The newsflow is negative and puts pressure on the risk appetite: 1) falling economic indicators, 2) deleveraging in China and 3) central bank exit strategies.
In the base case scenario, the recovery scenario holds, the halt of the debt-fueled real estate boom in China will not lead to a systemic crisis, and central banks will continue to be very cautious in withdrawing monetary policy stance.
Economic indicators point to falling economic momentum
Economic indicators point to a further decline in economic momentum. This development is mainly due to three adverse developments (delta, bottlenecks and increased inflation). There is considerable uncertainty about the extent and duration of these growth brakes, which are probably only temporary. The baseline scenario involves growth above potential until full employment is reached. However, the risk of a pause in the recovery has increased further.
The overall (manufacturing and services) flash PMI for the developed economies (DME) continued to fall across the board in September and is now around 8 points below the May high. Only the Services PMI in Japan has risen (due to easing measures). It is striking that the services PMI has fallen more sharply than the manufacturing PMI since May (output manufacturing: 54.2, output services: 52.8). The negative impact of the increase in new infections can be seen here. Considerable bottlenecks stand out in the Manufacturing PMI. The Delivery Times PMI at 24.6 points to even longer delivery times. In line with this, the output price PMIs are at a high level (total: 60.4). Inflationary pressure remains elevated.
The problem with Evergrande
The troubles of real estate developer Evergrande in China have spurred fears of a systemic crisis. The problem is by no means company-specific. Here, a business model based on high debt growth coincides with a structural (not cyclical) stop of this development enforced by politics. Last year, economic policy defined upper limits for balance sheet ratios in order to curb further debt build-up.
For real estate developers at three debt ratios such as leverage (“Three Red Lines”) and for banks at two ratios on the share of the real estate sector in the total portfolio (“Two Red Lines”). These measures have already led to a marked cooling of the real estate sector. This means lower investment activity, lower government revenues and, precisely, liquidity problems for real estate developers with the potential of system-wide consequences. Falling real estate prices would also be negative for private consumption.
On the positive side:
- The measures in the real estate sector are part of the transformation process in China to prevent a middle-income trap.
- Policymakers have the tools not to let the crisis escalate (no Lehman moment).
The uncertainty is not so much about whether these tools will be used, but about the specific steps: timing, extent and nature of selective economic support and lender of last resort measures (liquidity).
Key rate increases by central banks
Central banks in the developed economies are phasing out their ultra-expansive monetary policy stance. However, this is happening very slowly. The aim is to prevent a market correction (a tantrum) in the markets.
The american central bank (Fed) has announced the imminent start of a reduction in the bond-buying program (probably in November). “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” Forward guidance for future policy rates was also taken upward. The median of Fed members is one rate hike for the end of 2022 (revision from 0.1% to 0.3%), 1.0% for the end of 2023 (revision from 0.6%), and 1.8% for the end of 2024.
The Bank of England also argued in favor of key rate hikes in the MPC statement (“some developments during the intervening period appeared to have strengthened the case”). According to the BoE, a rate hike could take place before the end of the QE program, theoretically already this year.
The Norges Bank was the first central bank in the DME to unsurprisingly raise its key rate from 0% to 0.25%. In contrast, the central bank in Brazil has already raised the key interest rate for the fifth time this year (from 5.25% to 6.25%; March: 2%). In Brazil, long-term inflation expectations are not firmly anchored, so it has to react to short-term inflation increases. In line with hawkish central bank signals in the DME, government bond yields have risen.
Prognoses are no reliable indicator for future performance.