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Why China can contain financial crisis and support oil demand for tanker stocks

Inflation (<a href='/quote-page/cpi/'>CPI</a>) 2013-06-25Enlarge GraphContinued from Must-read: Financial woe abroad drags tankers down, outlook negative

Inflation’s impact on spending and investment

Central banks often set a target on inflation rate because a mild inflation rate encourages people to spend more, while it also points out that demand is rising more than supply—a situation that suggests a growing economy. When inflation is high, however, central banks will use monetary policies to bring interest rates up in order to cool the economy down by tightening the availability of loans. On the other hand, when the inflation rate is low and the economy is slowing down, central banks will lower interest rates and increase the availability of loans to encourage spending and investments.

Low inflation and monetary policy

Globally, inflation has remained subdued. China’s consumer price index (CPI), which measures the price of a basket of goods that people living in China generally buy, rose 2.40% year-over-year in May 2013. While European and U.S. inflation rates are relevant because the countries are China’s largest trading partners and affect China’s exports, China’s inflation rate is most applicable to the central bank’s monetary policy decision.

Inflation has remained low over the past few months, as China’s manufacturing activity remains weak—though not too negative (see Ignore HSBC, China’s official PMI aids shipping for explanation). While weak manufacturing activity means weak growth in the short term, weak manufacturing would be positive for tanker firms that are becoming more dependent on China’s economic growth and oil imports (see Tanker rates to remain depressed, negative outlook ahead for how the global oil trade is changing), because low inflation leaves room for the central bank to loosen monetary policy if necessary.

A crash unlikely

While recent data on the country’s financial system showed signs of fragility, as interbank repo rates rose to a record (see Must-read: Financial woes abroad drags tankers down, outlook negative) and the price of insuring against a default in China’s government bond rose—a similar situation to 2007 and 2008—the current inflation rate isn’t as high as the rate was back then. This means a crash similar to the crash of 2008 is unlikely to happen again, because the central bank has the tools to stabilize the financial sector.

So, while oil prices (a key driver of tanker performance) fell recently due to China’s financial woes and Fed Chairman Bernanke’s speech on winding down the asset purchase program (see Why oil price is a key driver of tanker stocks), it’s likely that oil price will fluctuate near current levels for a while. Tanker firms such as Teekay Corp. (TK), Tsakos Energy Navigation Ltd. (TNP), Ship Finance International Ltd. (SFL), and Teekay Tankers Ltd. (TNK), as well as the Guggenheim Shipping ETF (SEA), may experience weaker demand growth in the short to medium term as the government tolerates lower growth, but the world isn’t going to collapse.

Analysts have also discussed that a looser monetary policy could be restricted because of soaring housing prices. Read on to see whether this is true in Research shows China’s soaring housing prices actually support tanker firms.

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