Is China really to blame for the global sell-off?

After one of the most brutal starts to a year for financial markets in two decades, all eyes have turned to China as the cause for the rout seen in global stocks, but some investors are starting to dig a little deeper for the cause of the volatility.

An investor walks past an electronic screen showing stock information at a brokerage house in Nanjing, Jiangsu province, January 19, 2016.
China Daily | Reuters

While most would agree that Chinese data, its weakening currency and unstable stock market have been a major catalyst for the sharp moves in stocks, markets are also beginning to question global growth more generally in the wake of tighter monetary policy in the U.S. and a feeble performance seen in Europe.

"The market mood soured overnight - again - as the International Energy Agency warned of an oil glut as Iran returns to the market and other major producers keep supply coming," said global macro strategist at Societe Generale, Kit Juckes.

"For once, the short-term focus isn't on Chinese markets, where equities are weaker but not dramatically so and the currency is stable. But that just goes to show that bottling up volatility in one market simply displaces it to others," he said.

The S&P 500 is down 8 percent this year alone, European stocks have fallen over 9 percent and the Nikkei entered into bear territory on Wednesday, off by 21.33 percent from its 52-week high in June 2015, after closing down 3.7 percent.

"Clearly, the fundamentals do not justify such pessimism. China is running a current account surplus of $60 billion per month, has $3.3 trillion of reserves and real rates that are far higher than in developed markets," said head of research at emerging markets asset manager Ashmore, Jan Dehn.

"So what accounts for this weakness? Consider first the currency. FX has now become the dominant global asset class; in a sense that what happens in FX markets largely drives sentiment in other financial markets. This did not use to be the case, but repeated doses of quantitative easing have pushed yields to zero and at this threshold the marginal unit of capital will flow into the FX markets rather than bond markets," he said.

China's central bank intervened in foreign exchange markets this week, by forcing some banks to set a reserve ratio in their offshore renminbi deposits, in an effort to stabilize the currency. The spread between onshore and offshore Chinese renminbi stretched to a record earlier this month before the People's Bank of China intervened in the offshore CNH market, in Hong Kong.

US dollar strength

Commodity prices have also continued to slide, with U.S. crude touching its lowest since 2003, amid a global supply glut, exacerbated by mounting worries about the strength of the Chinese economy and its demand for global commodities. U.S. crude oil dropped more than 4 percent in early trading, falling to as far as $27.32 a barrel.

CEO & chief investment officer of Fasanara Capital, Francesco Fillia said the three key risks for markets in the current environment are further U.S. dollar strength, oil breeching new lows and further renminbi weakening, with a stronger greenback the number one risk to markets over specific China worries.

"In what might prove to be a policy mistake, with its forward guidance the Federal Reserve prepared the ground for a potential of 100 basis points (bps) of hikes in 2016, likely in four bites of 25bps at the four Federal Open Market Committee meetings. Less than half of it is priced in now.

"The Fed might find it hard to avoid hiking some of it without losing the face, in an electoral year. Further strength of the USD will weigh on EM's dollar-debt position, therefore on emerging market (EM) currencies, including CNH, and most obviously on commodities and oil, high yield and credit as a follow-on effect.

Dehn also argues that the U.S. appears to be "hurtling" towards recession, after the Atlanta Fed revised its fourth quarter growth down, with the strengthening of the dollar making matters worse.

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