The markets face many uncertainties

At the end of last week, economic indicators pointed to some favourable developments in the United States, and not-so-favourable ones in Switzerland. At Uncle Sam’s, the Philly Fed index, which measures manufacturing activity in the Philadelphia area, exceeded expectations by jumping 30.7 points even as analysts expected a drop. Retail sales also rose by 0.7% in August, whereas the market had also predicted a decline. In Switzerland, the State Secretariat for Economic Affairs revised down its forecast for GDP growth for this year. It’s now expected to grow by only 3.2% instead of the 3.6% forecast in June. The factors mentioned include the wave in new cases linked to the Delta variant as well as production capacity problems. The US dollar logically advanced against the Swiss franc to its highest level since April at 0.9333. It actually rose against all major currencies, with the euro falling to 1.17 on Monday before recovering.

The greenback’s strength is not only riding on the new macroeconomic figures being published, but also by its status as a safe haven. And this week has been a turbulent one for the financial markets. It was evident in the foreign exchange market and in equity markets as well. On Monday, most global stock markets were down around 2%, with banking and energy stocks being the most affected assets. Only the airline sector’s stocks were doing well as they welcomed the US decision to reopen its borders to vaccinated foreigners. Even the Tech Giants (Google, Apple, Facebook, Amazon, Microsoft) saw some profit-taking, with their capitalisation dropping by 500 billion since the high of 7 September. The VIX index, which measures volatility on the markets and is known as the fear index, jumped to 25 points, the level seen in May. Finally, cryptocurrencies also took a beating, with Bitcoin falling back to USD 40,000. There are two main reasons for the market downturn. The first one is on the front page of all the newspapers: Evergrande.

Evergrande is a very large Chinese company, the second-largest in the construction sector. It has over 200,000 employees and indirectly provides work for 3.8 million Chinese. The company’s problem is its staggering debt, estimated at around $300 billion or about 2% of China’s GDP. And now the company is finding it very difficult to service such debt. Yesterday, the company failed to honour a payment and now has 30 days to do so. This is partly because the pandemic has deprived the company of revenue from shopping centres and also because the Chinese state tightened its regulations by prohibiting the company from selling properties before they have been completed. An estimated 1.6 million flats have been sold but not finalised. In one year, Evergrande’s share price has dropped tenfold. Has the company become ‘too big to fail’? Will the Chinese government bail it out? Which banks are exposed to its debt, and at what level? If the company fails, will we see contagion in the banking sector and at an international level? These are the questions that worry all parties concerned.

The second matter for concern relates to the United States. On Sunday, U.S. Treasury Secretary Janet Yellen made a strong case before Congress for raising the debt ceiling that came into effect on August 1 ($28.4 trillion). If this limit is not raised, the United States will be unable to issue new loans to finance itself and by October the country will not have enough money to pay its employees, its pensioners and, more broadly, all its creditors. Since the 1960s, the ceiling has been raised or suspended 80 times and the United States has never defaulted. But the raising of the ceiling comes with intense political struggle, uncertainty and nervousness.

This is the context for the current FOMC meeting, an event that as always is of great interest to the markets. The Fed should, like the ECB, pave the way for tapering, although no specific timetable or figures are expected at this time. We will also have to pay attention to the Fed’s economic forecasts: will they be modified by the latest inflation and growth data? If the focus is on inflation and production concerns, this will send a hawkish signal to accelerate the tapering timeline. If the discussion is more about slowing growth, then the longer term maintenance of accommodative policy will be discussed.