Investors on European markets have found themselves caught in a pincer between the uncertainties surrounding the largest global economies, the United States and China. The central banks of both countries are beset with problems and doubts about the best route to follow in order to stimulate their respective economies.
European Central Bank chief economist, Peter Praet, expressed concerns about the negative effects of the low commodity prices on inflation, similar to those aired by Federal Reserve vice chairman Stanley Fischer. There is also a very real risk of importing lower inflation together with Chinese goods after the devaluation of the yuan, one of the measures applied by the People's Bank of China to spur economic growth and to stabilize the markets.
All the main European markets suffered losses on Wednesday. The French CAC 40 (PX1, +2.99%) lost 1.4% to 4501.05 while Germany’s DAX 30 (DAX, +3.22%) dropped 1.3% to 9.997.43. In London, the FTSE 100 (UKX, +2.1%) moved 1.8% downwards to 5979.20.
The most important underlying cause of the turmoil on equity markets is the persistent fear that the Chinese economy is slowing at a far faster pace than investors had originally anticipated. The comments from Chinese officials after the devaluation of the yuan defended the move as being necessary to give them room to maneuver against continued dollar strength rather than an attempt to improve exports and stimulate the economy.
David Riedel, president of Equity investment firm Riedel Research Group expressed similar views to the Chinese officials saying, “The real culprit at the bottom of all this has been the strength of the U.S. dollar. Investor sentiment had favored the view of a rate increase by the Fed and this perception had fuelled the strengthening of the dollar in the belief that the Federal Reserve would be the only central bank to hike interest rates.” He added, “And therefore, there would be this policy differential that would make the U.S. dollar more attractive.”
Riedel also said, “The best case scenario is that the Fed goes ahead and does raise the rates and the dollar can trade flat to down, which would help alleviate pressure on other currencies, help stabilize commodity markets and allow the market to digest the impact of a minimal rate hike. Unfortunately, with all this turmoil, it seems like there’s talk with the September rate hike not being off the table, but pushed towards the edge of the table.”