News of the week summary - 07/16/2023

China will increase support for the property sector to stabilize the economy

China is poised to introduce additional economic support measures as a response to extending loan relief for developers, according to reports from state-run financial newspapers. 

In a joint statement, the People's Bank of China (the Chinese central bank) and the Chinese financial regulatory administration have pushed financial institutions to extend loan terms for property companies. This decision reflects regulators' belief that it will take longer than anticipated for developers to normalize fundraising and operations, suggesting that the housing market and developer risks are more severe than initially assessed.

Around 30% to 40% of developers' total debts consist of loans due by the end of 2024, which, if implemented, may alleviate developers' liquidity concerns in the short term. China's property crisis has hindered the country's economic recovery, leading to expectations of further government intervention to stimulate demand. To resuscitate the market, regulators are expected to implement more supportive policies, including reducing down payments in specific non-core neighborhoods, lowering agent commissions, and relaxing restrictions on residential purchases. Chinese financial publications suggest that China will accelerate policy rollout to foster the stable development of the real estate market and boost business confidence among private, state-owned, and foreign firms.

Despite this, some experts believe that the measures introduced so far are insufficient to stabilize the property sector. The focus on developer financing is seen as inadequate to address the broader issues facing the housing market. Analysts anticipate further easing measures on the demand side, such as lower down-payment ratios and eased purchase restrictions. However, these relaxations may be limited to smaller regions, rather than broad city-wide applications. The complexity of the property market may prevent a quick and comprehensive solution to the crisis.

Chinese exports lower than expected

China's trade is facing challenges due to a decline in foreign shipments and weak domestic demand, aggravated by a gloomy global growth outlook and geopolitical tensions. In June, China's exports decreased by 12.4% in dollar terms, marking the second consecutive month of declines and the sharpest drop since the start of the pandemic in 2020. Imports also fell by 6.8%, resulting in a trade surplus of around 70 billion dollars for the month. This weakening of export demand is a widespread issue, with notable declines in exports to the US, Asean, South Korea, Japan, Taiwan, and various European countries.

The decline in global demand, coupled with central banks' potential interest rate hikes to combat inflation, makes it unlikely that foreign demand for Chinese goods will provide substantial support for the country's economic recovery. The global economy's sluggish growth and potential for a mild recession in the US further complicate the situation. There is also the risk of an escalating technology trade war with the US, which could have consequences for certain exports.

The use of "basis trade" strategy by hedge funds could amplify financial stress

Hedge funds' leveraged trade (meaning through debt) in US Treasury futures has raised concerns about global financial stability, according to the Bank of England (UK's central bank). Short positions in Treasury futures by leveraged investors have increased recently. In the event of significant price movements, deleveraging these positions could amplify financial stress. Hedge funds use this strategy, known as the basis trade, to exploit pricing differences between cash bonds and futures. Although it tends to work well in low volatility environments, it backfired during the pandemic in 2020.

The BOE warns that these risks have not been adequately addressed and could re-emerge, particularly given the potential for higher interest rates and increased market volatility. Increased scrutiny on financial stability risks posed by non-banks is becoming a global concern, especially after the UK's bond market experienced a significant downturn in 2020. The BOE has expanded its stress tests to include hedge funds and pension firms. The basis trade has also drawn attention in the US, with inquiries by regulatory authorities and the Federal Reserve.

Inflationnary pressures ease in France

In France, inflationary pressures are showing signs of easing as fewer firms are raising prices, and some are even reducing them. According to France's central bank monthly survey, only 8% of industrial companies implemented price increases in June, the lowest proportion in over two years. Meanwhile, 6% of companies reduced tariffs, reaching a near three-year high. In the construction sector, fewer businesses raised prices in June compared to May, and the situation remained stable in the services sector.

Bank of France Governor Francois Villeroy de Galhau expects a noticeable slowdown in the pace of consumer price increases in the coming year, despite potential persistence in price increases for core consumer goods and services. This signals that the euro area may be moving past the peak of its inflation spike, prompting discussions within the European Central Bank about the timing of interest rate increases. Villeroy believes that the high point of interest rates is nearing, and a plateau will follow, emphasizing the need to maintain this level for an extended period to achieve the target inflation rate of 2%.

The survey also indicates that economic activity in France is holding up, with growth in industry, services, and construction in June. The Bank of France maintains its forecast of a 0.1% expansion in gross domestic product for the second quarter. The governor suggests that the positive outlook is indicative of the French and European economies gradually emerging from inflationary pressures while avoiding a recession.