From the perspective of monitoring an unfolding global crisis, things turned only more concerning this week. The Shanghai Composite declined to 2,450 in early Friday trading, the low since November 2014 – and down almost 26% y-t-d. Across the globe in Europe, Italian 10-year yields jumped to 3.80% in early-Friday trading, the high going back to January 2014. The spread between Italian and German 10-year sovereign yields surged to as high as 340bps, the widest spread since March 2013.
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October 19 – Reuters (Samuel Shen, Andrew Galbraith and Noah Sin): “China’s regulators lined up to rally market confidence on Friday with new rules, measures and words of comfort… Vice Premier Liu He, who oversees the economy and the financial sector, supplemented regulators’ moves by saying the recent stock market slump ‘provides good investment opportunity…’ Earlier in the day, the securities regulator, central bank and banking and insurance regulator all pledged steps to bolster market sentiment… Friday’s announcements were largely aimed at putting a floor under the tumbling stock market.”
“With pressure mounting and anxiety setting in, China’s stock markets are anticipating the comeback of the ‘national team,'” read the opening sentence of an early-Friday morning article from Beijing-based business media group Caixin. Sure enough, the Shanghai Composite rallied 4.1% off morning lows to close the session up 2.6%. The ChiNext growth index surged 5.6% from its opening level to gain 3.7% for the day. Friday’s afternoon rally, however, couldn’t erase the week’s losses. The Shanghai Composite ended this week down another 2.2%. ChiNext’s Friday melt-up reduced the week’s losses to 1.5%.
October 19 – Reuters (Massimiliano Di Giorgio): “European Economics Commissioner Pierre Moscovici said on Friday he wanted to reduce tensions with Italy over its 2019 budget, adding it was important to see how Rome responded to the Commission’s objections to the fiscal plan. Speaking at a news conference after a two-day visit to Rome, Moscovici said Brussels shared Italy’s declared goals of boosting growth and cutting debt, and reiterated that no decision had yet been taken over the budget. He said he wanted to ‘reduce tensions and maintain a constructive dialogue’ with Italian authorities…”
At least for a few hours, Commissioner Moscovici’s comments quelled tensions in the Italian (and European) bond market. After trading as high as 3.80% early in Friday’s session, yields then sank 32 bps to end the week at 3.48%. Italy’s bank index rallied almost 5% off intraday lows to end the session down 0.4% – and the week down 2.9%. Italy’s MIB equities index rallied 2.0% to end the day little changed (down 0.9% for the week).
It’s worth noting that Spain’s 10-year yields ended the week up six bps to 1.73%, trading this week to the highest yields since March 2017. Things were looking dicey early Friday, as Spanish yields jumped to 1.82%. This briefly pushed the Spanish to German sovereign yield spread to 140 bps, the wide since March 2017. Portuguese yields traded as high as 2.11% Friday morning, with the spread to bunds widening to 170 bps (widest since May). Portuguese yields ended the week at 2.01%.
European debt markets dodged a bullet. After trading down to about 39 bps early Friday, German bund yields ended the week four bps lower at 0.46%. Friday afternoon’s bond rally pushed Italian yields down nine bps for the week to 3.47%. Portuguese yields ended the week two bps lower and French yields three bps lower. Moscovici saved the day, reversing what appeared to have the makings of a problematic de-leveraging episode and blowout in European periphery yield spreads.
October 17 – Bloomberg: “China’s broadest measure of new credit jumped in September, exceeding all estimates, as officials changed the dataset to reflect surging bond issuance amid steps to encourage investment in infrastructure. Aggregate financing stood at 2.21 trillion yuan ($319bn) in September… That compares with an estimated 1.55 trillion yuan… The central bank revised the calculation for aggregate financing for a second time this year, adding in local government special bond issuance. That took the total in August to 1.93 trillion yuan, from 1.52 trillion yuan previously. New yuan loans stood at 1.38 trillion yuan, versus a projected 1.36 trillion yuan and 1.28 trillion yuan the previous month. Broad M2 money supply increased 8.3%, from 8.2% in August. China’s policy makers have stepped up their efforts to increase credit supply…”
It is not only the Europeans galvanized to quash intensifying Crisis Dynamics. China’s September Credit data was an eye-opener. “Aggregate financing” jumped to 2.210 TN RMB, or $319 billion, with system Credit continuing its ongoing double-digit annual expansion (10.6%). September growth was about 40% above estimates and a 45% jump from August (growth is typically stronger in September). This puts system Credit growth (excluding national government borrowings) for the first nine month of 2018 at $2.087 TN, down about 10% from comparable 2017. Q3 Credit growth, however, ran slightly ahead of Q3 2017.
Chinese officials again adjusted the composition of aggregate financing data, which now includes local government bond issuance. According to Bloomberg (Chang Shu and Justin Jimenez) “netting out the new sub-component…, the figure comes in… lower than the consensus forecast.” September saw enormous issuance of “special local government bonds” (apparently for infrastructure spending), more than offsetting the ongoing contraction of “shadow” lending. Barely positive for the month, net Corporate Bond Issuance slowed notably.
New bank loans came in at about $200bn, only somewhat above estimates. Year-to-date, new loans are running 18% above comparable 2017. Consumer (chiefly mortgage) borrowings remained quite strong, at $108bn in September. This puts y-t-d consumer borrowings 18.2% above comparable ’17.
October 15 – Bloomberg (Chris Anstey): “China’s moves to boost liquidity in an effort to safeguard economic growth are eroding the country’s yield premium over the U.S., putting ‘renewed pressure’ on the yuan, according to Citigroup… ‘Going by its latest policy moves, China has likely halted or even abandoned its financial-deleveraging program’ amid the trade war with the U.S., Liu Li-Gang, chief China economist at Citigroup…, wrote… The People’s Bank of China has pumped 3.4 trillion yuan ($492bn) into the banking system so far this year through regular open-market operations and cuts in lenders’ required reserve ratios, Citigroup estimates.”
Beijing these days faces a very serious dilemma managing system Credit. As has become over the years quite the pernicious habit, officials are responding to heightened Bubble Fragility by aggressively stimulating system Credit. They would surely favor the expansion of productive Credit, but increasingly it appears they’ll take lending growth wherever they can get it. Portends trouble.
A few of the more obvious problems: 1) Especially with the crackdown on “shadow” finance, Beijing now pushes enormous quantities of risky late-cycle Credit into an already bloated and vulnerable banking system. 2) Stimulus measures are prolonging late-cycle excess throughout increasingly fragile mortgage and apartment Bubbles. 3) China risks stirring further consumer price inflation momentum. September’s 2.5% y-o-y CPI rise was exceeded only one month going back to 2013. 4) The size and characteristics of China’s runaway Credit expansion pose escalating risk to their already vulnerable currency.
October 14 – Reuters (Clare Jim): “China’s property developers usually look forward to the months dubbed ‘Golden September and Silver October’ as the high season for new home sales. This year is proving to be different. Instead, they are feeling a chill and one major realtor has warned that ‘winter’ is coming as developers struggle to maintain sales momentum despite gimmicky promotions and discounts. After almost two years of local and central government measures to calm the red-hot market, more signs are emerging that the property sector, a major pillar of China’s economic health, is finally slowing down… ‘There’s downward pressure on home prices especially in third and fourth-tier cities,’ said Nomura chief China economist Ting Lu. ‘They have been previously rising on stimulus policies for two to three years and now they have reached a peak.'”
October 16 – Financial Times (Tom Hancock): “A wave of protests by Chinese homeowners against falling property prices in several cities has raised fears of a downturn in the country’s real estate market, adding to pressure on Beijing to stimulate the economy. Homeowners in Shanghai and other large cities took to the streets this month to demand refunds on their homes after property developers cut prices on new properties to stimulate sales. In Shanghai, dozens of angry homeowners descended on the sales office of a complex that offered 25% discounts to demand refunds, causing clashes that damaged the sales office, according to online reports that were quickly removed by censors. Similar protests have been reported in the large cities of Xiamen and Guiyang as well as several smaller cities.”
Keep in mind that these are China’s inaugural mortgage and housing Bubbles. Borrowers have never experienced a nationwide downturn. Neither have bankers; same for regulators. A housing bust would pose risk to social stability, not to mention the banking system and economy. Chinese officials over the years have tried about everything to rein in the Bubble. They were just never willing to inflict the degree of pain necessary to break inflationary psychology. They mistakenly cultivated the perception apartment prices only rise and Beijing will always act to support the market. Now they face a gargantuan Bubble with limited options.
The easy bet is that Beijing will see few alternatives than to adopt only more aggressive reflationary measures (they “worked,” after all, in the U.S. and elsewhere!). But will China enjoy the latitude to pull it off? There’s a question well worth pondering: “Is China ’emerging’ or ‘developed’?” Emerging economies invariably lose the flexibility for aggressive Credit expansion and system reflation. Over recent months, we’ve watched Argentina hike rates to 60%, Turkey to 24% and other EM central banks raise rates more moderately, all measures to stem the risk of disorderly currency collapse.
Will China retain the flexibility to set low interest rates, to aggressively expand Credit along with adopting other reflationary measures? Or is China, the “King of EM,” facing the prospect of a destabilizing currency crisis? A scenario where China is forced to hike rates to support the renminbi would be so destabilizing for its apartment Bubble and banking system that it’s difficult to contemplate. That leaves international reserve holdings, capital controls and a rather pressing question: How much “hot money” (and leverage) has gravitated to China’s high-yielding instruments?
When I ponder China’s incredibly bloated banking sector, its historic apartment Bubble, its local government debt issues, massive future national government borrowings – and likely one of the most maladjusted economies ever – I unfortunately don’t see a stable currency in China’s future.
October 16 – Financial Times (Don Weinland): “China could be facing a ‘debt iceberg with titanic credit risks’ following a boom in infrastructure projects by local governments around the country, S&P Global has warned. Local governments may have accrued a debt pile hidden off their balance sheet as high as Rmb30tn to Rmb40tn ($4.3tn to $5.8tn) following ‘rampant’ growth in borrowings, the rating agency estimated. The mounting debt in so-called local government financing vehicles, or LGFVs, hit an ‘alarming’ 60% of China’s gross domestic product at the end of last year and was expected to lead to increasing defaults at companies connected to regional authorities… Richard Langberg, an analyst at S&P, said there are Chinese cities with ‘hundreds’ of the local financing vehicles across the country. While defaults at a handful of smaller LGFVs could be handled by the financial sector, ‘if they start to let the bigger ones go then we are getting into uncharted territory,’ he said.”
October 16 – Bloomberg: “The rout in Chinese equities is throwing the spotlight on $613 billion of shares pledged as collateral for loans. Loans extended to company founders and other major investors who pledged their shareholdings as collateral emerged as a popular financing channel in recent years. But given the losses in equities — Shenzhen’s stock benchmark is down 33% in 2018 — there’s a growing risk that brokerages will be forced to sell the shares, accelerating the downturn. At least 36 companies have seen pledged shares liquidated by brokerages since the start of June, more than triple the 10 in the first five months of the year… At least two firms announced after Monday’s close that their shares were at risk of forced selling… ‘There’s a liquidity crisis in the stock market, and pledged shares are again starting to sound the alarm,’ said Yang Hai, analyst at Kaiyuan Securities Co. ‘If there are no real policies to cure the array of problems and ailments in our market, no one will be willing to take the risk.'”
Reports say a meeting is being arranged between President Trump and Chinese President Xi Jinping at the coming G20 meeting, tentatively for November 29th. Much could unfold by then. The mid-terms are now just two weeks from Tuesday. And it is especially challenging to look out six weeks and contemplate the status of global markets. “Risk off” has gained significant momentum around the globe.
With their stock market in a tailspin, one might expect the Chinese to be rather motivated to adopt conciliatory language and work toward progress on the trade front. Yet there’s another scenario that’s not as obvious – and certainly not comforting. Mr. Xi and Chinese leadership may feel they have been betrayed and mocked. They distrust the Trump administration, now recognizing their true objective is not trade as much as it is containing China’s ascending financial, economic, technological, military and geopolitical power. They are livid that the administration would adopt such a belligerent approach and relish in China’s financial distress. A new Cold War has commenced. It would be a zero-sum battle of rival superpowers.
The administration clearly believes they have the Chinese right where they want them. President Trump is quick to note the big decline in China’s stock market. For a number of years now, I’ve feared a major consequence of a bursting Bubble would be the Chinese blaming “foreigners” (chiefly the U.S. and Japan) for their hardship. I just never imagined it would be so straightforward for Beijing to directly link a cause and effect.
The Chinese Bubble is again at the precipice. The last comparable episode, back in late-2015/early-2016, came in different global backdrop. China implemented additional stimulus measures, while the ECB and BOJ boosted QE and the Fed postponed “normalization”. For the most part, rates were near zero globally and bond yields were declining. Pricing pressures were still leaning disinflationary. Global risk markets were neither as inflated nor as fragile as now.
That crisis episode saw the PBOC employ $100s of billions of reserves to stabilize the Chinese currency, in a global backdrop approaching $2.0 TN of annualized central bank liquidity injections. Back then, China was facing a relatively stronger economy and a booming apartment Bubble inclined for “Terminal Phase” excess.
The Chinese have considerably less flexibility today. The burst EM Bubble poses major financial and economic risks for a much more fragile Chinese system. At about $3.0 TN, China’s international reserves are down a (mere) trillion from 2014 highs. And pushing more Credit, investment and speculation into Chinese housing at this “Terminal Phase” is a perilous proposition.
For too long China needed to rein in Credit growth. They made an attempt. Not surprisingly, the results have been unsatisfying. The risk of Bubble implosion has now incited yet another round of stimulus measures. But Bubble risk is indomitable, risk that expands parabolically during the “Terminal Phase.” I believe there are a number of important factors – domestic and international, economic and financial – working against Beijing’s current stabilization efforts. Chinese officials might be at the cusp of finally losing control. The Trump administration provides a most convenient scapegoat.
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