Euphoria gripped global stock markets in January, following several months of strong, upward trajectories. Some commentators described it as a “melt up,” meaning it was the last stage of a rally, before a collapse. They were, it could be argued, correct, as at the beginning of the month there was the now much talked-about global sell-off.
The S&P 500 slumped by 10%, officially making it a “correction.” The Hang Seng Index dropped by more than 5%, the Nikkei 225 fell by 4.75%, and this was echoed on all major indices worldwide.
The rattling of markets was caused by the herd mentality of investors, or fear feeding on itself. But what caused this fear in the first place?
Despite the sell-off being a global phenomenon, it was triggered primarily by two key events in the US. The first was the release of the nearly 3% year-on-year wage increase, with more robust than expected new jobs growth. With the US economy now at full employment, this data fuelled the markets’ inflation concerns. The second was the drop of American healthcare stocks, after Amazon announced it was considering entering the industry.
There are, I believe, three key ways that the sell-off will impact Asia.
One, dollar-denominated debt may become more expensive to repay in local currency terms should the dollar rally as Fed rates rise to curb inflation and Treasury yields rise, so hurting those Asian governments and sovereigns who are net borrowers in US dollar debt. However, the US dollar will fall if markets sense that lthe Fed will not raise rates to curb inflation, so the opposite effect will happen in the event of a slack Fed.
Two, stronger American growth will lead to a widening US-Asia trade deficit, as American corporations and households buy Asian investment goods – this includes earthmoving equipment from Hitachi – and consumer goods. This may accentuate a tense trade relationship, in particular with South Korea and China. This might make it a good time for holding shares in Asian exporters.
And three, central banks tend to hold their FX reserves in government bonds. Weakness in the US Treasury market may tempt some Asian central banks to sell their treasuries, and buy euro, yen or even sterling government debt instead, potentially leading to further weakness in confidence in the treasury market. Asian government and central bank officials will need to be careful on how they comment on the treasury market.
This global sell-off indicates that turbulence has returned to stock markets, which will create important buying opportunities. It also underscores once again the interconnectedness of our ever-more globalized world.
Published in Daily Times, February 19th 2018.