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Massive Bailout’ Needed in China, Banking Analyst Chu Says

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Charlene Chu

Charlene Chu, a banking analyst who made her name warning of the risks from China’s credit binge, said a bailout in the trillions of dollars is needed to tackle the bad-debt burden dragging down the nation’s economy.

Speaking eight days after a Communist Party newspaper highlighted dangers from the build-up of debt, Chu, a partner at Autonomous Research, said she was yet to be convinced the government is serious about deleveraging and eliminating industry overcapacity.

QUICKTAKE China’s Pain Points

She also argued that lenders’ off-balance-sheet portfolios of wealth-management products are the biggest immediate threat to the nation’s financial system, with similarities to Western bank exposures in 2008 that helped to trigger a global meltdown.

The former Fitch Ratings analyst uses a top-down approach to calculating China’s bad-debt levels as the credit to gross domestic product ratio worsens, requiring more credit to generate each unit of GDP.

While Chu is on the bearish side of the debate about the outlook for China, she’s not alone. In a report on Monday, Societe Generale SA analysts said that Chinese banks may ultimately face 8 trillion yuan ($1.2 trillion) in losses and a bailout from the government, citing the scale of soured credit within state-owned enterprises.

Interviewed in Hong Kong last week, Chu estimated as much as 22 percent of all China’s outstanding credit may be nonperforming by the end of this year, compared with an official bad-loan number for banks in March of 1.75 percent.

Question

What do you see as the biggest risk in the financial system?

Answer

“China’s debt problems are large and severe, but in some respects a slow burn. Over the near term, we think the biggest risk is banks’ WMP portfolios. The stock of Chinese banks’ off-balance-sheet WMPs grew 73 percent last year. There is nothing in the Chinese economy that supports a 73 percent growth rate of anything at the moment. Regardless of all of the headlines and announcements about the authorities cracking down on WMPs, they have done very little, really, and issuance continues to accelerate.

“We call off-balance-sheet WMPs a hidden second balance sheet because that’s really what it is — it’s a hidden pool of liabilities and assets. In this way, it’s similar to the Special Investment Vehicles and conduits that the Western banks had in 2008, which nobody paid attention to until everything fell apart and they had to be incorporated on-balance-sheet.

“The mid-tier lenders is where these second balance sheets are very large. China Merchants Bank is a good example. Their second balance sheet is close to 40 percent of their on-balance-sheet liabilities. Enormous.”

Question

Who buys a WMP?

Answer

“The products used to be predominantly sold to the public, but now they’re increasingly being sold to banks and other WMPs. We’re starting to see layers of liabilities built upon the same underlying assets, much like we did with subprime asset-backed securities, collateralized debt obligations, and CDOs-squared in the U.S. The range of assets is much more diverse than mortgages, but we have significantly less visibility on the assets than we did with subprime.”

Question

After the People’s Daily commentary, is it clear that the government is serious about deleveraging?

Answer

“The word deleveraging should not be used when discussing China. Deleveraging means negative credit growth, or a contraction in the ratio of credit to GDP. China is nowhere close to deleveraging. Over the years, I have learned from watching the authorities respond to issues like WMPs that there is often a large divergence between official rhetoric and actual action. It’s encouraging to see policy makers acknowledge the severe overcapacity problem, but I am sceptical that much headway will be made any time soon, given how painful implementation will be and the pushback they will inevitably receive at local levels.”

Question

Is a financial crisis or a very dramatic economic slowdown now inevitable?

Answer

“Not yet, but we’re getting there because the problem is getting so big. We’re still adding 10 to 20 percentage points to the ratio of credit to GDP every year — that has not changed despite the fact that credit growth has decelerated. If the government was to come out with a very aggressive — and it would have to be incredibly aggressive — bailout package for corporates, as well as financial institutions, it would do a lot in terms of dealing with some of this debt overhang and getting rid of the black cloud that’s hanging over the country. However, the idea that China needs a massive bailout in the trillions of U.S. dollars isn’t something I think the authorities are on board with or accept yet. They still believe they can grow out of it.”

Question

Could your assessment of China’s debt situation be based on faulty assumptions?

Answer

“If we’re wrong, and there’s always a chance of that, it’s going to be because we’re under-appreciating the economic growth potential in China — that there is some more strength to the consumption story and services story than we sense now, and that these are about to take off and propel the country out of these debt problems.”

Question

How does China’s debt build-up compare to Japan’s previously?

Answer

“If you look at Japan, the credit expansion wasn’t anywhere close to the size of China’s, and China’s continues to grow at a rapid rate. There is also a somewhat Wild West, chaotic nature to a lot of the shadow banking going on in China that is different from the shadow credit we saw in Japan. What’s positive for China is that they’ve got a leadership team that is not as afraid as the Japanese leadership is of radical change. So, if China’s authorities ever do decide debt is the center of their problems and they need to do something about it, we won’t have decades of complacency with nothing really done. On the negative side, China has a much weaker social safety net and a much poorer population, which makes social and political instability a real concern.”

Question

What’s your assessment of China’s capital flows?

Answer

“The party line is that outflows are all about offshore debt repayment, but that accounts for a minority of the flows we are seeing. We think most of the money is leaving through trade mis-invoicing, which is very hard to shut down. Although capital outflows have quieted down, the underlying motivations for people to move their money out of the country are still there. This problem has not gone away.”

Is the CEO/Founder of Investors King Limited. A proven foreign exchange research analyst and a published author on Yahoo Finance, Nasdaq, Entrepreneur.com, Investorplace, and many more. He has over two decades of experience in global financial markets.

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Gold

Gold Plunges as Recession Fear Disrupts Global Market

Gold, the world’s leading haven asset, plunged with global uncertainty as investors continued to accumulate Dollars ahead of the inevitable recession.

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gold bars - Investors King

Gold, the world’s leading haven asset, plunged with global uncertainty as investors continued to accumulate Dollars ahead of the inevitable recession.

In a recession, cash is the king. Hence, while global investors prefer to save in dollars, especially with borrowing costs on the rise and the Federal Open Market Committee (FOMC) expected to raise interest rates by another 50% to 75% basis points in the month of July.

The U.S Dollar rose to a 20-year high this week and is expected to continue in the near term as I do not see demand for the greenback abating anytime soon given the severity of global risks and uncertainty.

The price of gold dropped from $1814.19 per ounce it peaked on Monday to $1732.14 on Wednesday before slightly paring losses to $1743.74 at 10:36 am Nigerian time on Thursday.

“Gold’s price reaction has been rather muted as it had already started to price in a rising probability of another sharp rate hike in July,” said Suki Cooper, an analyst with Standard Chartered.

“In recent sessions, gold has succumbed to the risk-off sentiment as the dollar has benefited.” Risk-off is when traders and investors reduce their exposure to risk and concentrate on protecting their capital.

According to Tai Wong, an independent metals trader based in New York, rising interest rates means holding the dollar at no additional interest rate is better.

He said, “The hawkish Fed minutes which suggested an ‘even more restrictive stance’ provided no relief for metals markets.”

“While a short-covering rally is possible if payrolls are soft, a lasting upturn (for gold) will require a softer U.S. CPI reading next week. That’s needed to pull the Fed back from launching another massive tightening volley,” Wong added.

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Crude Oil

Oil Drops Below $100 a Barrel Amid Recession Concerns

Global oil prices plunged on Wednesday as concerns over demand outweighed supply concerns. Energy investors fear recession would hurt demand regardless of current supply challenges being faced by the OPEC and allies due to Russian sanctions.

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Oil

Global oil prices plunged on Wednesday as concerns over demand outweighed supply concerns. Energy investors fear recession would hurt demand regardless of current supply challenges being faced by the OPEC and allies due to Russian sanctions.

Brent crude oil, the international benchmark for Nigerian crude, plunged from $114.70 a barrel on Monday to $98.49 a barrel on Wednesday before pulling back to $100.21 a barrel on Thursday at 1:57 am Nigerian time.

The U.S. West Intermediate Oil fell to $93.15 a barrel on Wednesday before paring losses to $95.13 per barrel on Thursday.

Both contracts recorded their largest daily drop since March on Tuesday on recession fears and other bearish pressures, which also kept a lid on Wednesday’s price rise.

Oil prices have seen a knock from a resurgent dollar, which is holding at a 20-year high against the euro and multi-month peaks against other major currencies.

A stronger U.S. dollar usually makes oil more expensive in other currencies, which could curb demand.

Renewed concerns of COVID-19 lockdowns across China could also cap oil price gains.

Adding to the downward pressure on prices, all oil and gas fields that were affected by a strike in Norway’s petroleum sector are expected to be back in full operation within a couple of days, Equinor said on Wednesday.

Norway’s government intervened to end the strike on Tuesday.

But analysts expect a quick resurgence in oil prices as supply tightness persists, pointing to front-month spreads which have held up despite Tuesday’s price fall.

Brent’s six-month market structure was in steep backwardation of $14.82 a barrel, little changed from the previous day. Backwardation exists when contracts for near-term delivery of oil are priced higher than those for later months.

“The price action overnight, with both contracts trading in near 15 dollar ranges, hints more at panic and forced liquidation, than a structural change in the tight supply-demand situation globally,” said Jeffrey Halley, a senior market analyst at OANDA, adding that oil prices may be in danger of overshooting to the downside.

Meanwhile, Caspian Pipeline Consortium (CPC), which takes oil from Kazakhstan to the Black Sea via one of the world’s largest pipelines, has been told by a Russian court to suspend activity for 30 days, although sources said exports were still flowing.

Operations at Kazakhstan’s giant Tengiz oilfield were not disrupted by an explosion on Wednesday and were continuing, the operator said, after the blast killed two workers and injured three.

 

 

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Recession Meltdown

Recession fears buffeted markets overnight, with the price action across various asset classes looking like a self-sustaining negative feedback loop, triggering more stop losses as prices slumped and dragging in trend-following momentum-hunting fast money.

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By Jeffrey Halley, Senior Market Analyst, Asia Pacific, OANDA

Recession fears buffeted markets overnight, with the price action across various asset classes looking like a self-sustaining negative feedback loop, triggering more stop losses as prices slumped and dragging in trend-following momentum-hunting fast money.

Europe endured a torrid day as the Norwegian oil worker strike proved the last straw for an energy-starved Europe. European equities plummeted and rightly so, as Europe’s energy-from-Russia Achilles heel was cruelly exposed. The Euro also capitulated, EUR/USD taking out 1.0350 on its way to a 1.50% loss to 1.0260. Sterling and UK equities were also hammered by the extra headwind of political instability as three senior ministers resigned overnight with immediate effect. There may be some respite for Europe today though as the Norwegian Government imposed a settlement on both sides effectively ending the strike. It is likely to be temporary.

In the US, equity markets opened much lower, but US bond yields outdid them, slumping on recession nerves overnight and sending the US 10-year down to 2.805%, leaving the 2-year 10-year yield curve teetering on inversion. Perversely, the slump in US bond yields, which might also be due to haven inflows and not just recession fears, saved the bacon of US equity markets. US stocks reversed most of their losses, and ironically, the Nasdaq actually rallied to a 1.75% gain. The still-richly-valued growth stocks of the Nasdaq are the most interest-rate sensitive on US markets, and small moves in the risk-free discount rate have outsized price impacts in these environments. Still, the Nasdaq gains looked like a mechanical rear-guard action and not a brave new dawn. A US and Europe recession won’t do their ambitious valuations any favours either.

The big winner overnight was the US Dollar, which rallied imperiously versus both developed and emerging currencies. A sign of the nerves around US Dollar strength came from China today, which set a much weaker Yuan fixing rate of 6.7346 versus the US Dollar, as it glanced around at the slump in other Asia currencies overnight. The only winner was the Japanese Yen. USD/JPY held steady overnight at 135.90, to my great surprise, as the US/Japan rate differential plummeted lower. However, it has immediately fallen by 0.50% to 135.15 in Asian trading. As I have said previously, the long USD/JPY has become a dangerous one as the primary reason for it occurring in the first place, the US/Japan rate differential narrows sharply.

Oil prices also slumped overnight on recession hype, and I’ll talk about that later. Ironically, one of the night’s outperformers was Bitcoin, which reversed intraday losses to close unchanged at $20,200.00. I can only surmise that the Nasdaq’s rally lifted Bitcoin as well so that’s the short-term correlation to watch now, although it has already fallen 1.80% to $19,800.00 this morning. My line in the sane for Bitcoin remains $17,500.00, everything above that will be noise, failure should trigger another wave of margin stop outs among the geniuses conjuring 20% returns out of thin air.

Commodities also slumped overnight on recession fears, notably copper. But as a grouping, hard and agricultural commodities look to have peaked a few weeks ago except for European natural gas for obvious reasons. Gold finally fell below $1780.00 an ounce overnight, an ominous technical development. But spare a thought for palladium. It is trading at $1909.00 an ounce this morning, it’s hard to believe it traded at $3400.00 an ounce in early March.

Asian markets are starting the day on the back foot for different reasons. The PBOC USD/CNY fix today will have regional central bankers looking over their shoulders, although looking at the price action of pairs such as USD/INR and USD/IDR overnight, it looks like regional central banks are increasing their US Dollar selling. Mostly, though, it is China and covid zero that are weighing on the sentiment in Asia, which was going to be fragile anyway. As I have said till I am blue in the face, covid zero means covid zero in China, not one and down and we all live happily ever after. The City of Xi-an has enacted a series of restrictions overnight, and 9 districts of Shanghai are undergoing mass testing. Chinese authorities will try, initially, a district-by-district approach to restrictions, But nobody should be under any illusion that they won’t go harder and faster if needed. As I’ve said before, China needs to get lucky 100% of the time, omicron has to get lucky once. This remains a key risk factor too often ignored by anybody pondering China markets in 2022.

The Asian data calendar is empty today except for Malaysia’s Bank Negara policy decision. The market is locked and loaded for another 0.25% rate hike to 2.25% and I won’t disagree. With USD/MYR testing 4.4200 this morning, they won’t have a choice. No rate hikes likely see USD/MYR starting with 4.50 in double time. South Korea, the Philippines and Indonesia all face the same unsavoury choice in the weeks ahead at their policy meetings, especially with another Federal Reserve hike looming at the end of the month.

On the subject of the Fed, the noise will increase that Fed will now have to mollify the pace and size of its rate hikes. Unfortunately, inflation in the US, like elsewhere, is showing no signs of abating and the data recently has really been that bad, much like Australia. This is more likely to be a story for Q4. If the US JOLTs Job Openings remain at 11 million or above, and the US Non-Farm Payrolls is comfortably above 250,000, there will be no sensible reason for the Fed to blink. Most of all, it is a credibility issue. Having got transitory inflation so utterly wrong and stubbornly clung to a dogma past its sell-by date, if the FOMC blinks now, they may as well do an Elvis and leave the building. Puppies and kittens don’t need to be trained to chase their tails, we certainly don’t need it from our central banks, who aren’t even cute to boot.

This afternoon we get German Factory Orders and Pan-Europe Retail Sales. The releases won’t make good reading and could heap more pressure on the Euro and European equities, although I don’t discount the Norwegian oil strike settlement giving both a temporary reprieve. US JOLTs Job Openings will cause recession head-scratching above 11 million, but June’s ISM Manufacturing PMI for June and its activity, prices, new orders, and employment sub-indexes will probably decide the direction of travel in the short-term. The FOMC Minutes afterwards will probably be discounted somewhat given market developments over the past two weeks.

Asian equities slump on China lockdown fears.

US equities endured a torrid session overnight, dropping initially, but then rallying hard as US yields fell across the curve. With markets racing to price in a US recession, the US equity performance was somewhat counterintuitive with the rate-sensitive Nasdaq outperforming. If US yields find a floor after the US data released tonight, Wall Street’s recovery could find itself flagging. The S&P 500 finished 0.16% higher, the Nasdaq stormed to a 1.75% gain, while the value-centric Dow Jones closed 0.42% lower. In Asia, US futures are steady, with the S&P 500 and Dow almost unchanged, while the Nasdaq futures have booked a 0.28% gain.

Asian markets are mostly having a bad day at the office as they race to price in both a US recession overnight and also the potential for wider virus restrictions in China following overnight developments. The prospect of more covid zero restrictions in China is an unwelcome dose of reality for Asia and is certainly carrying more weight, although Asian currency weakness is also in play.

Japan’s Nikkei 225 is 1.20% lower, with South Korea’s Kospi dropping by 1.10%. In Mainland China, the Shanghai Composite has slumped by 1.25%, with the CSI 300 close behind, falling by 1.10%. In Hong Kong, the Hang Seng has lost 1.40%.

Across regional Asia, on Manila is defying the odds once again, jumping by 1.40% this morning. Elsewhere, it is a sea of red. Singapore is relatively steady, down just 0.05%, while Kuala Lumpur is 0.50% lower, Jakarta has lost 1.05%, Taipei has slumped by 1.75%, and Bangkok has eased by 0.20%. Australian markets have been spared the worst of the selloff, despite resource prices tumbling overnight, thanks to its Wall Street correlation of late. The ASX 200 and All Ordinaries are down by 0.30%.

European equities had a terrible day yesterday thanks to natural gas supply fears and political instability in the UK’s case as well. With the Norwegian government stepping in to impose a settlement between the striking oil workers and employers, European markets may gain a temporary reprieve this afternoon.

US Dollar soars on haven demand.

The US Dollar soared versus both developed and emerging market currencies overnight, as recession fears saw a spike in haven demand for US Dollars. Quite a bit of that looks to have been recycled into US bond markets as well, adding to the recessionary downward pressure on yields. The dollar index leapt 1.26% to 106.49, a two0decade high. It remains there in Asia and the next technical target is the 109.00 area. Having broken out of a 5-year triangle at 102.50 in April, its longer-term target remains in the 1.1700 area. Support is at 1.0585, the overnight breakout point, and then 1.0500, followed by 1.0350 and 102.50. ​

The Norwegian oil strike deepened recession fears and broke Euro yesterday, EUR/USD plummeting 1.51% to 1.0265, a multiyear low. In Asia, it has eased another 0.10% to 1.0253. The overnight low at 1.0235 is initial support, followed by 1.0130 ahead of 1.0000. As I have said before, any deeper interruption of Europe’s natural gas supplies will mean a move below parity and a European recession. Since breaking a multi-year support line at 1.0850 in April, Euro has never looked back. Although risks are skewed to the downside now, the Norwegian strike settlement may allow EUR/USD to find some friends this afternoon. It has resistance at 1.0300, and then the 1.0350 breakout, followed by 1.0600.

GBP/USD fell by 1.18% to 1.1960 overnight, easing to 1.1945 in Asia. Recession fears are also complicated by political instability in London now following multiple ministers resigning overnight, with eh Bank of England also sounding a loud economic warning as well. That makes constructing a bullish case for Sterling challenging and a move back towards the March 2020 lows near 1.1400 can’t be discounted. It has immediate support at the overnight low at 1.1900, followed by 1.1800. Resistance is at 1.2000 and 1.2200.

USD/JPY, rather surprisingly, finished almost unchanged at 135.86 overnight but has immediately moved 0.30% lower to 135.45 in Asia today. With the US/Japan rate differential narrowing sharply, long USD/JPY becomes more dangerous by the day and the risks increase of an ugly correction lower to wash out the speculative longs. If US yields find a floor, USD/JPY may cling to its gains for now though. USD/JPY has resistance at 136.65 and 138.00, with support at 134.25 and 132.00.

AUD/USD and NZD/USD have also fallen sharply overnight to 0.6800 and 0.6160, where they remain in Asia. The overnight fall in resource prices will be an additional headwind for the Australian Dollar in particular, but both remain at the mercy of international investors who use them to express risk sentiment. AUD/USD is in danger of testing 0.6700 this week, and NZD/USD 0.6000. Failure will signal a deeper move lower is in progress.

Asian currencies retreated overnight, led by USD/KRW, which gained 1.0% to $1308.00, and USD/PHP, USD/INR, and USD/IDR, which all rose around 0.50%. A weaker Chinese Yuan fixing by the PBOC today has kept the pressure up on Asian currencies, as has fears of more China lockdowns. Notably, USD/IDR has breached 15,000.00 this morning and rates hikes from Seoul, Jakarta, Manila, and New Delhi are now a certainty. The price action overnight and this morning does suggest that Asian central banks are around selling US Dollars, but with Asian currencies gaining no solace from lower US yields, this looks very much like a risk aversion move that will keep the pressure up on local currencies. Bank Negara should hike by 0.25% this afternoon, but if they don’t, look for extended MYR weakness.

Oil plummets overnight on recession fears.

Recession fears saw oil markets plummet overnight, with both Brent crude and WTI taking out their 2022 rising support lines in no uncertain terms. Brent crude slumped by 7.90% to $104.75, having tested $101.00 a barrel intraday. WTI slumped by 8.75% to 100.90, trading as low as $97.50 a barrel intraday. In Asia, both contracts remain under pressure as China lockdown nerves sweep the region. Brent crude has fallen 0.90% to $103.85 a barrel, and WTI is 0.60% lower at $100.00 a barrel.

The price action overnight, with both contracts trading in near fifteen dollar ranges, hints more at panic and forced liquidation, than a structural change in the tight supply/demand situation globally. Although I acknowledge recession risks in the US, and covid zero ones in China, the world’s two largest consumers, the futures markets in both Brent crude and WTI remain in heavy backwardation. That says that in the physical market, supplies remained as constrained as ever, and despite the noise seen overnight, oil prices may be in danger of overshooting to the downside.

Having said that, the failure of the 2022 support lines on both contracts so comprehensively must be respected, as are looming recession risks around the world. But with Russian oil supplies set to drop as the year progresses and it runs out of Western parts to maintain fields, and with the rest of OPEC hopelessly uninvested in maintaining production capacity, I fear the days of $100 oil will be with us for some time yet. That said, Brent crude and WTI are likely moving into a new $95.00 to $110.00 barrel range.

Brent crude has resistance at its 2022 trendline at $108.85 a barrel, followed by the 100-day moving average (DMA) at 110.30. Support is at $101.00, $100.00, and then $96.25 a barrel, it’s 200-DMA. WTI has resistance at its 100-DMA at $106.95, followed by the 2022 trendline at $108.50 a barrel. Support is at $99.60, $97.50, and then its 200-DMA at $93.40 a barrel.

Gold capitulates.

The massive strength of the US Dollar across asset classes overnight was more than gold could withstand, despite lower US yields. It wilted in the face of US Dollar strength and finished the overnight session 2.40% lower at $1765.00 an ounce. In Asia, it has eked out a tiny gain to $1767.40 an ounce.

With gold moving inversely to the US Dollar and no other inputs driving the price, gold’s only salvation from here is entirely reliant on a sudden reversal of course by the greenback. Having finally broken out lower from its multi-month $1780.00 to $1880.00 range, the failure of $1780.00 is an important technical development. Assuming the Dollar rally continues, the technical picture suggests a move lower to $1720.00 an ounce in the days ahead.

Gold has resistance at $1780.00, $1785.00, and $1820.00, its downward trendline. Support is at $1764.00 and then $1720.00, followed by $1675.00. Failure of the latter sets in motion a much deeper correction, potentially reaching $1500.00 an ounce.

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