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Over the past year, markets did nothing but go up steadily reaching new all-time highs practically all over the world. The only problem was that QE programs and historically low interest rates created this bonanza and not by fundamental factors. Thus, it becomes clear that eventually the party should have ended. The only question was when.
Last week the Chinese real estate company Evergrande announced that there is no guarantee that it will be able to meet its financial obligations in the current situation. In this context, thousands of people have demonstrated in front of their offices demanding the return of their money.
Although it is not expected that the Asian giant’s crisis will be as devastating as that of Lehman Brothers in 2008, the impact will be felt all around the world. The tension in the Hong Kong Stock Exchange is already moving to both Europe and the United States. The big question is whether the Chinese government will finally let the company fail or whether it will undertake some kind of public intervention.
Taking into account that the company’s liabilities represent approximately 2% of the Asian country’s GDP, the second option seems more feasible. Otherwise, the bankruptcy of Evergrande would not only mean the destruction of millions of direct and indirect jobs, but a real economic catastrophe.
One of the great fears is the possible “contagion effect”. Evergrande’s main creditors are Chinese banks and investors, who would lose billions if the giant defrauded its financial obligations. In this context, it shouldn’t be a surprise that the People’s Bank of China was forced last Friday to inject 14,000 million dollars to reassure the market, which was uneasy about the possible fall of the giant.
It should be added that concerns about Evergrande arise at a time when the Chinese economy has already started to slow down. The restriction measures put in place to contain the Covid-19 outbreaks have led to a drop in retail spending and travel. Measures to lower property prices have compounded the problem, dragging down iron ore futures in China that fell to nine-month lows. In fact, the collapse in iron prices will also have a strong negative impact on the largest mining companies.
Speaking of tapering, according to the minutes of the last meeting, Fed officials appeared to be very close to announcing the gradual reduction of bond purchases. However, some of the later data has pushed the arguments in the opposite direction. It is worth mentioning that in December the Fed said it would not change bond purchases until there was “further substantial progress” in recovering the 10 million jobs that were missing at that time due to the pandemic.
As a result, the Fed remains divided by those who prefer to wait and those who want to start tapering as soon as possible, arguing that purchases are doing little to help recruit people, and they pose a risk if, by keeping long-term interest rates low, they fuel bubbles in segments like housing. However, a recent weakening in inflation may dampen any sense of urgency to act faster.
The following few weeks will be crucial to understand whether the market is about to correct.
