Volatility in China has poured over to the US. What is causing it, should it continue, and what impact will this have on the Fed???
China
China continues to struggle through an economic slowdown. A lack of action by China’s central bank has been met with a broad sell off of global equities. The world is waiting for China to take more extensive measures to stop the bleeding in its economy.
The Shanghai Composite (SSEC) has fallen 38% from its high through 8/24/2015. This is surely a steep fall, however, it is important to remember that the SSEC was up 59% from April 3rd to June 11th when it reached its high before falling off[1]. The shear volatility of the SSEC should clearly warrant our caution as to a cause for domestic stock volatility.
Oil demand in China has slumped. Commodity prices have continued to slump with oil demand down and the ever increasing supply glut on the market. Current estimates have supply and demand getting back in order in 2016. This impacts companies in the oil industry, but not the broad economy. In fact falling fuel costs keep inflation at bay and keep discretionary dollars in the consumer’s pocket.
US
Housing data was mixed, but mostly positive as building permits were down, but still came in at 1.119M, housing starts increased to 1.206M for July, and existing home sales improved to 5.59M[2]. Core consumer prices (CPI) remained unchanged at 1.8%, keeping inflation under 2%. Core prices reflect consumer prices excluding volatile fuel and food. Also, manufacturing fell to 52.9, but still well into expansionary territory.
Stocks in the US are well off their highs from earlier in the year with the S&P 500 down 11.3% through 8/24/2015 from its 52 week high[3]. This puts it officially in correction territory.
Trading volume in August are often times low as vacations are typically in full swing. When trading volume is low, you have less buyers and sellers on the market which can cause greater volatility. Trading volume last week was low and definitely contributed to the sharpness associated with market activity.
With the S&P 500 officially in correction territory (a fall of 10% or more from its 52 week high) it would be a good idea to get some perspective on corrections.
- # of corrections in the last 4 years: 1
- # of corrections in prior 2 years: 2
Truly a 10%, or greater, corrections should occur more often than once every 4 years. The lack of corrections over the last several years is likely attributable to the Federal Reserves (FRB) easy monetary policy.
How will this impact the FRB?
The 2 major ways this will impact the FRB are:
- The jobless rate could increase as more oil jobs are lost and corporate America cuts jobs to meet earnings.
- Oil prices will continue to keep inflation in check causing less of a concern about runaway inflation.
These two considerations could forestall the FRB’s intent to raise rates in 2015.I believe in the absence of firm economic data showing these impacts (by September) the FRB will likely still make the move. If they do not begin to increase rates in 2015 there will be no traditional mechanism by which to loosen monetary policy later when it is truly needed.
All things considered the economic landscape in the US especially that of the consumer is healthy. The occurrences in China, while real and currently impacting our markets are likely not to be long term determinants to our health as an economy. We will be watching the impact it has on our real economy to see how it develops, but currently it amounts to a corrective environment, not a recessive environment.
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[1] www.investing.com – indices, SSEC
[2] www.investing.com – economic calendar
[3] www.morningstar.com – indices