Why China’s financial woe affects oil shipping (tanker) companies (Part 4)

Market Realist

Continued from Part 3

Inflation and interbank repo rates

What the central bank does is one thing. What the central bank is able to do is another. In Part 3, we talked about how the interbank repo rates (which are the rates that banks charge each other for borrowing cash in exchange for securities such as government bonds) will likely stay elevated in the short term. But is the central bank able to contain the risk just within the financial sector? Or will it spill over to the rest of economy and hurt economic growth? To answer those questions, we should also investigate an indicator that central banks often look at: inflation.

Inflation ticks up in June

For June, China’s consumer price index (CPI) grew 2.7% due to higher food prices, while its producer price index (PPI) fell 2.7% year-over-year. The consumer price index reflects the price of goods that consumers in China spend on average, whereas the producer price index reflects the wholesale prices received by domestic producers of goods and services. The producer price index remains weak, although it has improved from May’s 2.9% decline, as falling commodity prices continue to drag down domestic mining companies.

Investors widely look at the two indexes because a high inflation rate, although often suggestive of strong demand and economic growth, lowers the purchasing power of money and leads to hyperinflation. This can lead in turn to an economic collapse, because either goods will become too expensive to purchase or money will become worthless. When money is worthless, the financial system collapses.

Inflation and monetary policy

So when inflation is high, central banks can’t loosen monetary policy, which would lower interest rates by injecting more money into the economy. If they do loosen monetary policy, they’ll allow more people to borrow more, which will further increase demand for goods and drive prices higher. This was the case back in 2008, when interbank repo rates jumped.

Given that both indicators of inflation remain weak or low, the central bank can loosen monetary policy to support the economy if repo rates do rise further. This is positive for tanker companies such as Teekay Corp. (TK), Tsakos Energy Navigation Ltd. (TNP), Ship Finance International Ltd. (SFL), Teekay Tankers Ltd. (TNK), and Nordic American Tankers Ltd. (NAT), as well as the Guggenheim Shipping ETF (SEA). A crash like the one we saw in 2008 is unlikely to happen soon.

For more indicators on how China is doing, or to follow where the interbank interest rate is going, see our Macro Trends page.

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