Please see below article received from Legal & General yesterday afternoon, which provides an update on China’s high-yield bond market and Chinese equities, and how they may affect currency, commodity, and Western equity markets.
Four is the magic number
Throughout the rout, our emerging-market economists have maintained a very consistent line of argument: the consensus is underestimating the likely hit to growth associated with this squeeze on property developers, and the government’s threshold for intervention is further away than the market thinks.
That changed last week. The consensus seems to have finally capitulated, with a number of high-profile downgrades to growth outlooks. We think that we are now nearing the 4% line in the sand for the government: growth below that level puts long-term prosperity goals at risk, and is not consistent with the need to maintain a robust jobs market.
With the market having finally adjusted enough, we are also seeing the first signs of a policy response in relaxed restrictions for homebuyers’ access to mortgage finance and a dilution of the “three red lines” policy that has constrained highly leveraged developers.
On Wednesday, the People’s Bank of China took the unusual step of publishing monthly mortgage lending data for the first time, seemingly to highlight the nascent recovery at the start of the fourth quarter. The state-owned Securities Times opined that “for real-estate developers, the feeling of the recovery of the financing environment will become more and more obvious” going forwards.
For us, that all adds up to a signal that we are hitting a policy inflection point. That encourages us to dial up exposure to the theme: either directly through China’s high-yield bond market, or indirectly through Chinese equities. We might find the intentions of the authorities hard to understand at times, but we don’t think it’s sensible to doubt their ability to underwrite the near-term growth outlook when they see fit.
At sixes and sevens over US inflation
We learnt last week that US inflation hit 6.2% in October. That’s the highest rate since November 1990, the month “Home Alone” was released in cinemas. However you choose to slice and dice the data (core, median, trimmed mean, etc), inflation pressures look to be broadening.
On the Atlanta Fed’s underlying inflation dashboard, there are now a lot of red lights flashing and there are growing warnings of a peak at or above 7% in the months ahead.
But the bond market has been a fickle friend to the vigilantes this year. Anyone who sold out of the longest-maturity bonds in the spring in anticipation of the string of upside inflation surprises has been disappointed, with 30-year futures rallying over 10% since March. The financial media have been full of anecdotes in recent weeks of storied macro hedge funds suffering gut-wrenching losses on bond trades gone awry. Recent price action suggests that, in the wake of those losses, there has been considerable forced liquidation of positions.
For us, that “cleaning up” of the market makes it interesting to sell duration again. Last week, we did exactly that in both the US and Europe across dynamically managed portfolios.
When Kevin McCallister was busy defending his home against the Wet Bandits in 1990, 10-year US Treasury yields were above 8.5%. The contrast with today could barely be more different, with yields now at the dizzy heights of 1.5%.
In the US, we think that some sterner words from the Federal Reserve await in the weeks ahead. In Europe, bond scarcity has driven the short end of the German curve below money-market rates. Risks are never entirely one-sided, but we’re happy to run with tactical duration shorts against that backdrop.
Can a stitch in time save nine?
The University of Michigan survey of consumer sentiment has tumbled to levels rarely seen outside recessions. The survey’s chief economist noted: “Consumer sentiment fell in early November to its lowest level in a decade due to an escalating inflation rate and the growing belief among consumers that no effective policies have yet been developed to reduce the damage from surging inflation.”
And it’s not just US consumers feeling the pinch. In the face of tumbling approval ratings, Joe Biden has suddenly propelled inflation-fighting to the top of his economic agenda, arguing that “reversing this trend is a top priority for me”.
It’s unclear what that means. Throwing federal money around like confetti is a strange way to fight inflation, but the administration continues to insist that the recently signed Infrastructure Bill and the larger “Build Back Better” agenda have nothing to do with the price pressures in the economy. They even have the chutzpah to argue that these programmes – aimed at tackling a host of other pressing challenges – will help pull down inflation by bolstering the supply side of the economy.
Perhaps the most obvious inflation-fighting tools in the administration’s arsenal are releasing oil from the Strategic Petroleum Reserve (SPR) and cutting tariffs on Chinese imports. The SPR contains the equivalent of 600 million barrels of oil in underground tanks in Louisiana and Texas. It was used to lean against oil prices in 2011 under the Obama administration (with Joe Biden in the Vice President’s office) and has been under discussion by the administration over the past month. This obviously wouldn’t be a long-term fix to cool oil prices, but it would represent a short-term supply boost of up to 4.5 million barrels per day.
Tariffs have been frozen since the Trump presidency at an average rate of just above 19% (up from 3% before the trade war started). It would have seemed unthinkable a few months ago that Biden would consider rolling back tariffs given the political danger of being outflanked by the Republicans on this issue.
However, maybe that calculus is changing with the growing inflation concerns. Tariff reduction would offer marginal relief on the outlook for both US inflation and Chinese growth. It would be very warmly welcomed by financial markets as a result. A virtual summit between Presidents Xi and Biden is scheduled for this week. We’ll be watching closely for any hints of a thaw in relations.
Please check in again with us soon for more relevant content and news.