Morning Report: FOMC week.

Vital Statistics:

  Last Change
S&P futures 4,341 -80.2
Oil (WTI) 70.17 -1.75
10 year government bond yield   1.32%
30 year fixed rate mortgage   3.07%

Stocks are lower this morning on fears of a hard landing in China. Bonds and MBS are up.

 

The big event this week will be the FOMC meeting on Tuesday and Wednesday. The markets don’t see any changes in the Fed Funds rate, however we could see some further language about reducing bond purchases. Aside from the FOMC announcement, we will get housing starts and new home sales.

 

The NAHB Housing Market Index improved a point in September to 76. This is a sentiment indicator for homebuilders.

 

Fears are increasing that the Chinese government is going to let property developer Evergrande fail. Evergrande is the most indebted property developer in the world, with something like $300 billion in liabilities. “Everyone is looking at Evergrande and saying ‘has the time come for a major default in that area, and then the potential for contagion into the broader property sector?’” said Edward Park, chief investment officer at Brooks Macdonald. “It’s an imminent risk now rather than being a theoretical risk as it has been for the past few years.”

The consensus so far seems to be that Evergrande won’t be a “Lehman-type moment,” in reference to the 2008 decision to let Lehman fail, which supposedly caused the 2009 financial crisis. The hope is that a collapse in Evergrande would be limited to the real estate sector and not impact financial sector (and therefore the overall economy) too much.

I suspect this is probably not going to happen. People who insist that Lehman and “subprime” blew up the economy in 2009 have it backwards. The issue was not the financial sector – that was the symptom. The issue was a real estate bubble – which was the disease. Real estate is such a leveraged product that if real estate prices fall by a meaningful amount, equity can be wiped out in a hurry. Real estate bubbles are therefore the Hurricane Katrinas of banking and the contagion spreads fast. When real estate bubbles burst, they throw shrapnel everywhere.

Managing a burst real estate bubble can be done – Japan did it. While there were a few developer and bank failures over the course of the decades that followed, Japan managed to prevent the economy from entering a Great Depression style tailspin. What was the cost? Little-to-no GDP growth from 1989 onward, and a debt-to-GDP ratio of 2.4x.

What does this mean for the US? I suspect the punch line is that we will see a flight to the US dollar and US Treasuries, and that will prevent rates from rising too much. If the Chinese economy hits a hard landing, they will try and export their way out of it, so import prices will fall and that should keep inflation from getting out of hand.

10 Responses

  1. I am 65 pages into Irreversible Damage. I use my digital access to the Austin Public Library and it was on hold until yesterday. Previously I had read the introduction on the website.

    The book was first recommended to me [us] by Scott, then I read the Economist’s favorable review. Now I find that my oldest daughter has read it and also has recommended it to her friends, one of whom has a daughter who has suddenly decided to Trans.

    I also can already recommend it. The author is in no way bigoted in this matter. Her writing is calm, not inflammatory. She seems to me to be onto something.

    My daughter adds that she was tentative in discussing the book with others because the reviews in America had been so politicized, what with an ACLU defender of the First Amendment tweeting it should be banned and conservative sites in love with the book. However, she found no actual resistance or “cancelling” from her friends and she says all who have read it found it food for serious thought and consideration.

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  2. Brent, when will the impact of the Fed ending pump and dump hit the markets? Is the drop we’re seeing now only about China or could it involve some of that?

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  3. “Managing a burst real estate bubble can be done – Japan did it. While there were a few developer and bank failures over the course of the decades that followed, Japan managed to prevent the economy from entering a Great Depression style tailspin. What was the cost? Little-to-no GDP growth from 1989 onward, and a debt-to-GDP ratio of 2.4x.”

    Didn’t this result in the “zombie banks” for Japan for years? Did they actually clean it all up?

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  4. “The hope is that a collapse in Evergrande would be limited to the real estate sector and not impact financial sector (and therefore the overall economy) too much.

    I suspect this is probably not going to happen. ”

    Meaning that the collapse will impact the financial sector and overall economy?

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  5. Impressive:

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  6. Of course this is how it would play out:

    “Texas doctor who violated state’s abortion ban is sued, launching potential first test of constitutionality

    On Monday, an Arkansas man said he decided to file a lawsuit to test the constitutionality of the Texas measure after reading a news report about Braid’s declaration. Oscar Stilley, a former lawyer convicted of tax fraud in 2010, said he is not personally opposed to abortion, but believes that the measure should be subject to judicial review.

    “If the law is no good, why should we have to go through a long, drawn-out process to find out if it’s garbage?” Stilley said in an interview after filing the complaint in state court in Bexar County, Tex., which includes San Antonio.

    He also noted that a successful lawsuit could result in an award in court of at least $10,000 for the plaintiff.

    “If the state of Texas decided it’s going to give a $10,000 bounty, why shouldn’t I get that 10,000 bounty?” said Stilley, who is currently serving his 15-year federal sentence on home confinement.”

    https://www.washingtonpost.com/politics/courts_law/texas-abortion-doctor-sued/2021/09/20/f5ab5c56-1a1c-11ec-bcb8-0cb135811007_story.html

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