They were studying the snow forecasts in Davos on Friday. But the 3,000 bankers and CEOs who had flown to the Swiss ski resort for the annual gathering of the global business elite were not interested in what conditions would be like on the slopes this weekend. Rather, they were focused on the monster blizzard stalking the US.
At the end of a week in which the price of oil had fallen to a 12-year low, the price of the black stuff was finally moving north again, breaching the symbolic $30 mark. The reason? Traders were betting that demand for fuel would increase as the big freeze gripped large parts of the US.
The world’s stock markets were also clawing back lost ground. With many having been in bear territory – defined as a 20% fall from their peak – they were buoyed by hints from the European Central Bank that it was considering further action to boost the eurozone’s crumbling economy.
It was the signal that the markets were desperate for after days of relentless bad news that stretched from the Arabian Gulf to Wall Street, from steelworks in south Wales to oil rigs in the North Sea, and which had begun with the bombshell announcement that China’s GDP had grown by “only” 6.9% in 2015, its lowest rate in 25 years.
As the Davos jamboree wound up on Saturday, Tidjane Thiam, chief executive of Credit Suisse, captured the mood. “The market is very worried about China,” he said, adding that dealers were sceptical about official figures showing its economy was growing at close to 7%. “The markets believe there may be a hard landing or a very significant reduction in growth which will have a big impact on the rest of the world. There is a fear that we are walking into a global recession.”
But with central banks’ interest rates at historic lows and billions of pounds in quantitative easing – printing money – expended, the institutions charged with breathing life into a flatlining global economy have few weapons to draw on. “I think that the arsenal of many central banks has been significantly depleted and we no longer have many of the options that existed in years past,” said Eric R Peterson, partner at consultancy giant A T Kearney. “My sense is that we have an incredibly complex and challenging combination of short-term and long-term-range challenges to face. When you put it all together, in my view you have a global economy on a hair-trigger. In the short term even the most minor shocks or perturbations can generate very significant effects.”
Sitting off the coast of Iran in the Strait of Hormuz are huge tankers loaded with an estimated 50 million barrels of oil now waiting to be given their destination. Ship brokers in London are on red alert for new business coming out of Iran as one of the world’s largest oil producers bursts back into life, now that sanctions against it have been lifted. Tanker experts at Clarkson, the world’s biggest broker, said they had already seen one request to charter a Suezmax-sized tanker for a shipment of crude from Iran to a westward destination. “Things are a bit hazy at the moment, and it will take time to get going,” said one broker, pointing out the sanctions deal was signed off only last weekend.
But already Iran’s re-entry to the oil markets is having an impact. And it could not have come at a worse time. The International Energy Agency is warning that oil markets could “drown in oversupply” this year. The US fracking revolution has meant the world’s superpower is no longer heavily reliant on Middle Eastern oil. But, despite this, Saudi Arabia and other major oil producers are keeping the wells pumping. This is happening at a time when economies are slowing, which means a decline in demand for fuel.
And it is not just China that is causing concern. The International Monetary Fund’s latest global forecast downgrades the outlook for many emerging countries, notably Russia, Brazil and South Africa. For commodity producers – the likes of mining firms that extract iron ore and steel manufacturers – a global slowdown threatens their profitability. Many have seen their share prices plunge as analysts judge them to be overvalued. And where commodity producers lead, other businesses often follow.
“I think the concern about the recovery remaining fragile must have increased and that, even if the market is overreacting, the downturn in stock prices could be bad for the economy,” said Wouter Den Haan, an economics professor at the London School of Economics. “We may get a stalling of the recovery or possibly another recession. I don’t see Armageddon, but I do see the risk factors on the downside getting bigger.”
A chief concern is that the recovery after the 2008 crash has been built on shaky foundations. “We’ve gone through this major recession and lots of these problems aren’t really fixed,” Den Haan said. “I don’t think the financial sector has changed that much. Growth in the UK and US is nice, but it’s really not the kind of growth that we’ve seen in past recoveries.”
At Davos it was left to Christine Lagarde, managing director of the IMF, to promote an upbeat message. She pointed out that the fund predicts the world economy will grow 3.4% this year, up from 3.1% in 2015. But even Lagarde had to temper this message by admitting there were four significant downside risks to the prediction: China; the impact of falling commodity prices on producers; the fragile state of some emerging market economies such as Russia and Brazil; and the possible disruption that could be caused by the US Federal Reserve raising interest rates when other central banks, including the European Central Bank and the Bank of Japan, are still providing additional stimulus.
Concerns about these risks are gaining momentum. As Thiam pointed out, large institutional investors have been taking their money out of the markets. Some of the exodus has been driven by the huge sovereign wealth funds that were built up by the major oil producers when the cost of crude was above $100 a barrel, liquidating investments now that oil prices are plunging. But psychology is also playing a part. The herd is in danger of stampeding.
One senior policy maker attending Davos said he was reassured that commercial banks were now forced to hold more capital as insurance against losses than was the case two years ago, because otherwise the meltdown would have been more serious. This may help to explain why the prevailing view in Davos was that, at best, 2016 will be a bumpy year marked by modest growth and market turbulence. But, in private, many were more pessimistic. The unspoken fear is that 2016 could turn into another slump similar to that which followed the collapse of Lehman Brothers in September 2008.
This is certainly the view of Albert Edwards, an economist at Société Générale and the City’s leading bear. In a recent and characteristically pessimistic note to his bank’s clients, Edwards warned that the world was on the brink of “another debacle every bit as large as the 2008 global financial crisis”.
His warning was heavy on hyperbole. “I believe the events we now see unfolding will drive us back into global recession,” said Edwards, who predicts “a trade war not unlike that in the 1930s”. He pointed out that, on 23 December, in response to the devaluing of China’s yuan currency, a move that made its exports cheaper, the US hiked tariffs on Chinese steel imports by a staggering 256%. For workers caught in the crossfire, a trade war can be ruinous. The 750 workers at Tata Steel’s plant at Port Talbot in south Wales who were laid off last week know only too well what the cheap price of Chinese steel means.
Oil rig workers in the North Sea also face an uncertain future as other oil producers refuse to blink and continue feeding the global glut. More than a dozen offshore rigs, the highest number in more than a decade, have been towed into the Scottish Firth as the plunge in crude prices has all but killed off North Sea exploration. Two rigs have already been towed away to be scrapped in Turkey. More are expected to arrive soon.
Edwards is clear about whom he blames for what is happening to the global economy. The central banks’ deployment of quantitative easing – the buying back of debt from banks to give them cash to start lending again – has helped inflate asset prices around the world. “The illusion of prosperity is shattered as boom now turns to bust,” Edwards warns.
Such strident views are not shared by many economists. But even more moderate commentators, notably the Nobel prizewinner Joseph Stiglitz, appear concerned that the economic tectonic plates are shifting.
“There’s a reasonable chance that there is something more fundamental going on,” Stiglitz said last week. “There was a kind of excessive euphoria; undoubtedly the QE monetary policy pumped up asset prices but didn’t do much for pumping up the real economy. Where was all the liquidity going? Some of it went just into the balance sheet and wasn’t lent out, but some of it went to increasing asset prices.
“Many analysts, including me, believed that there was going to be a major correction. Very hard to tell when. Whenever there is such a major correction there are ups and downs.”
The turbulence in the markets – and in particular the speed with which it has erupted – caught the Bank of England wrongfooted. Having been upbeat about the UK’s economic prospects only late last year, governor Mark Carney finds himself declaring “now is not the time to raise UK rates”.
While this is good news for people with variable rate mortgages, it is an embarrassing admission that the economic recovery is built on anything but solid foundations. Confirmation of this came in figures published on Friday showing that British retail spending at Christmas suffered its biggest year-on-year fall in more than six years. The figures indicated that Britain’s economy was slowing. This has political consequences: the UK’s tax take is now unlikely to meet the Treasury’s predictions. As a result, few now will bet on the chancellor, George Osborne, meeting his budget goals when the financial year ends in March.
Market meltdowns should carry a health warning. While they can presage wider economic problems, they are not infallible barometers. As the late American economist Paul Samuelson famously observed: “The stock market has forecast nine of the last five recessions.”
JP Morgan’s asset management team believes much of the gloom has been overdone. They observe: “Much of the bad news has already been priced into markets which are forward looking and have known about the slowdown in China for a while. We think the outlook is slightly better from here. China’s growth rate remains high relative to everywhere else. We are still looking at an economy that over the next five years could expand by more than $5 trillion. So the message is not to panic.”
This will be a comfort to UK banks which have significant exposure to China and Hong Kong. But few believe that, following Friday’s rally, there are no nasty shocks ahead. Indeed, some analysts fear further falls in the market could turn into a rout.
“In the short term, the FTSE’s commodities-led rally has legs and we cannot rule out a move towards 6,000 in the coming sessions,” Jawaid Afsar, a senior trader at Securequity, told Reuters. “However, its medium-longer-term remains uncertain … the FTSE is still flirting around its ‘bear market’ territory and a fall below 5,800 could lead to a slump towards the 5,200-5,300 area.”
Many people would be forgiven for thinking that when traders’ screens flash red it has little to do with them. But they would be wrong. Pensions experts Hargreaves Lansdown calculate that a 20% fall in the value of a pension pot close to retirement could wreck a person’s best-laid plans. For example, a 65-year-old with £50,000 in their pension at the end of April 2015 could have bought an annual annuity income of £2,739. Despite an increase in annuity rates, the market downturn means that the same 65-year-old can now expect to buy an annual income of just £2,306.
Whether those due to retire in a few years’ time, or indeed those still working in Britain’s ailing steel and oil sectors, can dare hope for a rosier future will to some extent be determined by the scale and speed of China’s slowdown. Ominously, George Soros, the financier who forced Britain out of the European exchange rate mechanism by betting against the pound, used his appearance at Davos to warn that a hard landing for China was now “unavoidable”. Soros stressed that he was not offering a prediction. “I’m not expecting it,” he said. “I’m observing it.”
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