Plan B
Doug Nolan
It was an interesting week.
The S&P500 traded little change and within a narrow range.
The VIX (equities volatility) Index traded intraweek to the low (16.17) since January 4, 2022.
Friday was option expiration.
Both puts and calls lost value.
It has been a nice period to write options – and with the bank crisis and all, there have been plenty purchased.
And while all was quiet at home, there were inklings of risk aversion in global markets – especially late in the week.
A Friday Bloomberg “Inside EM” headline: “Currencies, Stocks Weaken as Risk-Off Mood Sets In.”
EM CDS jumped 10 bps (to 241), fully reversing the previous week’s decline and trading near a one-month high.
The Brazilian real fell 2.8%, and the Colombian peso lost 2.2%.
The South Korean won dropped 2.0%, “its biggest weekly drop in two months.”
Chinese markets were notably weak.
Double-digit inflation pushed UK two-year yields up another 13 bps to 3.73%, trading this week to the highs since February.
Italian two-year yields rose nine bps to a six-week high of 3.49%.
April 21 – Bloomberg (Alexandre Tanzi and Augusta Saraiva):
“US bank deposits fell last week, indicating the financial system remains fragile after a string of bank failures.
Deposits decreased by $76.2 billion in the week ended April 12, according to seasonally adjusted data from the Federal Reserve out Friday.
The drop was mostly at large and foreign institutions, but they also fell at small banks.
Meantime, commercial bank lending rose $13.8 billion last week on a seasonally adjusted basis.
On an unadjusted basis, loans and leases fell $9.3 billion.”
Federal Reserve Credit declined $15.5 billion last week, with a three-week drop of $125 billion.
Still, Fed Credit remains $266 billion higher than pre-SVB (March 8th) levels.
Over recent weeks, the benevolent Fed has not been the dominant liquidity provider.
April 19 – Wall Street Journal (Rachel Louise Ensign, David Harrison and Hannah Miao):
“Banks are turning to an obscure government-linked lender to shore up their balance sheets following the industry’s rockiest period in years.
The Federal Home Loan Bank system—established during the Great Depression to help promote mortgage lending and now a source of liquidity for banks of all stripes—issued a record $495 billion of debt in March to fund loans, which are called advances, the system’s Office of Finance said.
Banks ramped up borrowing that month as customers pulled out deposits…
The 11 government-sponsored home-loan banks have drawn scrutiny in recent weeks because Silicon Valley Bank, Signature Bank and Silvergate Capital Corp. borrowed billions from them.
Those banks all went out of business in March in a stunning series of collapses.”
I could only chuckle at the WSJ headline, “Banks Leaned on a Little-Known Lender in March as Customers Fled.”
Interesting how a financial institution whose assets increased $524 billion last year, to $1.247 TN, has remained under the radar.
They’re quickly becoming better known.
To issue a half a Trillion of debt in a month is an unprecedented feat – even for a GSE.
And speaking of unprecedented feats in the realm of Credit excess, we need to spend some time on China.
Aggregate Financing, China’s metric for system Credit growth, expanded $782 billion during March, up from February’s $459 billion and 20% ahead of estimates.
It was a record March, exceeding even pandemic March 2020.
At $52.2 TN, Aggregate Financing was up 10.3% over the past year, 22% over two years, and 70% over five years.
A big March put Q1 Aggregate Financing growth at an incredible $2.111 TN.
This is the largest three-month growth in China’s history.
For perspective, growth was 21% greater than Q1 ‘22, 41% ahead of Q1 ’21, and 17% greater than booming Q1 ‘20.
New Loans expanded $566 billion, 18% above forecast.
New Loans surged a record $1.667 TN during Q1, 38% above previous record Q1 2022 – and 62% high than (record at the time) pandemic Q1 2020.
Loans were up 12.2% y-o-y, 21% over two years, 41% over three years, and 80% over five years.
Corporate Bank Loans surged a March record $393 billion.
At $1.305 TN, it was a record quarter, 27% ahead of Q1 2022, 68% ahead of Q1 2021, and 59% above pandemic Q1 2020.
For perspective, Q1 growth was double pre-pandemic Q1 2019.
Corporate Loans expanded 15% over the past year, 29% over two years, and 80% over five years.
Consumer (chiefly mortgage) Loans surged $185 billion in March, the strongest monthly gain since January 2021. At $370 billion, Q1 growth was double Q1 2022 – and just shy of the Q1 record from 2020.
A strong March pushed one-year growth to 7.1%, with Consumer Loans up 18% in two years, and 83% in five years.
Government Bonds increased $89 billion, with Q1 growth of $266 billion.
Q1 growth was 34% ahead of Q1 2022 and more than double Q1 2021.
Government Bonds expanded 14% over the past year, 33% over two years, and 83% over five years.
China’s Q1 GDP was reported at a stronger-than-expected 4.5% y-o-y.
Retail Sales jumped a stronger-than-expected 10.6% y-o-y in March.
“China March New Home Prices Rise at Fastest Pace in 21 Months” – as the 0.44% March increase had analysts declaring housing recovery is at hand.
Year-to-date apartment sales are up 7.1% versus depressed year ago levels.
The China recovery story is generating some buzz.
Considering the past year’s double-digit, $5.0 TN, Credit surge – results are anything but impressive.
There was pent-up demand, which helps explain the surge in retail sales.
While also benefiting from some pent-up buying interest, apartment sales remain weak.
The great Chinese apartment Bubble has burst and will now be uncharacteristically impervious to reflationary measures.
Interestingly, the Shanghai Composite dropped 2.0% in Friday trading (down 1.1% for the week).
China’s growth-oriented ChiNext Index sank 3.6% this week to a one-month low.
Slipping 0.32%, China’s renminbi traded to a five-week low versus the dollar.
China sovereign and bank CDS traded moderately higher.
Despite all the recovery enthusiasm, developer bonds were under heavy selling pressure.
Dollar bonds from Evergrande, Sunac, Longfor and Kaisa all traded to the highest yields since at least December.
April 21 – Bloomberg (Dorothy Ma and Lorretta Chen):
“China’s junk-bond market is close to erasing all of this year’s early 11% gain, as optimism regarding government efforts to revive the property market clashes with the reality of private developers’ still-weak liquidity.
Average note prices hit their lowest level since Jan. 3 on Thursday at 72.7 cents on the dollar…
Fresh declines Friday were led by Wanda Properties Global Co., whose bonds’ record tumble this week has topped 20%.
Following a three-month surge from all-time lows, China high-yield prices are on pace for a third-straight monthly drop.”
April 21 – Bloomberg (Lorretta Chen):
“Dalian Wanda Group Co. has become the latest source of angst in China’s credit market, with dollar bonds of billionaire Wang Jianlin’s conglomerate sinking to distressed levels just months after they were issued.
This week’s plunge occurred as investors brace for a potential surge in cash outlays by the group.
Wanda and its units could face the equivalent of $1.9 billion in principal and interest payments on loans and public bonds, including put options, the rest of this year…
The declines accelerated Friday for two dollar bonds sold by a Wanda unit earlier this year, each falling a record 12 cents…
The notes have slumped nearly 30% this week.”
April 16 – Bloomberg (Shuli Ren):
“Call it luck or stellar crisis management.
China, one of the world’s most indebted nations, has not experienced a full-blown financial crisis, yet.
There were a few close calls.
In 2019, the government had to seize a regional bank, for the first time in decades, to prevent a run on deposits.
Last year, a wave of real estate developer defaults ended up with homebuyers threatening mortgage boycotts.
Both scares got defused…
But there is one more elephant in the room: Borrowings from local government financing vehicles.
For years, municipalities have been relying on these off-balance-sheet entities to fund infrastructure and support the local economy.
LGFV debt rose to 57 trillion yuan ($8.3 trillion) in 2022, or 48% of China’s gross domestic product, according to… the International Monetary Fund.”
Excerpts from my Q1 recap McAlvany Wealth Management Tactical Short conference call presentation:
Beijing has done an about face.
They’ve clearly thrown in the towel on reining in credit excess.
Caution thrown to the wind.
And to dump this amount of new credit on such a deeply maladjusted system is playing with fire; a gamble that makes me uncomfortable.
It is, however, consistent with the view that Xi’s global ambitions have become China’s top priority.
He needs a stronger economy, as he forges trade and military alliances to counter the U.S. and West.
Uninterrupted growth is necessary to further expand his military and global superpower ambitions.
In what was a notable escalation of rhetoric, Xi last month took a direct swipe at the U.S., saying, “Western countries, led by the United States, have implemented all-round containment, encirclement and suppression against us, bringing unprecedentedly severe challenges to our country’s development.”
And the following week Bloomberg reported similar from The People’s Bank of China, where the PBOC will “appropriately respond to the containment and suppression of the US and other Western countries.”
And this statement was released following “a meeting to study Xi’s speeches during the National People’s Congress session…”
I can only shake my head.
These comments speak to an irreparably damaged China/U.S. relationship.
It was the most direct effort by Xi to blame the U.S. for China’s expanding problems.
I’ve long feared that China’s bursting bubble would somehow see Beijing holding its U.S. and Japanese adversaries responsible.
Well, it’s happening.
At the minimum, it’s doubtful that the Fed and PBOC will be on the same page with crisis management cooperation as they were in 2008.
I hope I’m wrong on this.
But I’m compelled to share a fear.
Beijing is now in full crisis management mode.
They are expending tremendous resources to restart their boom - fighting a deflating bubble with all the might the communist party can muster.
Beijing is working 24/7 to build alliances to counter U.S. global power and influence.
They are executing a comprehensive plan for economic revival at home and profound change globally.
Meanwhile, Beijing is also preparing for “Plan B.”
Sure, massive stimulus and state-directed lending can ensure China meets near-term GDP targets.
I just don’t see China escaping Bubble Dynamics.
Indeed, the more egregious this late-cycle monetary stimulus, the more perilous their predicament.
So, I worry about China’s “Plan B”.
Beijing is clearly preparing its military and people for confrontation with the U.S., a conflict I fear will be increasingly likely when China’s economic gambit falters.
Xi and the communist party will never accept responsibility for so mismanaging China’s financial system, economy, and international reputation.
Crisis will have Beijing pressing the Taiwan issue, deflecting attention and responsibility, while odds increase for a direct showdown with the U.S.
I’ve discussed previously how boom periods engender perceptions of an expanding global pie.
Cooperation, integration, and alliances are seen as mutually beneficial.
But when the cycle turns, the pie is increasingly viewed as stagnant or shrinking; zero sum game thinking dominates.
Insecurity, animosity, disintegration, fraught alliances, and conflict take hold.
We are in a period of momentous change.
A historic global Bubble has begun to deflate.
The war in Ukraine has unleashed pernicious forces that will be difficult to control.
China’s autocratic communist government has towering ambitions - inflated by a historic Bubble that is now leaking a lot of air.
Japan has a new central bank governor that will need to end a historic monetary experiment that was for a decade left to run wild.
Across the globe, economies big and small, wealthy and poor alike, confront unprecedented debt overhangs.
Policymakers almost everywhere face the predicament of elevated inflation and weakening growth prospects.
We’re at a critical juncture in the global bubble, where acute fragility is forcing another round of desperate measures meant to hold crisis dynamics at bay.
Over recent quarters, we've witnessed major instability and volatility.
I suspect this has become the new normal.
We should be prepared for the environment to turn only more uncertain and tumultuous, with odds rising for a major accident.
In conclusion, I see developments at home and abroad corroborating the new cycle thesis.
I just wish I could be more optimistic about future prospects.
Much has to go right - and we need some lucky breaks - to avoid a destabilizing downturn.
So much is uncertain.
However, there’s one thing I am certain about: additional monetary inflation and massive government deficit spending are not the answer.
They only make things worse.
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