Burned After Reading
By Michael Every of Rabobank
Well, someone just got burned: and who is next?
USTs yields continue to fall and the US curve to bull flatten, shouting “policy error!” at the Fed and those in bond markets expecting both the Fed and other central banks to be hiking ahead. Like the Fed’s Bullard, with his stated threat of two hikes next year(!) Getting ahead of that curve, USTesla slumped 12% and is now down $199bn in just a few days. So much for asking for personal financial advice from Twitter in-between toilet humour. That dip may put back Musk’s upcoming trip to Mars. More so if Michael Burry of “The Big Short” fame is right.
US PPI yesterday stayed at a record high, if in line with market expectations, at 8.6% y/y. “Transitory.” Moreover, the NFIB survey’s ‘actual price changes’ sub-index hit 53, the highest since March 1980: it was 15 a year ago. Although below the peak of 67 seen in October 1974 following the oil-price spike after the Yom Kippur war, it means higher prices loom, just as high energy prices imply pricier food via fertilizers. It’s US CPI today, of course, where consensus is a 5.9% y/y print, the highest since December 1990. In response, the White House is again demanding OPEC+ pump more oil, which they refuse to do, and/or the US may release oil from its strategic reserve. Industry experts point out the issue is more of refining capacity, not physical supply constraints, which the strategic reserve is supposed to be for.
Fear not: Yellen says the Fed, which she doesn’t run, will not allow 1970’s style inflation to return. The same Yellen who told us there will never be another financial crisis in her lifetime, just as the Fed warns of the risks of one building even as it aims to raise rates. ‘Helpfully’, the CBO says it won’t have finished looking at the deficit implications of the Build Back Better bill by 15 November, suggesting infrastructure may be the only Biden bill to pass. If so, Yellen will be right: high inflation well into 2022 will be followed by deflation as demand collapses. Indeed, the NFIB outlook was -37 in October, the joint lowest with November 2012. Equally, while global export values appear to be doing well, this is inflation: volumes are far weaker – which might solve the crisis at ports the hard way. Yet if the CBO nods and BBB passes, it’s inflation and logjams.
A similar either/or plays out in China, where the “contained” Evergrande crisis –which even the Fed has noticed– is seeing contagion. Junk bond yields are soaring and the trend is spreading to better quality credits and large banks, with investment grade yields up 8-10bp yesterday. As developers who have not crossed any debt redlines ‘mysteriously’ see their bonds plunge, Bloomberg reports the 10 largest developers carry debts of $1.7 trillion…on book. Off book and contingent liabilities are likely *far* higher. Worse, Chinese cities are now tightening the use of proceeds from presold properties, effectively forcing developers to use this cashflow to finish construction rather to repay debts. Can you guess what happens next?
Yet Goldman is quoted saying: “It’s unlikely the government will tolerate the impact on growth that would come about if it were to allow such a large number of developers to fail,” and putting other people’s money where its mouth is by snapping up developers’ USD debts. The logic is that central banks bail us all out and common prosperity is just “regulatory change”. As Michael Pettis argues in a Godley/Minsky vein long echoed here, it is also that Beijing must U-turn, spend on infrastructure (which Simon Rabinovitch of The Economist shows is likely already overbuilt), or growth slumps and, as Bloomberg puts it, ‘China Looks a Lot Like Japan Did in the 1980s’.
The official Securities Times now reports developers may be allowed to issue more domestic bonds, which Chinese banks will buy (lucky them!), according to “unnamed sources”, while the New York Times take is ‘As China’s property crisis spreads, Beijing says there’s nothing to see’. As such, there appears push-and-pull over policy (or a time lag at the Times). Yet there is another option, which we saw echoes of in the sudden excitement in educational shares yesterday on news they could start after-school tuition again….before seeing it was on a limited non-profit basis, with the only cashflow from adult exam courses. Common prosperity over equity, sorry.
That option is this: don’t bail out all the developers; merge and nationalise the best; then use their physical capital to build social housing, not swanky apartments. Yes, there are still huge issues related to propping up property prices as de facto Chinese pensions, and massive lost tax revenues. But don’t rule it out: and imagine Wall Street backing the safe, low returns of an ‘ESG’ housing project it would never dream of financing in the US! In what may be a similar vein, China is also banning unlicensed firms and individuals from making product recommendations to its $3.7 trillion mutual funds industry. Is this a step towards funds being steered towards state goals? Have you looked at the trend in Western fund management?
Today also saw Chinese CPI at 1.5% y/y vs. 1.4% consensus and 0.7% last month, and PPI at 13.5% y/y vs. 12.1% expected and 10.7% prior. For PPI, that is the highest level since June 1995. Clearly the consumer side of things is getting worse but is still being protected by Beijing, but the producer side is being walloped. Yes, China should slowly get this PPI surge under control vis-à-vis electricity now it is going all in on coal again, and as the PBOC offers discounted 1.75% loans on national green products,…which may also be the new stimulus to offset housing. Food prices are potentially a very different issue, however.
Lastly, the White House is flexing its foreign policy muscles…over Bosnia, which should really be EU turf, and Nicaragua, calling its recent election “undemocratic” and threatening new sanctions. Nice to see that the big problems and big sanctions are being tackled head on at a time when China is building replicas of US navy vessels for target practice. Of course, Biden and Xi have an online summit next week, so there is that.
Wed, 11/10/2021 – 10:25