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You have to forgive me this week. I’m sick (not COVID). Should be back next. Below find the latest wrap of everything China and commodities. Needless to say, it is playing out precisely as foreseen with a growing growth scare beginning to take down commodity prices and increasingly threatening all bloated markets.
Chinese authorities remain resolute as their economy slows:
Expectations for near-term easing cooled after Chinese central bank officials said that the country will maintain prudent monetary policy and that there is no shortfall in base money supply.
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There is no large monetary base gap in China, and the supply and demand for liquidity will maintain balanced in the next months, said Sun Guofeng, head of the PBOC’s monetary policy department.
The People’s Bank of China (PBOC) has adequate tools to smooth out periodic fluctuations in liquidity caused by factors such as fiscal revenue, expenditures and government bond issuance, he said. “The central bank is fully capable of maintaining reasonably abundant liquidity.”
The central bank has used a combination of monetary policy tools, including cutting the reserve requirement ratio (RRR), relending, medium-term lending facilities (MLF) and open-market operations, to inject liquidity, Sun said.
The market should not assess market liquidity condition simply according to banking system liquidity and banks’ excess reserve ratio, but should watch DR007 ( the 7-day interbank pledged repo), the most important gauge to watch for market liquidity condition, he noted.
DR007 averaged 2.15 per cent in August, 5 basis points lower than the interest rate on the 7-day reverse repo in the central bank’s open market operations, which means “they are very close”, he said.
“Current conditions may not require as much liquidity as before to keep money market interest rates operating stably,” Sun said.
Pan Gongsheng, vice governor of the PBOC, said at the same event that “the room for our monetary policy is relatively big and that is the major difference between China’s monetary policy and that in the US and other major economies.”
The likelihood is that they will break eventually and CNY fall. That is unless Xi Jinping can handle MUCH lower growth than forecast. All that matters, for now, is that Chinese policymakers are going to run that gauntlet.
There is still the great white hope:
As many big construction projects will be launched in the rest of the year and local government bond issuance is expected to accelerate, cement demand will continue to strengthen and cement prices will be supported, said Wei Yu, analyst at the research unit of Ccement.
China’s local government bond issuance in the first half of the year was slower than the same period last year, but in the second half, bond sales will pick up and be faster than a year earlier, which will help stabilise infrastructure investment growth, Lv Wenbin, an official from the state planner NDRC, said on Wednesday.
The NDRC will guide and push local governments’ work in preparing projects for special-purpose bonds and make the bonds play an active role in driving effective investment, he said.
Official data showed that the total issuance in the first seven months of the year reached 1.35 trillion yuan, compared to a 3.65 trillion yuan quota for the year of 2021.
I expect some uptick but not enough. Local governments are too weighed down by the property bust.
The pointy end of it all is now gushing blood:
Another day, another dismal development for “China’s Lehman”, with Bloomberg reporting that just hours after Fitch joined Moody’s in a triple-notch downgrade of China’s property development giant (from CCC+ to CC), coupled with a warning that “default appears probable”, the dollar bonds of China Evergrande fell to fresh lows, after a report from financial intelligence firm REDD that the firm plans to suspend interest payments on loans from two banks due Sept. 21, and asked a lender to wait for instructions about an extension plan..
For those saying that there is a word for this, you are right: it’s technical default, or “selective default” in the parlance of rating agencies; it occurs when a borrower fails to pay one or more of their obligations but continues to meet other payment obligations, and usually precedes a full-blown default and/or bankruptcy although in China the distinction tends to be a little blurry.
Following the news, Evergrande’s dollar bond due 2025 fell 1.5 cents on the dollar to 24.2 cents with all other USD bonds sliding in sympathy…
… having already been hammered earlier after Fitch said that its 3-notch downgrade “reflects our view that a default of some kind appears probable.”
Evergrande itself warned last week of default risks if its efforts to raise cash fall short. Last Friday, the company also said its contracted sales in August, including those to suppliers and contractors to offset payments, dropped 26% compared with a year ago.
The insolvent Evergrande has become one of the biggest financial worries in China, the epicenter of a potential default shockwave given its massive pile of $305 billion in liabilities to banks, shadow lenders, companies, investors, vendors and home buyers. Investor fears that a default is imminent have led to a crash in the firm’s bonds in recent weeks, which are now trading as if the company is already broke, and triggered fears about contagion risk in the broader credit market.
In the previous two days, several Evergrande bonds were suspended from trading following a liquidation scramble. The company’s 6.98% bonds due July 2022 were suspended temporarily after falling more than 20% in Shenzhen, according to a statement from the city’s stock exchange that echoed a similar intervention on Friday. On Tuesday, Evergrande’s 5.9% local bonds dude 2023 were also halted after a plunge.
Having been a largely isolated affair, fears about Evergrande’s rapidly unfolding liquidity crisis finally spilled over and led to contagion at other Chinese property developers. As the FT reported, Fantasia Group, a third property company facing refinancing concerns, said in a statement to the Hong Kong stock exchange on Monday evening that it had made several purchases of its own bonds, one of which matures in December. Its bonds sank to 78 cents on the dollar. Fantasia said in the filing that the purchases of its own bonds would “reduce the company’s future financial expenses and lower its financial gearing level”.
In language reminiscent of Evergrande’s challenges, Moody’s late last week estimated that Guangzhou R&F did not have enough cash to cover its debt repayments in the next year and a half, meaning it would need to rely on “new financing or asset sales”.
In a separate filing late on Friday, it said the bonds had also been bought through companies wholly owned by Fantasia’s founder Zeng Jie, niece of Zeng Qinghong, a former vice-president of China.
Chinese property developers are also grappling with tighter credit conditions and weaker sales within China after Beijing introduced rules last year to constrain developers’ leverage, not to mention choppy trading on international markets, where they are some of Asia’s biggest high-yield borrowers.
“Overall, the funding conditions have tightened and the offshore bond market is also getting more volatile,” said Kaven Tsang, a senior vice-president at Moody’s. “That actually has some negative implications on the market as a whole,” he added. “The refinancing risk has increased.”
One look at the yield on Chinese junk bonds – which has risen to levels not seen since the covid pandemic shut down the entire Chinese economy back in March 2020 …
… shows just how serious China’s property crunch has become, even as stocks in the US continue to flirt with all time highs without a care in the world.
The PBoC can bring some relief to this with rate cuts but not enough, either. Only a turn in the Three Red Lines and associated reform measures will do it and there is no suggestion of that anywhere.
That brings us to commodities. Leading us off is iron ore which is turning wildly volatile:
I still expect to be sub-$100 before year-end. And if Beijing miscalculates on Evergrande, a price more like $60. The latter is no longer a tail risk.
There is still plenty more pressure to come for steel. The Chinese property bust is the largest factor. Steel output cuts are jamming the underlying weakness up the raw material supply chain at record speed. There is more to come :
Inventories remain fine, telling us just how fast the COVID stimulus is going bust:
But we still have to factor in the collapse of steel exports that is dead ahead and rolled in August to 5.05mt. I expect us to return to the COVID lows as tariffs bite:
In short, iron ore’s doom is at hand.
In other commodities, the coal boom has now entered melt-up but this is very short term as well. As Chinese steel demand tanks, the artificial shortage (based upon very short-term Shanxi and Mongolian border closures) in coking coal will pass as mills restock. Coking coal will then crash just as iron ore is today. This horizon can be measured in months.
Thermal and LNG may hold up better for a while but I still expect them to deflate over 2022. There is no sustained shortage there, either, once we’re through the northern winter and Russian supply hiccups.
As for base metals, they’ll also crash as the wider market starts to price a Chinese growth scare and or shock deep into 2022. ESC and greening arguments are a mix of complete horseshit and being too far ahead of the curve.
At a minimum, we’re confronting a major commodity rout here and, increasingly likely, a significant correction in all markets.