Remember when everyone said
That Jay and his friends at the Fed
Would taper their buying
While still pacifying
Investors, lest screens all turn red?
Well, what if before the Fed spoke
That Evergrande quickly went broke?
Would traders still bet
The buying of debt
Will end? Or would that, fear, provoke?
Fear is in the air this morning as concerns over the status of China Evergrande’s ability to repay its mountain of debt seriously escalate. Remember, Evergrande is the Chinese property developer with more than $300 billion in debt outstanding, and that has said they will not be repaying an $84 million loan due today, with the prospect for interest payments due this Thursday also gravely in doubt. One cannot be surprised that the Hang Seng (-3.3%) reacted so negatively this morning, after all, that is the Evergrande’s main listing exchange. Other property developers listed there came under substantial pressure as well, with one (Sinic Holdings Group) seeing its price fall 87% before trading was suspended.
Of equal interest to the fact that equity markets are trembling on the Evergrande story is the plethora of press that continues to explain that even if Evergrande goes bust, any fallout will be limited. Columnists and pundits point to the damage that occurred when the Fed allowed Lehman Brothers to go bust and explain that will never be allowed again. And while I’m certain they are correct, financial officials have exactly zero interest in allowing that type of situation to repeat, it remains far from clear they can prevent it. That is, of course, unless the Chinese government is going to step in and pay the debts, something that seems highly unlikely. As I continue to read and hear how this situation is nothing like Lehman, having had a front row seat to that disaster, I cannot help but see a great many parallels, including many assurances that the underlying cause of that contagion, subprime mortgage loans, was a small portion of the market and any fallout would be controlled. We all know how well that worked out.
Remember, too, that Chinese President Xi Jinping has been aggressively attacking different sectors of the Chinese economy, specifically those sectors where great wealth (and power) was amassed and has implemented numerous changes to the previous rules. This is the key reason the Shanghai stock market has underperformed the S&P 500 by 25% over the past year. One of Xi’s problems is that property development has been a critical part of the growth of China’s economy and a source of significant income to all the provinces and cities. Proceeds from the sales of property have funded infrastructure as well as helped moderate taxes. If Evergrande goes under, the impact on the entire Chinese economy seems likely to be significant. And all this is happening while the growth in China’s credit impulse has been declining rapidly, portending slower growth there anyway.
History has shown that situations of this nature are rarely effectively contained and there is usually fallout across numerous different areas. Consider that global equity market indices have been hovering just below all-time high levels with stretched valuations on any measure on the basis of TINA and FOMO. But between the two key emotions evident in investing, fear and greed, I assure you, fear is by far the more powerful. While anything can still happen, fear is starting to spread more widely today than last week as evidenced by the sea of red across all equity markets today.
If you think that the Fed is going to taper their asset purchases into a period of market weakness, you are gravely mistaken. The combination of slowing growth and market fear will induce a call for more support, not less, and history has shown that ever since October 1987 and Alan Greenspan’s response to Black Monday, the Fed will respond with more money. The question this time is, will it be enough to stop the fall? Interesting times lie ahead.
Most of Asia was on holiday last night, with only Hong Kong and Australia (ASX 200 -2.1%) open. But Europe is open for business and the picture is not pretty. The FTSE 100 (-1.55%) is the best performing market today with the continent (DAX -2.15%, CAC -2.1%) emblematic of every market currently open. US futures, meanwhile, are the relative winners with losses ‘only’ ranging from the NASDAQ (-1.1%) to the Dow (-1.6%). Now, don’t you feel better?
It can be no surprise that bonds are in demand this morning as risk is undeniably ‘off’ across all markets. Treasury yields have fallen 3.6bps amid a flattening yield curve, while European sovereigns have all seen price gains as well with yields there slipping between 2.6bps (OATs) and 3.2 bps (Bunds). In every case, we are seeing yield curves flatten, which tends to imply an increasing expectation of weaker economic activity.
Commodity prices are broadly under pressure as well this morning, with oil (-2.0%) leading the way but weakness across industrial metals (Cu -2.0%, Al -0.65%, Sn -1.2%) and agriculturals (corn -1.6%, wheat -0.9%, soybeans -1.0%) as well. Gold (+0.2%) on the other hand, seems to have retained some of its haven status.
Speaking of havens, the dollar, yen and Swiss franc remain the currencies of choice in a crisis, so it should be no surprise they are today’s leaders. Versus the dollar, the yen (+0.4%) and franc (+0.2%) are the only gainers on the day. Elsewhere in the G10, AUD (-0.55%), SEK (-0.5%), CAD (-0.5%) and NOK (-0.4%) are the worst performers. Obviously, oil’s decline is weighing on the krone and Loonie, but AUD is feeling it from the rest of the commodity complex, notably iron ore (Australia’s largest export by value) which has fallen to $105/ton, less than half its price on July 15th!
In the emerging markets, RUB (-0.8%) is feeling the heat from oil, while ZAR (-0.55%) has metals fatigue. But every EMG currency that was open last night or is trading right now is down versus the dollar, with no prospects of a rebound unless risk attitude changes. And that seems unlikely today.
On the data front, aside from the Fed on Wednesday, it is a housing related week.
|Wednesday||Existing Home Sales||5.88M|
|FOMC Rate Decision||0.00%-0.25%|
|Flash PMI Manufacturing||60.8|
|Friday||New Home Sales||710K|
As well as the Fed, on Thursday the Bank of England meets and while there is no expectation of a policy move then, there is increasing talk of tighter policy there as well. Again, if fear continues to dominate markets, central banks are highly unlikely to tighten, and, in fact, far more likely to add yet more liquidity to the system. Once the Fed meeting has passed, the FOMC members will get back out on the circuit to insure we understand what they are trying to do. so, we will hear from five of them on Friday, and then a bunch more activity next week.
Today’s watchword is fear. Markets are afraid and risk is being tossed overboard. Absent a comment or event that can offset the China Evergrande led story, I see no reason for the dollar to do anything but rally.
Good luck and stay safe