10 February 2016

What you need to know about the financial market turmoil

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What are markets worried about?

Investors are concerned about declining world growth, deflation, interest rates turning negative, the consequent impact on banks’ profitability and whether markets can remain liquid if banks pull back.

Can central banks just cut interest rates?

Nobody is sure what central banks can do in this environment, which is part of the problem. Interest rates are already low, and negative in Japan and the euro zone.

What is the problem with European banks?

The euro zone is stagnating and one third of sovereign bonds in Europe are effectively paying a negative interest rates. As banks own plenty of these, their profitability is hurting.

What about Deutsche Bank?

Investors are questioning whether it has sufficient capital and whether it can pay the coupon on one of its own bonds. The bank and the German finance minister, Wolfgang Schauble have issued reassuring statements and the shares have rallied.

What about the US economy?

It is still growing, which is why the US Federal Reserve raised interest rates in December. However, survey data has since indicated a slowdown. We will hear more when Janet Yelland, chairman of the US Federal Reserve, gives evidence to Congress later today and tomorrow.

What about the UK economy?

This is slowing. The Bank of England has cut its growth forecast for this year from 2.5% to 2.2% and today we learned manufacturing is contracting.

What about Brexit?

This is a risk on investors’ minds globally. It is an uncertainty, which they don’t like, but it has also shone a harsh spotlight on the failings of the EU and the euro zone.

What about the London housing market?

This is a bellwether. But in recent days British housebuilders’ shares have plunged. Even though housebuilders are reporting record activity, there is a belief that the London housing market has slowed sharply due to the absence of overseas buyers, an excess of new flat developments, and the chancellor’s new, steeper, stamp duty regime.

What about the Chinese economy?

The current problems began in China. The Chinese economy grew by 6.9% in 2015, the lowest for 25 years. Lack of Chinese demand for commodities has driven down the international price of everything from milk to copper.

Will there be another financial crisis or a recession?

This cannot be ruled out, but is currently unlikely as banks are better capitalised with more liquidity than they were before. The oil price is also under $35, giving a welcome boost to consumers.

Will there be political consequences?

Almost certainly. In a deflationary environment, company profits and wages growth will flatline or turn negative. Apart from the Brexit referendum pencilled in for June, the next big political event is in Germany. Angela Merkel faces a Bundestag election in September which will test her coalition. The US Presidential election is in November.

Does anybody benefit?

Yes. Those who hold cash, which in a deflationary environment can buy more. And maverick politicians who question the status quo, like Donald Trump.

George Trefgarne is founder of Boscobel & Partners, a communications firm.