese RMB is pegged to the US dollar and US monetary policy gets exported to China. This means that a strong US economy and a weak Chinese economy give rise to a tug of war at the centre of the global financial system. However, we believe the market’s doom and gloom is over the top. This is because the policy solutions are simple, feasible and being executed by the US and Chinese authorities. They are threefold and work best in combination.

First, the Fed must tread cautiously, releasing hawkish communication only when capital flows out of China are relatively becalmed – this is exactly what the Fed did last September, when it decided against raising interest rates at that time. WeI believe it will do so again with respect to the next rate hike. 

Second, China can use fiscal policy to adjust domestic demand conditions to a strong exchange rate – and this is what the Chinese government is  doing at the moment. 

Third, China can change its exchange rate policy, by allowing the RMB to depreciate against the US dollar in the face of US dollar strength, and – given the authorities’ reluctance to allow the RMB to float freely at this point – manage it against a basket of major currencies rather than the US dollar alone. Again, this is exactly what China is doing at the moment. 

As such, we expect to see markets negotiate this hurdle once they get a better look concerning US and Chinese policy, and also some evidence of its positive effect on the Chinese economy.