Year: 2023

Fed Needs to Cool Off Hot Job Market, Ex-Chair Bernanke Says

The Federal Reserve needs to cool off the overheated labor market to tame inflation, though it’s not clear how far unemployment must rise to achieve that, according to former Fed Chair Ben Bernanke and ex-International Monetary Fund Chief economist Olivier Blanchard.

While a steep run-up in goods prices was the main impetus to the surge in inflation over the last 2 1/2 years, the impact of a “very tight” job market is growing and is likely to prove more persistent, they wrote in a paper to be presented at the Brookings Institution on Tuesday. (…)

The argument that Bernanke and Blanchard lay out in their paper about the evolution of inflation jibes with that put forward by Fed Chair Jerome Powell last week.

In a joint appearance with Bernanke at a May 19 Fed conference, Powell played down the significance of the job market in the 2021 inflation spike.

“By contrast, I do think that labor market slack is likely to be an increasingly important factor in inflation going forward,” Powell said.

As he has before, Powell zeroed in on the persistence of inflation in a grab bag of services — everything from health care and education to haircuts and hospitality  — where labor costs are a high proportion of the cost of doing business.

Powell gave a clear signal at the conference that he is inclined to pause interest rate increases next month, saying the Fed has already tightened credit a lot and thus could now afford to look at how the economy evolves. 

The Fed chair has previously voiced hopes that the labor market can be brought into better balance more through a drop in job vacancies than through a big increase in unemployment. (…)

“With labor-market slack still below sustainable levels and inflation expectations modestly higher, we conclude that the Fed is unlikely to be able to avoid slowing the economy to return inflation to target,” Bernanke and Blanchard wrote in their paper.

“The extent of that slowing will depend however on the evolution of certain structural features of the labor market, notably the efficiency of the process of matching workers with jobs,” they added.

If job postings on Indeed are any indication (through May 12), the BLS metric for nonfarm openings will flatten out after its steep drop in Q1.

Retailers Near Restocking as Inventory Paring Winds Down Freight operators are hoping a shift for big store owners fuels a shipping rebound heading into the fall

Big retailers are signaling they are nearly done paring back their excess inventories and are preparing to fill their shelves with new merchandise this fall, potentially brightening prospects for freight carriers looking for revived restocking to drive a shipping rebound.

Target’s inventories at the end of the last quarter were 16% lower than the same period a year ago and Walmart cut inventories in its U.S. store operations by 9% over the past year, slashing hundreds of millions of dollars of goods from their balance sheets and suggesting space is opening up in their jammed supply chains.

Target Chief Operating Officer John Mulligan said on an earnings conference call Wednesday that the overstocking that weighed on the company last year was “in the rearview mirror” and that the retailer was turning toward getting fresh merchandise into stores for the fall.

“In terms of inventory, we’re in good shape,” Walmart Chief Executive Doug McMillon said on a Thursday earnings conference call. “In-stock is improving, and excess inventory keeps coming down. We see it in the numbers, and I’m seeing it on store and [Sam’s Club] visits.”

Inventories at U.S. general merchandise stores expanded 1.2% in March, according to Census Bureau figures, after pulling back over several months from a record high last August. (…)

Before the pandemic, retailers and wholesalers inventories (dash lines) were about equal. It looks like retailers have since put more of the burden on wholesalers which now carry 20% more stock:

Speaking of inventories:

Biden’s Billion-Dollar Oil Trade Faces a Big Test Washington awaits bids to refill crude reserves with modified price proposal

(…) Now the agency is learning that replenishing those stockpiles at the lower rate it wants—between $67 to $72—is more difficult, despite prices sliding near those levels at various points this year. On Monday, benchmark U.S. crude closed at $71.99 a barrel, within Washington’s window to buy. (…)

The Biden administration, which previously said it aims to buy 60 million barrels, has suggested it is in no hurry to refill the SPR without maximizing taxpayer returns. If successful, the new request for proposals could offer a blueprint for additional purchases. (…)

The Energy Department’s second try at buying up to 3 million barrels of sour crude, with proposals due May 31 and contracts expected to be awarded June 9, swaps its previous pricing approach for one based on differentials. That could help suppliers more accurately forecast costs and help limit potential losses.

Government officials asked companies to propose offers on sour-crude differentials. That figure factors in the average spread between West Texas Intermediate, the U.S. crude benchmark, and an American sour crude gauge known as Mars in the three days after notice of the award.

Those benchmarks were separated by 98 cents as of Friday, according to price-reporting agency Argus Media, meaning companies’ financial risk in the event of market choppiness could be in cents, rather than dollars, per barrel.

“In theory, the same problem still remains because dealers have to hold this differential for two weeks while waiting for the decision,” said Bouchouev, a longtime trader. “However, the differential is significantly less volatile than the oil price.”

For now, the more pressing question for Biden’s potential oil trade may be whether prices stay within the Energy Department’s target range.

Wall Street was bullish on oil late last year, but many analysts more recently slashed forecasts as Western economies slowed, Russia continued pumping out crude and China’s appetite for energy failed to push prices higher.

• Saudi Energy Minister Tells Oil Speculators to ‘Watch Out’

(…) “I keep advising them that they will be ouching — they did ouch in April,” Saudi Energy Minister Prince Abdulaziz bin Salman said at the Qatar Economic Forum in Doha on Tuesday. “I would just tell them: Watch out!” (…)

The Organization of Petroleum Exporting Countries and its allies, a 23-nation bloc known as OPEC+, will meet on June 3-4 in Vienna to review production policy for the second half of the year.

While several delegates have said there’s no need for further action now as curbs already in place will help tighten global markets, Prince Abdulaziz has been known for orchestrating surprise interventions.

“We have to be vigilant, we have to be proactive — as we in OPEC+ has been saying for quite some time,” he said. (…

Funds have turned the most bearish in more than a decade across a slew of oil contracts.

“Current speculative positioning is so extreme as to make a response from key OPEC members likely,” analysts Paul Horsnell and Emily Ashford at Standard Chartered Bank Plc said in a report on Monday. “We think the latest data has increased momentum toward a defensive cut.” (…)

From Oilprice.com:

• According to S&P Platts, global air travel has finally returned to pre-pandemic levels this month as total commercial flights per day averaged 105,682 in the first two weeks of May, up 20% year-on-year.
• Global jet fuel demand, however, is expected to remain below 2019 levels for now as efficiency gains and a slower rebound in long-haul travel, especially in Asia, limit the consumption upside for the fuel.
• IATA estimates that new airplanes trigger fuel efficiency gains of around 2% per year and the pandemic has seen a widespread drive to replace older aircraft.
• With international seat capacity now 10% below 2019 same-month levels, attesting to flights being on average shorter than before, a full jet fuel demand recovery to 8 million b/d isn’t expected until 2027.

A Housing Bust Comes for Thousands of Small-Time Investors They were offered the benefits of owning apartment-building rentals without any of the work, in real-estate investments that have already left some people empty-handed.

(…) From 2020 through 2022, real estate syndicators reported raising at least $115 billion from investors, according to a Wall Street Journal analysis of Securities and Exchange Commission filings.

So far, defaults have been rare. But real-estate analysts and property investors anticipate a wave of foreclosures ahead.

Congress in 2012 opened the door to the syndicators with a law that made it easier to market real-estate investments online. The law, intended to open financial opportunities to lower-income people, greatly expanded the reach and audience for syndicator deals.

Syndicators largely favored apartment complexes in the South and Southwest, where real-estate prices were lower, rents were rising and housing regulations were generally looser. Many of these locales had fewer renter protections, which made it easier to evict tenants and raise rents.

The rental-market boom made millions for syndicators and their investors through rising rents and escalating property values. Average rent for a one-bedroom apartment in Phoenix has increased 37% since January 2021, driven by pandemic migration and a limited housing supply, according to the rental listing site Zumper. (…)

Syndicator investors have few legal protections, said Joan MacLeod Heminway, a securities-law professor at the University of Tennessee in Knoxville, Tenn. Unlike public companies, syndicators in many cases aren’t required to give regular updates on their buildings’ financial performance, she said. As limited partners, investors have no say over spending. Some who lost their investment never knew the properties were in trouble until they were near foreclosure. (…)

Many syndicators are racing to either raise funds or sell properties before tipping into foreclosure. Most hold balloon-payment loans that require repayment when they come due this year or next. Those syndicators face large payouts when getting new, more affordable property loans will be difficult. Even firms with multibillion-dollar portfolios have used syndication to buy apartment buildings that no longer make enough money to cover debt payments, bond documents show.

“The bubble is going to start popping if these guys can’t get out of these deals in time,” said Ralls, of Acora Asset. Lenders also risk heavy losses. (…)

IMF says it no longer expects UK recession this year

China Has a Youth Unemployment Problem Because Grads Are Waiting for Nonexistent Jobs Many economists say the problem reflects a jobs mismatch that could defy government solutions for years.

Joblessness among young people aged 16 to 24 rose to a record of 20.4% in April, significantly higher than a few months ago and far above the prepandemic rate of 13% or lower in most of 2019.

The rise was all the more surprising given that urban unemployment overall fell to 5.2% in China as of April, compared with 6.1% a year earlier.

Some economists believe the job market for young people will get worse before it gets better, with a record 11.6 million college students set to graduate this summer. 

A central problem, economists say, is that China isn’t creating enough of the high-wage, high-skill jobs that are sought after by its expanding base of educated young people, many of whom have loftier expectations than previous generations.

Rather than trade down for lower-wage jobs, many young people are opting to wait for more opportunities, even though such opportunities might not be available. (…)

If China fails to supply a generation of young people with work, it could put pressure on wage growth and slow down Beijing’s desire to build an economy driven more by consumption. It could also undermine social stability, if more young people become dissatisfied. (…

The economy overall is becoming more oriented toward services. However, many of the services jobs created during the past decade are lower-end roles, such as delivery drivers and restaurant waiters, which don’t necessarily attract university graduates, said Rory Green, head of China and Asia research at TS Lombard, a research firm. (…)

A survey by Zhaopin.com, an online recruitment platform, shows that around 30% of college students graduating this summer desire to work in the internet, telecommunications and education sectors, despite regulatory crackdowns in recent years that roiled many of those industries and left private employers wary of adding staff. (…)

Many are going back to school for more advanced degrees. A record 4.7 million undergraduate students signed up for exams to compete for 1.2 million spots in graduate schools this year. In 2021, nearly one-third of universities in Shanghai already had more graduate students than undergraduate students, according to a state media report.

Young people who delay entering the workforce or abandon job searches aren’t counted as job seekers in official statistics, according to Nancy Qian, a professor of economics at Northwestern University. If they were counted, the actual jobless rate would be even higher, she said. (…)

Citi Says Buyers Plow $21 Billion Into US Stocks Positioning is increasingly “one-sided,” the bank strategists wrote.

(…) The weekly flow of new longs was one of the largest seen in recent years, it added.

“The momentum is clear, and positioning is increasingly one-sided. Longs outnumber shorts by more than 9 to 1,” said Citi strategists led by Chris Montagu. “The few remaining shorts are all in loss, but a short squeeze is not likely to significantly impact markets.”

That echoed with Goldman Sachs Group Inc.’s prime brokerage unit data: Hedge funds that make both bullish and bearish equity wagers have snapped up US shares for two straight weeks, with total purchases reaching the fastest pace since October. (…)

For the rally to carry on, investors might want to see a broadening of risk taking.

John Authers: Is the S&P FANG’d Out? Debt Isn’t the Only Ceiling A breakout past 4,200 meets resistance as this rally’s dependence on the tech giants makes allocators nervous.

(…) Breakouts from a range can have a big impact on market psychology. So can failed breakouts.This matters. There is a dose of nerves about taking it to those levels. Further, Wall Street’s strategist community is braced for the S&P 500 to fall from here by the end of the year.

My Bloomberg colleague Lu Wang keeps a regular score-sheet of estimates. Her latest poll of 23 strategists, published at the end of last week, found an average end-year prediction of 4,017, with a median of 4,000. Analysts’ forecasts tend to be dragged upward by strong performance, but they are still at this moment predicting a decline of almost 5%. So the flirtation with a new high hasn’t yet created too much optimism among asset allocators. (…)

To be clear, it’s very unusual for smaller caps to trail so badly if stocks have really hit rock bottom and moved on to the first stage of a bull market. Indeed, if last October’s lows for the S&P 500 really were the trough, this is an unprecedentedly narrow recovery, owing almost everything to a small group of stocks. The following statistics are from Jonathan Krinsky of BTIG LLC:

Of the nine meaningful drawdowns since 1995, the average percentage of Russell 3000 stocks trading above their 200-day moving average at the 150-day mark post the bottom was 70% (min 56%, max 88%). As of the 150-day mark following the Oct. ’22 low, it was just 36%. In other words, it would be by far the weakest breadth this far off a major bottom of any new uptrend over the last ~30 years.

Generally, when markets embark on a durable advance, they need far more stocks to join in. (…)

There are lots of other things going on at present, of course, but the current nerves over the 4,200 level stem in large part from a rally that many didn’t expect, focused in a few companies that the active management community had missed out on. It’s rational for them to try to strengthen their competitive position when they’re judged against their peers by piling into those stocks — even though many still believe that they are too expensive, and that the stock market has come too far, too fast.

As investing is often about predicting the actions of others, a decisive close above 4,200 might make it rational to pour even more into the market. It’s common to call the rally after the Global Financial Crisis the most hated in history. This one might well now be running it close, at least among active managers.

Charts from Ed Yardeni, FYI:

• S&P 500 seen dipping between now and year-end – Reuters poll 

The S&P 500 index of U.S. shares will slip marginally between now and year-end as past interest rate hikes, troubled regional banks and weak earnings weigh on sentiment, according to strategists in a Reuters poll.

They see the benchmark index (.SPX) ending the year at 4,150, down slightly from Monday’s close of 4,192.63, but still up about 8% from the end of 2022, based on the median forecast of 43 strategists polled by Reuters during the last two weeks. (…)

The latest poll forecast for the S&P 500 is down slightly from the 4,200 year-end 2023 target in a February Reuters stocks poll. (…)

At the same time, the S&P 500’s forward 12-month price-to-earnings ratio is now at 19 compared with 17 at the end of 2022 and a long-term average of about 16, according to Refinitiv data.

“Historically, when you’ve seen this level of valuation, it’s normally associated with re-acceleration in earnings and also an outlook for double-digit earnings growth going forward. We don’t see that happening,” said Nadia Lovell, senior U.S. equity strategist at UBS Global Wealth Management, which has a 3,800 year-end S&P 500 target. (…)

In 2024, the S&P 500 will end at 4,500.

• PE groups sell stakes at discount on expectations valuations will stay low ‘Follow-on’ share offerings have rebounded even as prices have languished below IPO heights

BTW:

Goldman Says Treasury Will Drop Under Its Cash Minimum June 8-9

• Janet Yellen doubts the US can pay all its bills by June 15, telling NBC that getting to that date is “very difficult.” Goldman economists said they see the Treasury’s cash levels below the bare-minimum $30 billion mark by June 8 or 9, or sooner. They assigned a 30% chance of a deal this week and the same odds “shortly before” the deadline. (Bloomberg)

Jerome Powell Keeps June Interest-Rate Pause in Play Fed chair says banking strains could mean rates don’t have to rise as much to tame inflation

(…) “Until very recently, it has been clear that further policy firming would be required. As policy has become more restrictive, the risks of doing too much versus doing too little are becoming more balanced,” Powell said Friday at a conference hosted by the central bank. (…)

Earlier, New York Fed President John Williams presented research at the conference showing the Covid-19 pandemic didn’t change estimates of a “neutral” interest rate that neither stimulates nor restricts demand, a finding with important implications for how high officials may raise rates to slow the economy.

Between the 2008 financial crisis and the 2020 pandemic, Fed officials and economists had concluded the neutral rate of interest—or the level that balances supply and demand when the economy is operating at full strength—had declined sharply. That, together with weak growth following the crisis, ushered in a period of historically low interest rates.

Williams said a widely followed model used to estimate the inflation-adjusted neutral rate of interest showed “there is no evidence that the era of very low natural rates of interest has ended.”

If estimates of the neutral rate of interest shifted higher, officials could conclude that the rates needed to slow inflation would be considerably higher. If those estimates haven’t changed, then the fed-funds rate might be expected to return to less than 3% if the Fed succeeds in bringing inflation down to its 2% target over the next few years. (…)

• Fed Official Is Open to Forgoing June Rate Hike Minneapolis Fed President Neel Kashkari said he could support holding interest rates steady at the central bank’s next meeting.

• Economists push back expected Fed rate cut to 2024, NABE poll shows

Economists now believe the U.S. central bank, which is debating whether it needs to raise rates again, will lower its targeted policy rate in the first quarter of next year, according to the survey released by the National Association for Business Economics.

In February, survey respondents saw the Fed cutting rates in the final three months of this year. Forecasters maintained their view on the peak level of the Fed’s benchmark overnight interest rate, which jibes with the central bank’s current target range of between 5% and 5.25%.

The NABE survey showed respondents split over whether the U.S. economy would fall into recession, although the poll’s median view sees modest levels of growth prevailing through 2024, with an expected 0.4% rise between the fourth quarter of 2022 to the final three months of 2023.

Respondents upsized their estimate of inflation in 2023, seeing the consumer price index up by 3.3% from the last quarter of 2022 to the final quarter of 2023, according to the survey. In February, respondents expected inflation would be up 3% over the same period.

The survey also found upgraded outlooks for the job market, with respondents now saying they expect an average 142,000 jobs to be gained per month, up from 102,000 in the February survey. The jobless rate, currently at 3.4%, is projected to average 3.7% this year, down from 3.9% in the February poll.

(Factset)

Updated r* Estimates from the NY Fed Suggest Incrementally Dovish Policy Risk

This morning [Friday] the NY Fed relaunched their estimates of the natural rate of interest (otherwise known as r*) that had been suspended since 2020. The new estimates update the Holston-Laubach-Williams (HLW) model to account for the unusual economic dynamics during the pandemic. The updated r* estimates are similar to prior estimates during the pre-pandemic period but imply a modest decline in r* since 2019, and in a speech accompanying the data’s release NY Fed President John Williams noted that the model’s estimate of r* would fall more significantly to zero by end-2024 if the economy evolves in line with current Blue Chip forecasts. We have previously noted several reasons why the HLW model estimates may have limited implications for the appropriate near-term policy stance, but the new estimates and the model-implied outlook might suggest some incremental dovishness if FOMC officials factor them into their policy decisions. (Goldman Sachs)

The NY Fed report is here.

US bank deposits and credit slip in latest week, Fed data shows

Deposits at all U.S. commercial banks slipped last week and overall credit provided by banks edged lower as well, Federal Reserve data released on Friday showed.

Deposits in the week ending May 10 totaled $17.10 trillion on a nonseasonally adjusted basis, down from $17.16 trillion a week earlier, the Fed’s weekly snapshot of the banking system’s assets and liabilities showed. Deposits, which had dropped substantially after the collapse in March of Silicon Valley Bank, were down at large banks and little changed at smaller ones.

Meanwhile, credit provided by banks dropped to $17.32 trillion from $17.37 trillion a week earlier, led by a decline in securities holdings. Loans and leases saw modest declines.

Deposits are not fleeing out, even at smaller banks:

And loans are not falling much. They are actually up since SVB, even at smaller banks:

• Private equity steps up lending as US banks pull back The turmoil facing U.S. regional banks has prompted some lenders to step back, leaving space for investors such as asset managers, private equity (PE) funds and insurers to lend more.

(…) “We expect to grow further by filling the void that regional banks are leaving as they pull back from certain types of lending,” said Dan Pietrzak, co-head of private credit at KKR, which manages $76 billion in credit funds. Pietrzak sees “attractive” assets in auto and consumer lending. (…)

“We see U.S. commercial banks retreating from real estate lending,” in some cases because regulators have instructed banks to reduce their exposure, said Andrea Balkan, managing partner overseeing Brookfield Asset Management’s real estate finance funds. “It’s times like this when we have a unique ability to grow.”

Investors providing private credit comprise 12% of the $6.3 trillion U.S. commercial credit market, according to Fitch Ratings. That compares with regional banks, which account for $4.5 trillion in loans, or 40% of the U.S. total. (…)

Shadow banks, as the private creditors are known, are able to lend with fewer regulatory hurdles. While private credit funds have grown swiftly, the risks they pose to the financial system appear limited, the Federal Reserve wrote in a report this month.

The International Monetary Fund painted a different picture, warning in April that the expansion of private credit may have added vulnerabilities to the financial system and called for more supervision of non-banks. The lack of public information about the loans makes it difficult for markets and regulators to measure risks “until it is too late,” the fund wrote. (…)

PE firms have more than $1 trillion that could be deployed on credit deals, Christopher Sheldon, KKR’s co-head of credit and markets, estimated in a recent paper. (…)

“You’ll start to see other areas becoming attractive, including auto lending, small & medium enterprises (SME) and consumer lending, fund financing,” Greg Olafson, president of Goldman Sachs Asset Management’s alternative investments business.

• US regional bank stocks fall after Yellen says more bank mergers necessary

Auto Dealers Finally Have Cars to Sell Again Some brands are getting heavier on inventory than others as shoppers’ concerns about rising interest rates put a dent in demand.

Buyers are finding a bigger selection of models to choose from this spring selling season, in large part because of easing supply-chain woes and more stable factory output.

The replenished inventory also is shaping up to be an important test for car companies, many of which have said in recent years they would keep availability permanently constrained. Some brands, such as Jeep and Buick, are already getting heavy on stock, according to industry data. If supplies get bloated, it could put an end to the lofty prices and big profits the industry has enjoyed since the pandemic’s early days, analysts say. (…)

Overall, dealerships had about 1.8 million vehicles in transit or on lots at the end of April, a 50% improvement compared with the same period in 2022—but still about half the stock available two years before, according to data from industry-research firm Wards Intelligence.

U.S. auto sales have remained resilient, mostly because of pent-up demand, and even picked up in the first quarter of this year as inventory levels improved. Buyers are also still paying historically high prices—the average vehicle sold for about $46,000 in April—and the amount of discounting on the car lot remains well below prepandemic levels, according to data analytics firm J.D. Power. (…)

Micron Stock Tumbles as China Says Chips Are Security Risk Chinese regulators said its products failed to pass a cybersecurity review.

Beijing warned operators of key infrastructure against buying the company’s goods, saying it found “relatively serious” cybersecurity risks in Micron products sold in the country. The components caused “significant security risks to our critical information infrastructure supply chain,” which would affect national security, according to the statement from the Cyberspace Administration of China, or CAC. (…)

The tech sector has become a key battlefield over national security between the two largest economies, with Washington having already blacklisted Chinese tech firms, cut off the flow of sophisticated processors and banned its citizens from providing certain help to the Chinese chip industry. In a statement, the US Commerce Department said Beijing’s conclusion had “no basis in fact” and Washington will continue to try and limit industry disruptions with its allies. (…)

The move brings fresh uncertainty to the other US chipmakers that sell to China, the world’s biggest market for semiconductors. Companies like Qualcomm Inc., Broadcom Inc. and Intel Corp. deliver billions of chips to the country, which puts the components inside electronic products that are shipped all over the world. (…)

Micron derived nearly 11% of its revenue from mainland China in its last fiscal year. Sanford C. Bernstein said the worst hit to revenue would reach that level, but a “more realistic impact will be low-single digit percentage and only in the near term.”

CHINESE DOMINOS

A Poor Province in China Splurged on Bridges and Roads. Now It’s Facing a Debt Reckoning. Guizhou has sent out pleas for help with its finances and investors think Beijing will have to step in

Cracks have been showing in the finances of Guizhou, a southwestern province with jaw-dropping landscapes and some of the world’s highest bridges. It was one of China’s fastest-growing local economies over the past decade—thanks in large part to its heavy spending on infrastructure development.

More than 110 state-backed entities known as local government financing vehicles in Guizhou have outstanding bonds, which in many cases were issued to help pay for the construction of bridges, highways and tunnels. Including these entities, the provincial government had the equivalent of $388 billion in outstanding debt by the end of 2022, about 1.3 times its gross domestic product last year, according to Wind, a financial data provider. (…)

On May 16 the finance bureau of Guiyang, the capital city of Guizhou, made another public admission of its dire debt situation in a 2022 work report. “In recent years, Guiyang has done everything possible” to resolve its debt risk through write-offs and converting government debts to state-owned enterprises’ debts, the government said in the report. These technical methods “have been basically exhausted,” it said. “Debt risks may occur at any time if funds are not available in a timely manner,” it added. It also disclosed a hidden debt of approximately $5.5 billion based on a preliminary tally. The article was also quickly taken down.

What Beijing ends up doing to resolve Guizhou’s debt issues will have ramifications for investors and banks across China that own a lot of local government debt. Economists and analysts have warned that debts have reached unsustainable levels in many parts of the country, and that central-government bailouts could be needed to prevent problems from snowballing.

Chinese authorities largely stood aside over the past two years as the country’s largest property developers slid into financial distress, causing losses for investors and many businesses and depressing the land sales that were a big source of revenue for many local governments. There was also no government rescue earlier on for debt-laden HNA Group, a large airlines-to-hotels conglomerate that went into bankruptcy. Some state-owned Chinese companies that weren’t deemed to be systemic risks have also failed. (…)

China’s Politburo in April said local governments need to strengthen their debt management and “strictly control new hidden debts,” signaling that their borrowing needs to be reined in. (…)

Over the years, smaller local banks and local branches of big banks have lent heavily to these local governments. “It’s absolutely a problem. It is channeling the problems in the real economy to the financial sector and eventually could pose a threat to financial stability,” said Tianlei Huang, a research fellow at the Peterson Institute for International Economics.

Chinese local governments had roughly $5.3 trillion of debts outstanding as of early May. Those numbers don’t include the debt of the local government financing vehicles, which are considered off-balance-sheet liabilities that governments are also on the hook for.

Goldman Sachs estimated the total interest-bearing debt of Chinese LGFVs to be around $8.5 trillion in a recent report. The International Monetary Fund put the figure at $10 trillion. (…)

The Covid-19 pandemic and the housing downturn hit the province hard. Land sales slumped after many property developers ran into liquidity problems, hurting a major source of income for local governments. Stringent Covid restrictions on people’s mobility affected the amount of traffic on Guizhou’s roads and bridges, and their toll collections. (…)

• China’s $23 Trillion Local Debt Mess Is About to Get Worse What happened in cash-strapped Hegang points to a long economic slog for the rest of the country.

(…) Hegang represents just the tip of the iceberg of a local government debt problem that’s making investors increasingly nervous and that threatens to be a drag on the world’s second-largest economy for years to come. Goldman Sachs Group Inc. estimates China’s total government debt is about $23 trillion, a figure that includes the hidden borrowing of thousands of financing companies set up by provinces and cities.

While the chance of a municipal default in China is relatively low given Beijing’s implicit guarantee on the debt, the bigger worry is that local governments will have to make painful spending cuts or divert money away from growth-boosting projects to continue repaying their debt.

“Many cities will become like Hegang in a few years’ time,” said Houze Song, an economist at US think tank MacroPolo, noting that China’s aging and shrinking population means many cities don’t have the workforce to sustain faster economic growth and tax revenue.

“The central government may be able to keep things stable in the short term by asking banks to roll over local governments’ debt,” Song said. Without loan extensions, he added, “the reality is that over two thirds of the localities won’t be able to repay their debt on time.” (…)

A fiscal restructuring can be triggered in one of two ways: if interest payments on a municipality’s bonds exceed 10% of its expenditure, or if local leaders deem it’s necessary. China-based Yuekai Securities Co. estimated that as many as 17 cities had bond interest payments of more than 7% of their budgeted expenditure in 2020, meaning they are close to breaching that 10% threshold. The cities are mainly in poorer provinces like Liaoning in the northeast and Inner Mongolia up north. (…)

Problems are evident in other cities as well. Shangqiu, a city of 7.7 million people in China’s central Henan province, made headlines recently after almost shutting down its only bus service. In Wuhan and Guangzhou, proposed cuts to pensioners’ medical benefits prompted rare street protests earlier this year. Civil servants in wealthy cities like Shanghai are reportedly having their pay slashed. In Guizhou province, officials have begged Beijing for a bailout. (…)

EARNINGS WATCH

• 2023 EPS estimates have improved for the top 10 S&P 500 stocks but not for the bottom 490. via @WarrenPies, @3F_Research

• The ratio of the equal-weighted to market-cap-weighted S&P 500 indexes is down sharply since the banking crisis started on March 8. The former is down 2.5%, while the latter is up 5.0% (chart). (Ed Yardeni)

• Also from Ed Yardeni:

                                                                           S&P 500     IT     S&P ex-IT

• Forward revenue growth:        4.7%     -0.3%     5.8%
• Forward earnings growth:      -4.4%     -7.4%    -0.1%
• Short Squeeze: On the other hand, we’re seeing heavy shorts in overall aggregated US index futures (net speculative positioning) — on a similar scale as was seen in the early-2000’s as the bear market was ending… but also similar to 2007 when the bear market was just getting started. The bullish take is that a short squeeze could take the market higher. (Callum Thomas)

Source:  @topdowncharts Topdown Charts