The ructions in global financial markets in the last day or so are not so much a function of some US development, or a corporate or fund manager mishap; rather, they were the result of concerns that the Chinese authorities will work to slow its economy as it grapples with inflation risks and an overheated stock market.

There was no single decision or event that triggered the 8.8% decline in the Shanghai Composite Index on Tuesday. Rather, speculation over regulatory changes regarding stock trading, concerns that there may be an interest rate hike following strong inflation results in the last two months and perhaps a reassessment of the market boom (it is up around 130% over the last year) were all cited as reasons for the market slide.

The falls in China triggered weakness in global stock markets and a powerful bond market rally that sees the futures market pricing in interest rate cuts in the US by year end and effectively pricing out hikes in Australia, the UK and Europe.

Rarely have the US, European and global markets been driven to such an extent from trends in China – usually, it is the other way around. The hackneyed phrase, “when the US sneezes, the rest of the world catches cold” is the mantra of decades gone by. And it was true. But as China’s economy expands at breakneck speed and its markets slowly but surely open to domestic and international capital flows, it will assume a greater importance in driving global market trends. Who’s going to be the first to suggest that when China stumbles, the rest of the world falls over?

It could be argued that what happened in the last day or so is the first instalment of the changing world order.

Obviously, the US, Europe and Japan are dominant players in the world economy and financial market trends. This will remain and specific issues in each market can and will still have an important influence on market risks and trends. But from now, economic and market developments in China will be watched for their influence in global markets.

There were a couple of other events that exacerbated the market volatility – a weak US data print and a further assessment (not factually driven it seems) of problems in the sub-prime market exacerbated the amplitude of market trends.

While we all will be watching US trends for guidance in the world economy, monetary policy changes and investment strategy, it is increasingly obvious that China will increasingly drive global economic activity and market trends.

Peter Fray

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