China Signals Curbs in Lending, Hitting Global Stocks and Commodities Hard

Risk assets, including U.S. stocks and commodities, took a big hit today as investors reacted to China signaling they intend to “prick” a speculative property bubble. Chinese bank regulators are telling some banks to cut back on property loans after pumping a record 9.6 trillion renminbi (US$1.4 trillion) in new loans during 2009.

In a press conference, Chairman of the China Banking Regulatory Commission, Liu Mingkang said China will set curbs on demand drivers of credit. He indicated Chinese government bank regulators will carefully monitor loans for real estate and local governments. Mr. Liu also indicated banks are projected to extend 7.5 trillion renminbi, (US$1.1 trillion) in loans this year which is down nearly 22 percent from last year’s record amount.

The Shanghai Shenzen dropped 3.2 percent today and the Hang Seng fell 1.8 percent.

In the United States, stocks were down sharply with the S&P 500 index down 1.06 percent and the NASDAQ down 1.26 percent.

The U.S. dollar strengthened as well, boosted by China pressuring lenders to cut back and on data showing benign inflation and a rise in housing permits. The U.S. dollar index, which tracks the dollar’s performance against a trade-weighted basket of six major currencies, jumped over 1.1 percent to 78.34, up from 77.451. The dollar also got a lift from a weaker euro as Greece continues to face a fiscal crisis placing pressure on the euro.

Commodities were weaker on the flurry of positive news for the greenback. Major sector ETF losers today include commodity plays iShares Silver Trust ($SLV) down 4.8 percent, Market Vectors Steel ETF ($SLX) down 3.1 percent, Market Vectors Coal ETF ($KOL) lower by 2.9 percent, United States Oil ($USO) down 2.7 percent, and SPDR Gold Shares ($GLD) down 2.3 percent.

This action by China is interpreted as a strong signal that the extraordinary liquidity provided by global central bankers may begin to be pulled back sooner than anticipated. The strongest economies in the world like China and Australia are likely to reduce monetary liquidity first, eventually followed by industrialized nations in Europe, Japan, and the United States.

Risk assets like equities and commodities are likely to suffer if monetary tightening signals accelerate in the industrialized nations, especially in the United States. The major questions for investors are how soon and how intense central banks will engage in monetary tightening. The answer to the question will differ by country and depend largely on strength in GDP growth and whether inflationary pressures build up quickly.

Why Did Oil Surge Higher This Week?

Crude oil futures prices surged higher this week on supply concerns due to rising tensions in the Middle East, colder weather forecasts, and improved global economic growth prospects. A stronger U.S. dollar acted to temper the gains.

Middle East Tensions

Late Friday, Iraq said there was an Iranian incursion into an Iraqi oil field 280 miles south of Baghdad, elevating geo-political tensions and driving spot crude prices just above $74 a barrel. Iraq’s National Security Council asked Iran to withdraw its forces from the region.

Earlier in the week, Iran also successfully tested a long-range missile, receiving rebukes from the U.S. and and the United Kingdom. U.K. Prime Minister Gordon Brown also threatened sanctions.

Iraq is the third largest oil producer in the Middle East and Iran is the second largest.

Colder Weather Forecast

Between January and March, below-normal temperatures are expected from the U.S. Gulf Coast to the mid-Atlantic region, the National Oceanic and Atmospheric Administration said Thursday. Meteorologists are also anticipating colder weather in the eastern U.S. until the end of December.

Signals of a Stronger U.S. and Global Economy

On Wednesday, Federal Reserve officials declared that financial markets were healthy enough to remove emergency monetary supports. This was interpreted by oil traders that the U.S. economy may have turned the corner and be able to continue with positive growth, another bullish signal for increased oil consumption.

The Energy Department also said on Wednesday of this week that U.S. crude oil inventories declined to the lowest level since Jan. 9. Distillates inventories also fell 2.95 million barrels to 164.4 million barrels.

On Tuesday, OPEC also bumped its 2010 forecast for global oil demand slightly higher. OPEC said in its December Monthly Oil Market Report that demand for OPEC crude was expected to increase 100,000 barrels per day, or 30,000 barrels a day more than its previous month’s forecast on a baseline of 26,610,000 barrels per day in November..

A Stronger Dollar Tempers the Price of Oil

Oil prices backed off at the end of the day as the greenback advanced for a fourth straight day against a basket of six major currencies. Light, sweet crude January future price climbed $3.34 from last Friday’s closing price of $69.62 to close today at $72.96 per barrel.

The U.S. Dollar Index strengthened 1.7 percent for the week rising to 77.35 at 2:30 p.m. in New York, compared with 76.38 on Monday. Earlier, the greenback touched 78.14, the highest level since early September.

The U.S. Dollar Index measures the performance of the U.S. dollar against a basket of currencies including the Euro, Japanese Yen, British Pound, Canadian Dollar, Swiss Franc, and Swedish Krona. Initiated at a 100 value, it was created in March 1973 soon after the Bretton Woods system was dismantled. It has traded as high as the mid-160s and as low as 70.70 on March 16, 2008.

Rising geo-political tensions in the Middle East combined with ongoing worries about sovereign debt problems in Greece potentially impacting the Euro caught the attention of currency traders . As a result, traders were quick to reverse short trades betting that the greenback would fall further in value. A stronger dollar is generally associated with falling commodity prices, including oil.

Gasoline prices

For the tenth consecutive day, prices at the pump declined. The national average price of unleaded gasoline dropped slightly to $2.589 per gallon from Thursday’s $2.59 per gallon according to motorist advocate AAA.

ETF Market Action

The United States Oil Fund, an exchange traded fund (ETF) designed to track the movements of light, sweet crude oil ($USO) rose from $35.62 on the Monday morning open to close at $36.66 on Friday. In Friday trading, the price of the ProShares Ultra Crude Oil ETF ($UCO)  jumped higher by 1.7 percent from $10.96 to $11.15.