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News for October 23

Investors are concerned about the Chinese government debt which has exceeded 250% of the Gross Domestic Product. The latest research about the debt structure by Standard & Poors rating agency showed an additional volume of the government debt for $5.8 trillion (40 trillion yuan). That amount was not taken in the count before as some of the Chinese local governments took loans from so-called LGFV funds which were financed by the central governments in order to support several expensive infrastructure projects in the country. That growing debt pressure influences the weakness of yuan, adding risks to the financial sector. Although Chinese President Xi Jinping stated that lowering the overall government debt is the main target, the real priority remains to keep high growth pace of the Gross Domestic Product, even by injecting additional liquidity to the financial system. These measures would also help several local businesses to get an easy access for the borrowing funds for the long-term infrastructure projects. Another goal of the government is too keep foreign investor’s positive sentiment by showing sustainable economic growth results, though it would heart the financial sector attractiveness due to the additional debt risks.

Donald Trump kept fighting with the Federal Reserve about the tightening monetary policy. According to several statements by the U.S. President, the latest stock market crash is not related to the trade war escalation with China. He blames the Fed in the recent market sell-off, saying that the Fed ‘has gone too far with the interest rates hikes’. The Federal Open Market Committee had increased the borrowing costs in September, the third time in 2018, forecasting at least one more rate hike this year and two more increased in 2019. The main target of the regulator is to prevent the fast-growing economy from overheating and collapsing due to the growing threat from the inflationary pressure. However, The White House press secretary Sarah Sanders linked the historical economic achievements to the President’s policy and blamed the Fed in the recent equities sell-off, during which major stock indices plunged to lowes levels since February 2018. Donald Trump insists on ‘incredibly strong’ economic growth and he is not worried about the recent market plunge, calling it just a retracement which has been expected for a long time.

Source: Investopedia

The odds for further tightening by the Federal Reserve has been decreased dramatically due to the latest sell-off in stock indices. The market players’ expectation for the rate hike in December fell to 74% from 81% right after the worldwide stock indices plunged due together with the sell-off in bonds. Projections for 2019 have been decreased as well. Two more interest rates hikes are expected in the next year with not more than 80% chances for the third one. The Federal Reserve has been hiking the interest rate eight times starting from 2015, turning off the monetary stimulus in the scope of the sustainable economic growth in the U.S. Traders’ expectations were eased by the U.S. President Donald Trump’s attacks on the Fed right after the market plunge.

Wall Street is getting ready for the bearish market also because of the recent rumours about the U.S. six-month official review of the currency policy by several trade partners. In case if the U.S. will call China as the Forex manipulator, that would lead to an escalation of the recent tensions between the two largest economies worldwide. Such a scenario is possible, even though the probability is low, taking in count the fact that Chinese yuan weakened by 9% since the beginning of this year. The Chinese government is blamed in the intentional lowering of the currency, adding more competitive advantage to the local exporters. If the U.S. will name China as the currency manipulator, that will happen the first time since 1994. Such a decision would probably cause a new turbulence wave in the global equities markets, extending the largest losses since February. Chinese yuan is very close to cross the mark of 7 yuans per one dollar, which never happened since the latest global financial crisis. However, this is not the base-scenario for the markets which would comprehend these threats for the currency market mostly.

On the other side of the conflict, the Chinese Central Bank is getting ready for all of the possible risks choosing the monetary policy, including the worst-case scenario. Chinese officials insist on their opinion that the current yuan exchange rate is balanced and adequate to the increased demand for the U.S. dollar globally. The volatility is normal and the currency has a flexible mechanism of the exchange rate formation, according to the words of the Chinese Central Bank’s head. Moreover, analysts noted that the currency fluctuations were seen in both sides and yuan has been strengthening from time to time despite the strength of the U.S. dollar across the board. So, the Chinese side does not agree with the blames from the U.S. officials, naming those efforts as nothing but the geopolitical pressure.

The financial turbulence scenario has been researched by the Goldman Sachs as well. The investment bank’s analysts advice to buy Japanese yen versus South Korean won as the hedge in a potential turmoil in the financial markets worldwide. Any global sell-off like the one that happened last week would dramatically increase the demand for the safe-haven assets and currencies, lowering the capital outflow from countries with soft monetary policy, such as Japan. In contrast, South Korean won which is directed to the high-risk assets growth, would decline. The currency’s relation to equities makes it dependant on the situation with the local stocks market which could face a trouble in case of the U.S. shares would plunge to the second wave of sell-off in the U.S. 10-year bonds, the way it exactly happened last week. Long positions for JPY/KRW currency pair would be the best hedge for such a scenario.

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