The recent turmoil in China’s economy has raised concerns about its impact on global markets, but Wall Street seems more focused on the domestic factors that affect the US stock market. The performance of the US labour market and the direction of interest rates are the key drivers of investor sentiment, as they have implications for the recovery and inflation outlook.
China’s woes are not a major threat to Wall Street
China’s economy has been facing multiple challenges, such as the regulatory crackdown on its tech sector, the debt crisis of its property giant Evergrande, the Covid-19 resurgence, and the power shortages that have disrupted industrial activity. These factors have weighed on China’s growth prospects and triggered a sell-off in its stock market.
However, Wall Street has not been significantly affected by China’s troubles, as the exposure of US investors to Chinese assets is relatively low. According to a report by Goldman Sachs, US investors own only about 1.2% of China’s domestic equities and bonds, and less than 5% of China’s offshore equities and bonds. Moreover, the trade and financial linkages between the US and China have weakened in recent years, due to the trade war and the decoupling efforts.
Therefore, China’s woes are not a major threat to Wall Street, unless they escalate into a systemic crisis that could spill over to other emerging markets and disrupt the global supply chain. However, this scenario seems unlikely, as China has ample policy tools to manage its risks and prevent a hard landing.
US labour market and interest rates are more important for Wall Street
While China’s woes matter less to Wall Street, the US labour market and interest rates are more important for Wall Street, as they have direct implications for the US economic recovery and inflation outlook. The US labour market has been recovering from the pandemic-induced slump, but it still faces some challenges, such as labour shortages, skill mismatches, and Covid-19 uncertainties. The pace and quality of job creation will determine the strength of consumer spending, which is the main driver of US growth.
The direction of interest rates is also crucial for Wall Street, as it affects the cost of borrowing and the valuation of assets. The Federal Reserve has kept its benchmark interest rate near zero and maintained its bond-buying program since the onset of the pandemic, to support the economy and financial markets. However, as inflation has risen above its 2% target and growth has rebounded strongly, the Fed has signaled that it will start tapering its bond purchases later this year and raise interest rates in 2023.
The timing and speed of the Fed’s policy normalization will depend on the evolution of the labour market and inflation data. If the labour market improves faster than expected and inflation proves to be more persistent than transitory, the Fed may have to tighten its policy sooner and faster than anticipated. This could cause volatility and pressure on Wall Street, as investors may reassess their expectations and adjust their portfolios.
Wall Street is optimistic about the outlook
Despite the uncertainties surrounding China’s economy, the US labour market, and interest rates, Wall Street is optimistic about the outlook for the US stock market. The S&P 500 index has risen by more than 20% year-to-date, reaching new record highs. The earnings growth of US companies has been robust, supported by strong consumer demand, fiscal stimulus, and productivity gains. The valuation of US stocks is also reasonable, given the low interest rate environment and the positive earnings outlook.
Wall Street expects that the US economy will continue to recover from the pandemic shock, as vaccination rates increase and Covid-19 cases decline. The Fed will also likely maintain its accommodative stance until it sees substantial progress in achieving its dual mandate of maximum employment and price stability. Moreover, Wall Street hopes that Congress will pass President Joe Biden’s infrastructure and social spending plans, which could boost long-term growth potential and reduce inequality.
Therefore, Wall Street is confident that the US stock market will remain resilient and attractive in the face of China’s woes and other headwinds.
