China: Weaker economy to affect the global economy and markets – Danske Bank

Analysts at Danske Bank suggest there is a rising risk for global markets as a weaker Chinese economy will affect the global economy and markets.

Key Quotes

“Lift to global growth reverses: China is by far the biggest contributor to the global economy, driving one-third of global growth. The country was a major driver behind the global recovery in 2016. Commodity exporting emerging markets benefited strongly from both higher volumes and prices and developed markets saw a lift to exports to China and other emerging markets countries. With China slowing in 2017, the lift to the global economy reverses and this is a big reason why we look for a peak in the PMI cycle in H1.”

“From reflationary to disinflationary force: The sharp rise in commodity prices seen in 2016 was pulled largely by higher Chinese activity. With Chinese companies consuming 50% of global metals, China is a major driver of commodity prices. In the past few months, both metal prices and oil prices have declined, which in our view is linked partly to the softer Chinese economy. With the commodity price boost turning into a drag on global inflation, we believe global central banks will lose an important pillar in their mission to push inflation higher on a sustained basis; not least in the euro area, where slack is still ample and wage pressures low.”

“Less support to risk sentiment: A softer global cycle and rising downside risks from China have already had an impact on Chinese stocks, commodity prices and inflation markets, where euro area 5Y5Y breakeven inflation is back at 1.6% – the level reached when the ECB initiated its asset purchase programme in January 2015. So far, though, risk sentiment in the US, Europe and emerging markets has stayed upbeat on the back of strong profit growth and relief that political uncertainty is reduced following the election of Emmanuel Macron as the new French President. We recently turned neutral on equities on a short- to medium-term horizon.”

“Downside pressure on long bond yields: While Fed hikes and a possible change of forward guidance from the ECB are putting upward pressure on bond yields, the disinflationary force from China will put a downward pressure on yields. We believe these two forces will even each other out and expect range-trading markets for some time. Hence, we recommend investors take a tactical approach to acting in the bond market, trading the range rather than having a clear directional bias.”

“Headwind for emerging markets assets: So far, there has been very little impact on emerging markets outside of China. Emerging market equities have continued higher despite lower commodity prices and rising stress in China. However, if we are right that the China slowdown will continue this year, emerging market assets will start to face some headwind from this angle. Emerging markets are still a popular carry game among investors, though. Therefore, we stick to our overweight on emerging markets versus developed markets for now, as the carry from higher yields and lower valuation in stocks is attractive and drives flows into emerging markets. However, any sign of spillover from China to other emerging markets should be on the radar screen.”