The current market decline has led to a bout of pessimism among market participants, in which a number of fears have come to the fore which we discussed last week. To reiterate, briefly:
- Fears are abroad about the stability of the Chinese Yuan. We do not believe a currency war is in the offing, because it would be destructive to all concerned.
- Fears are abroad about Chinese economic growth. We continue to follow the China economists we have found to be the most accurate over the years, and with them, we anticipate moderating but far from catastrophic Chinese growth in the region of 6 percent.
- Fears are abroad about a recession in 2016. Economic data in the U.S. and elsewhere are not all rosy, as we noted above in our discussion of U.S. GDP growth trends, but they don’t suggest that a recession is around the corner.
- Fears are abroad about commodity-related bankruptcies. As we noted, busts are a normal part of the commodity cycle; we’ve seen it many times before. Banks have been conservative in their lending to commodity producers, keeping commodity loans low as a percentage of total loans, so contagion is unlikely.
Although we don’t believe that these fears have material justification in underlying economic conditions, we recognize that the Fed is sensitive to market concerns and to global macroeconomics — as we saw in October when an anticipated rate rise failed to materialize in the midst of (wait for it) market turmoil and concern over China. So although December’s dot plot calls for four rate rises in 2016, the environment that’s shaping up, combined with what we know about the FOMC’s sentiments, leads us to estimate that 2016 will bring us just two more rate rises. We believe the fundamentals of the U.S. economy are strong enough to bear more… but we suspect the Fed’s dovish bent will express itself through caution in 2016 — one more way in which 2016 will resemble 2015.
Fear will continue. As a professional colleague noted last week, many Wall Street participants, during times of negative psychology such as the present, extrapolate to the worst possible outcome and make that their projection. We can anticipate, therefore, that we will continue to see such worst-case projections and fears for some time.