By Michael O’Neill
Do you feel it? There is a disturbance in the force. It’s not quite the scale of destroying Alderaan, but Darth Powell and his FOMC stormtroopers are laying waste to bond and equity markets, boosting the US dollar, and driving energy prices higher.
Last week, Fed Chair Jerome Powell appeared to bless a November start to tapering the quantitative easing program. The news was widely expected and ignored. The FOMC dot-plot projection of a 2022 rate hike was not. It was a light-saber slash to the throat of bond traders and US dollar bears that continues to reverberate through markets.
Traders scrambled to sell Treasuries, driving the US 10-year Treasury yield to 1.56% from 1.302%. Equity traders were slow off the mark. Wall Street dismissed the September 22 FOMC statement and took the S&P 500 index from 4368.60 immediately before it was released to 4481.40 on September 27 in Asia. “Stocks Rule, Bonds Drool.”
Then the alarm bells rang. A sharp spike in energy prices, and rising delta-variant coronavirus cases in the US, coupled with the increase in interest rates was a Homer Simpson moment for traders. Doh! The S&P 500 gave back all its post-FOMC gains and then some, by mid-morning on September 28.
Source: YouTube/IFXA Ltd
It could get worse-much worse. Like waking up and finding the Chucky doll from Childs Play lurking on your nightstand worse.
The S&P 500 index doubled from the pandemic low of 2280.52 on March 16, 2020, to August 16, 2021, and then continued higher, reaching 4545.85 at the end of August. That’s quick. The saying “The bigger they are, the harder they fall” may be trite, but it applies.
The stock rally was not just juiced, it was steroids on top of steroids, thanks to over $6.0 trillion in US government and Fed stimulus programs. The expenditures were justified due to the risks to the economy from the pandemic.
But that was then; this is now. Governments worldwide are beginning the process of weaning their economies from ultra-low interest rates and massive social spending programs. Fed Chair Powell says, “the process of reopening of the economy is unprecedented as was the shutdown.” That’s another way of saying we don’t know what will happen.
It also means that the one-way move for stocks since the pandemic may be in jeopardy. Equity prices are already under strain from higher interest rates, slowing economic growth, the alphabet soup of COVID-19 variants, and surging energy prices.
What else could go wrong?
China is a good place to start. The so-called “Middle Kingdom” was Ground Zero for the COVID-19 pandemic, and they may be ground zero for the next global financial crisis.
Evergrande Group is one of the biggest property developers in China, and it is now threatening to become the next Lehmann Brothers.
In 2008 subprime mortgages were so far below subprime that they threatened to blow up the US and global financial systems. It is now known as the 2008/09 Financial Crisis.
In 2007, Lehman Brothers was a top-ranked investment bank. In 2008 it was bankrupt. They were denied a government bail-out even though institutions like Goldman Sachs, Morgan Stanley, and Citigroup received funding. Someone had to be the sacrificial goat.
Lehman Brothers didn’t collapse in one day. It was in dire straits in March 2008, went into remission in June, and died September 15.
Evergrande Group could suffer a similar fate. The company has over $300 billion in debt and rumours of its collapse sent global stock markets tumbling last week. Fears were assuaged this week when the Peoples Bank of China pledged to ensure a “healthy property market and to protect home buyers.” Reuters reported that although the government may not intervene, they are actively encouraging other property developers and companies to buy some of Evergrande assets.
Nevertheless, intervention may be necessary.
VOX eu.org wrote that real estate development and property services account for 29% of China’s GDP. Absorbing a significant housing slowdown would significantly impact growth. Even more interesting is that some cities in China are ridiculously expensive.
The price to income ratio for Beijing, Shanghai, and Shenzhen exceed a multiple of 40, compared to 16 in Vancouver, and 12 in New York
.Source: VOX eu.orgA Chinese economic meltdown would be bad for global financial markets and very bad for Asian countries. That’s because China doesn’t play by the same rules as the western world.
Xi Jinping is President of China. He was elected President in 2013, garnering 2,952 votes for and 1 against with three abstentions. No one knows who voted no. He isn’t going anywhere either, as he had term limits abolished in 2018 making him the de facto leader for life.
China kidnapped two Canadians in retaliation for Canada detaining Huawei CFO Meng Wanzhou pending extradition to the US. What civilized nation takes hostages?
China has slapped a slew of prohibitive trade tariffs and sanctions on Australia after that country called for a robust inquiry into the source of the COVID-19 virus. It most likely started in Wuhan, China, but that is not the preferred Chinese narrative, and they will use their financial clout to change the story.
Many analysts assume Chinese economic data is reliable and treat it the same as any G-10 nations reports. They shouldn’t. The St Louis Fed wrote in 2017 “Even if every Chinese economic number were reported truthfully and accurately to the best of an individual’s understanding, the official numbers would still fail to fully capture the evolution of an economy growing and changing so quickly.”
Hey Taiwan. If China needs to jump-start its economy following a real estate crash, guess who is coming to dinner?
The force has been disturbed but as Yoda said, “Difficult to see; always in motion is the future.”
Source: YouTube/Australia 60 minutes.