With inflation concerns and a contentious debt debate on their hands, the pressure is on Fed policymakers to raise interest rates and withdraw asset support without undermining the fragile economic recovery
China has often been dubbed a Lehman-in-the-making, a reference to the spectacular collapse of Lehman Brothers, which precipitated the 2008 global financial crisis. Chinese policymakers themselves have warned of the risk of a “Minsky moment”, the onset of a disorderly fall in asset prices brought on by an excessive build-up of leverage.
The deepening liquidity crisis at China Evergrande Group, the country’s second-largest property developer and the world’s most indebted, has rekindled fears of a loss of confidence in China’s economy and markets.
Investors’ concerns about the world’s second-largest economy have been amplified by Beijing’s broadening regulatory crackdown and a sharper slowdown in the past several months. Since early February, the MSCI China Index, a gauge of stocks listed on the mainland and in Hong Kong, has plunged about 30 per cent, compared with a 5 per cent rise for global equities.
The absence of Evergrande-driven stress in the world’s most widely traded asset classes suggests that worries about China are less about the developer’s plight than whether it is symptomatic of a more severe property-induced slowdown.
While there is a strong consensus that Beijing has a range of policy levers at its disposal to ensure that Evergrande’s woes do not result in a chaotic collapse into bankruptcy, there is much less certainty over how far the government is willing to go to take the heat out of the housing market.
Just because China will almost certainly avoid a systemic crisis does not mean that a costly policy mistake cannot occur. The turmoil in the country’s equity and currency markets in the second half of 2015 and early 2016 – whose spillover effects were far more severe – was caused mainly by a series of policy miscalculations on the part of Beijing.
Given the unpredictability and ferocity of the recent regulatory interventions, and the vital importance of the property industry to China’s economy, even a communications blunder – which contributed significantly to the 2015-16 sell-off – could cost Beijing dearly.
Still, it is important to put international investors’ growing concerns about China in perspective.
Already, by the start of this week, Evergrande had ceased to be the focal point for anxiety in global markets. Investors have turned their attention to the risk of a default of a different order of magnitude altogether: the possibility that America’s government will renege on its obligations by October 18 if a deeply divided Congress does not pass legislation to suspend or increase the so-called debt ceiling.
While a disastrous US debt default is even less likely than a disorderly collapse of Evergrande, the fact that Treasury Secretary Janet Yellen and Federal Reserve chairman Jerome Powell felt compelled to warn of the grave consequences of a failure to lift the borrowing limit shows just how politicised and polarised US policymaking has become, increasing the risk of a policy mistake.
Political rifts, including within President Joe Biden’s Democratic Party, over the size and scope of the government’s spending plans have fuelled a heated debate over the inflationary effects of ultra-loose fiscal and monetary policy.
Consumer prices, which have been dormant since the early 1980s, have become part of US political wrangling, heaping more pressure on the Fed. On September 22, the US central bank presented updated forecasts pointing to a faster timeline for interest rate increases despite mounting evidence that growth is slowing due to the fallout from the spread of the Covid-19 Delta variant.
The Fed’s hawkish tilt has startled bond markets. The benchmark 10-year US Treasury yield has shot up 20 basis points since the Fed’s announcement, injecting further volatility into stock markets.
While global investors are signalling confidence that Chinese policymakers have the necessary tools to prevent Evergrande’s debt crisis from spiralling out of control, they remain unconvinced about whether a faltering US recovery will be strong enough to cope with a faster-than-expected tightening in policy.
Faith in Chinese policymaking is much stronger than the belief that the Fed can avoid committing a policy error.
The findings of a client survey conducted by JPMorgan last week revealed that only 5 per cent of respondents thought the Evergrande saga would morph into an economic crisis that would have global implications. By contrast, only 3 per cent of respondents believed the supply chain disruptions that are endangering the recovery and driving up inflation would be short-lived.
While Chinese policymakers wield considerable influence over the fate of Evergrande, the Fed can do little to ease the supply-side constraints that are fuelling concerns about the risk of stagflation.
The pressure on America’s central bank to keep a lid on inflation while supporting the recovery is particularly intense given that Republicans and Democrats strongly disagree over the severity of the threat posed by the surge in prices, with the former in the “persistent” camp and the latter in the “transitory” one.
Right now, however, the risk of a US debt default, however remote, is likely to dominate the headlines, given that the brinkmanship is set to continue until the eleventh hour.
When it comes to the threat of a costly policy misstep, Washington looks like a more dangerous place than Beijing.
