Neil DennisIndustrial commodity prices have come under sharp pressure after China, one of the world's biggest consumers of metals and fuel, had its credit rating downgraded by Moody's.
Iron ore, copper, nickel and coal prices were all lower after the rating agency downgraded China's long-term local currency and foreign currency issuer ratings by one notch to A1 from Aa3. Moody's raised its outlook on China, however, to stable from negative.
Ratings from the Big Three
This was the first time Moody's has downgraded China's sovereign debt rating since 1989.
The big three rating agencies, Moody's, Standard & Poor's and Fitch, all have different ratings on China's debt – S&P has a AA- rating with a negative outlook, while Fitch's is A+ with stable outlook.
As can be seen in the chart below, the action by Moody's brought its rating into line with S&P, while Fitch is one notch below the other two.
The Big Three: Comparison of Moody's, S&P and Fitch ratings - Source: Wikimedia CommonsHowever, China's debt remains rated investment grade by all three agencies.
China’s debt issuance expected to rise
The move by Moody's reflects rising concerns that China's export-reliant economy will slow in the coming years as government reforms rebalance the economy to improve domestic demand.
"The downgrade reflects Moody's expectation that China's financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows," the agency said in the statement accompanying the downgrade.
Moody's expects China's debt issuance to increase in the coming years as its financial authorities provide monetary stimulus to the economy as it slows.
"The importance the authorities attach to maintaining robust growth will result in sustained policy stimulus, given the growing structural impediments to achieving current growth targets," Moody's said.
It continued: "Such stimulus will contribute to rising debt across the economy as a whole."
China’s growth slows
Industrial commodities are particularly sensitive to events in China, and slowing growth has hit the sector hard in the last six years.
Since 2010, when it recorded annual growth of 10.6%, China's economy has avoided a hard landing but has steadily slowed and in 2016 annual gross domestic product growth was down to 6.7%.
By western standards, 6.7% growth would appear stellar, but given China's history of high growth rates – averaging 9.9% between 1979-2010 – anything below 8% has lately been seen as less than pedestrian.
Commodity correlation
The correlation between China's growth and industrial commodities has been striking.
Just a few months after China recorded annual GDP of 14.2% in 2007, the Bloomberg Commodity Total Return index peaked, then tumbled during the first weeks of the financial crisis.
The Bloomberg index hit another, smaller peak in 2011 – at the height of the so-called metals super-cycle – but has since fallen 61%.
At the super-cycle peak, copper prices hit record highs. Since July 2011 the US High Grade Copper front month futures price has tumbled 74% to $2.58/lb, having fallen 0.8% today.
Iron ore prices peaked in February 2011, but after falling 1.9% today the price of Nymex Iron Ore 62% Fe was down to $61.90/tonne, a loss of 181% in little more than six years.
People's Bank of China: The central bank has around $3tn in foreign reserves to help maintain market stability - Source: Wikimedia CommonsSuper-cycle over
Many believe that this correction was due – that the super-cycle which peaked in 2011 was overdone – and that we now have more realistic market prices.
Moreover, analysts believe that markets have come to expect a slightly slower rate of growth from China as its economy – still the world's second biggest – continues to mature.
"Growing evidence that China’s economy is slowing has triggered recent falls in domestic equity and global commodity markets, but there has been no repeat of the broad global sell-off that accompanied worries about China in the recent past," say analysts at Capital Economics.
"This is a reasonable response – China’s growth may have peaked but it isn’t slumping."
Investment grade China
And it is this sentiment that is key to the Moody's move. The rating agency still considers China debt as an investment grade security.
The risks are balanced, Moody's says, but importantly: "China's sizeable foreign exchange reserves of around $3tn give the central bank abundant financial power to preserve the stability of the currency and thereby avoid financially destabilising scenarios of capital flight."
This should help underpin the markets. Those stock markets most exposed to China, particularly Australia, felt little or no impact from the Moody's move today – although the agency made its move fairly late on in Australia's trading day.