China Beige Book Warns Economic Slowdown Has Begun

When it comes to the global economy, few things matter as much as China, the trajectory of its economy and especially the pace and impulse of its credit creation, which is ironic because virtually all data coming out of China is fabricated and manipulated, and thoroughly untrustworthy, either on purpose or "by accident."

The latest example of the former was highlighted over the weekend, when we discussed that a nationwide Chinese audit found some local governments inflated revenue levels and raised debt illegally, once again making a mockery of China"s credibility on the global stage. As Bloomberg reported ten cities, counties or districts in the Yunnan, Hunan and Jilin provinces, as well as the southwestern city of Chongqing, inflated fiscal revenues by 1.55 billion yuan, the National Audit Office said in a statement on its website dated Dec. 8.

An even more blatant example of the former was highlighted in October ahead of China"s Communist Party Congress, when the local securities watchdog literally "advised" some loss-making companies to avoid publishing quarterly results ahead of the Congress as authorities sought to ensure stock-market stability during the critical gathering of China"s political elite.  As a result, at least 17 Shenzhen-listed companies announced delays to their earnings reports from Oct. 20 to Oct. 24, up from three during the same period last year.

However, now that the Party Congress is long over, China"s recent economic data offer a "warning for 2018" now that Beijing"s leaders are less motivated to prop up fake "growth" for purely optical purposes. That is the opinion of China Beige Book, and its president Leland Miller who said that "Incentives to ensure the economy was growing smartly at the time of the Communist Party Congress do not apply as next year wears on," CBB president Leland Miller and chief economist Derek Scissors said in a report released on Wednesday.

According to a private survey by CBB International, which collects anecdotal accounts similar to those in the Federal Reserve’s Beige Book, Q4 results already show some signs of a transition to slower growth,  The most recent sampling of 3,300 Chinese businesses showed:

• Hiring stopped accelerating due to a strong base of comparison


• Manufacturing orders also stopped accelerating 


• Inventory accumulation "is too fast for comfort"


• Sales-price inflation is weaker than in the second quarter


• Wage gains have stopped accelerating

Come to think of it, the CBB data is not that different from the official Chinese data which showed continued slowdown across most economic verticals:

 

"None of these is genuinely alarming yet, and none would be out of place in a typical quarter," the CBB"s Miller wrote. "But the first results after a CPC are not a typical quarter. If you expect a noticeable slowdown in 2018, the first post-Congress returns support those expectations."

To be sure, even here there is confusion: while at the 19th Party Congress, which marked the start of President Xi Jinping’s second five-year term, top leaders signaled less emphasis on pursuing economic growth at all costs, and greater dedication to deleveraging, during the main economic planning conclave in December which set priorities for 2018, they pledged to focus on "critical battles" against financial risk, pollution and poverty in coming years. Meanwhile, deleveraging - Xi Jinping"s endless crusade - was strangely forgotten. Indeed, as Goldman observed last week, "there was no explicit mention of deleveraging" as "recent policy statements increasingly use the phrase "control of leverage", in our view likely a reflection of increasing realism in policy making." This significant policy reversal prompted the WSJ last week to report that Beijing has effectively given up on its deleveraging pledge.

Leverage or not, the table below - courtesy of Bloomberg - shows CBB’s breakdown of how support for the expansion may erode:

Furthermore, evidence from the retail sector doesn’t support the government’s claims of a consumption boom, CBB said. While some large firms have strong sales and profitability improved this quarter, retail revenue growth finished last among major sectors, Miller and Scissors wrote.

"Retail’s performance is decidedly uninspiring. Revenue, capex, and hiring are inferior to manufacturing, while inventory growth is much higher."

The good news: overall hiring has held up and was generally in line with the prior quarter, with 48% of firms staffing up and 3% cutting workers. "Job growth remained stronger at state firms than private, regardless of company size," CBB’s survey found, although as we will show in a subsequent post, while hiring may remain strong, wages are tumbling in a troubling indication that China"s middle class is set for imminent disappointment and anger.

Meanwhile, inflation in wages, prices, and input costs were also roughly the same as in the prior quarter, and were moderately faster than last year, the report said. Profit growth improved.

That said, despite predictions of gloom as we enter 2018, the world’s second-largest economy proved bears fully wrong this year, exceeding analyst estimates in the first and second quarters, and is now on pace for the first full-year acceleration in growth since 2010, with GDP seen growing at 6.8% this year and 6.5% in 2018. There is a problem: this growth was on the back of a near record credit impulse since the February 2016 Shanghai accord, an impulse which is now over.

Which means that all else equal, and absent another gargantuan credit injection in the coming months, China"s bears are about to have their day in the sun all over again.

China"s Infrastructure Boom Heading For Rapid Slowdown In 2018

There have been signs since October’s Party Congress that China’s infrastructure boom was about to cool off as the leadership seeks to contain debt levels and focus on the quality not the quantity of growth. Subway building is one sector which has seen some high-profile project cancellations. In mid-November 2017, Caixin reported that China’s top economic planning authority, the National Development and Reform Commission, was “raising the bar for subway proposals” – increasing scrutiny in terms of fiscal conditions, population and GDP. In recent weeks, we’ve seen two large subway projects shelved, one in Hohhot, the capital city of Inner Mongolia (worth 27 billion Yuan) and another in Baotou, another Inner Mongolian city (worth 30 billion Yuan). As Caixin noted.

The cancellation of the Inner Mongolia subway projects is having a ripple effect in other cities. Several city governments, including those of Xianyang in Shaanxi province and Wuhan in Hubei province, said in statements that their subway plan are unlikely to win immediate approval under the central government’s crackdown on financial risks related to borrowing for such projects.

The crackdown on local government debt, a key source of infrastructure financing, will have a knock-on effect on Chinese GDP growth. A difficulty for China’s central planners is that the infrastructure share of Chinese fixed asset investment has been on a rising trend, surpassing 20% during 2017 versus just over 15% in early 2014. While we’ve been expecting China’s infrastructure spend to slow next year, we are surprised by the rate of slowdown estimated by Bloomberg, which surveyed a large number of forecasters.

China’s frenzied construction of roads, bridges and subways is set for a major slowdown, adding a headwind to economic growth in 2018. The nation’s fixed-asset investment in infrastructure will grow 12 percent next year, according to the median estimate in a Bloomberg survey, down from almost 20 percent in the first ten months this year. All 18 economists in the survey anticipated a moderation, adding to reports by Morgan Stanley, Goldman Sachs Group Inc. and UBS Group AG predicting a similar trend.

The cooling construction fever is taking shape as authorities renew a pledge to focus on debt management following the Communist Party Congress in October. In a rare move, China has suspended subway projects in some cities, and scrutiny has also toughened on public-private partnerships -- until now a widespread way to fund projects. The easing could even threaten global capital expenditure growth, as China represents one-fifth of the world’s total investment, according to estimates by Oxford Economics.

Infrastructure investment "grew much faster than other investments in the past five years," Larry Hu, chief China economist at Macquarie Securities Ltd. in Hong Kong, wrote in a note. "Policy makers might be able to accept slower growth for infrastructure spending from next year, as the growth in the past five years is unsustainable."

Slowdown or not, the scale of spending on Chinese infrastructure remains vast, about $1.7 trillion during January-October 2017. The pick-up in spending during the last two years followed efforts by the authorities to promote PPP (public-private partnerships) to finance infrastructure projects as one way to limit the growth in local government debt. As is the case with many things related to investment in China, the policy was quickly subject to abuse. In the majority of cases, the “private” partner in PPP projects turned out to be a state-owned firm, which merely added to the state’s debt burden via a different route. Eight local governments have been reprimanded by the finance ministry and the National Audit Office for “disguised borrowing”. We can only imagine the degree of abuse when local governments guaranteed returns on PPP-funded projects. According to Bloomberg.

The Ministry of Finance last month banned local governments from guaranteeing returns for private investors in PPP projects or backing a project’s debt. The national watchdog for state-owned enterprises also published rules to regulate state companies’ participation -- a potential blow to a major source of funding.

"A change in central government’s attitude towards PPP does not bode well for infrastructure in 2018," according to Yao Wei, chief China economist at Societe Generale SA in Paris. "A slowdown from the rapid pace this year looks inevitable."

The challenges for Xi Jinping and his top bureaucrats are mounting, as 2018 looks like it will see the convergence of a host of major reforms of which slower infrastructure spending and altering PPP funding arrangements are a small part. Other major ones include cooling the property market, reducing overcapacity in heavy industry, pollution control, continuing the crackdown on corruption, deleveraging and reforming the out-of-control shadow banking sector.

The China bulls will undoubtedly downplay the scale of these challenges, expecting little deceleration in Chinese growth, helped by a near seamless transition from investment to consumer-led growth. We will be amazed very impressed if Xi can pull it off.
 

"Not Our Fault" - ECB Says "Fake Data" Is To Blame For The Coming "Manias And Panics"

In the days ahead of China"s Communist Party Congress last month, which culminated with the crowning of Xi Jinping as the modern equivalent of a quasi-emperor, China’s securities watchdog made it clear to local companies that bad news would not be tolerated, and "advised" loss-making companies to avoid publishing quarterly results as authorities were desperate to maintain stock-market stability. As a result, as we reported at the time, at least 17 Shenzhen-listed companies announced delays to their earnings reports from Oct. 20 to Oct. 24, up from three during the same period last year.

Moral of the story: if you are about to report bad news, especially news which can destabilize the stock market, it is "prudent" to delay...  or simply not report at all, or alternatively just make it up. And since we are talking about China, whose government has itself admitted it has repeatedly fabricated both trade and GDP data in the past, fabricating data has become a way of life.

There is just one problem: as ECB board member Benoit Coeure explained yesterday, “fake data” is as much of a threat to economic and financial stability as “fake news” is to politics.  Speaking in Paris, the central banker said there "was a growing prevalence of poor quality data which risks fuelling economic manias and panics."

It was unclear if by poor quality, and/or "fake" data, the ECB was merely referencing any data that suggested the "recovery" was off track - in the same way that any news that criticizes the US and global political establishment has become synonymous with "Russian propaganda", and "fake news" - or if the ECB was genuinely worried about fabricated data, of the type that has made a mockery of China"s GDP which has printed between 6.5% and 7.5% for the past 3 years with such determination, the number has become a joke (as Michael Pettis warned last week).

Quoted by Reuters, Coeure said that since skewed public perceptions can even alter the course of monetary policy, the ECB is increasingly relying on large scale analysis of news to gauge whether its message is correctly received.

But that carries what he described as a “monkey in the mirror” risk - a reference to a behavioral experiment in which it is unclear whether an animal recognizes itself in the mirror or thinks it is a different animal.

"Just as there are concerns about ‘fake news’ dominating social media, there is a risk of ‘fake’, or at least poor quality, statistics driving out better quality ones in public discourse,” Coeure said adding ominously that “actions by economic agents could become less anchored to actual activity and more prone to manias and panics, with obvious implications for economic and financial stability.”

Reading between the lines, Coeure is clearly preparing to blame "fake economic data" when the ECB next disappoints markets, and bond yields - propped up by the ECB"s CSPP program - finally crash.

In other words, the next crash will be blamed not on central banks blowing the biggest bubble in history but... drumroll... "fake data"!

Of course, the crash when it comes, will hardly be a surprise: recovering from the biggest recession in decades, the ECB has relied on a plethora of unconventional and still not fully understood tools to kick start growth, boost employment and raise inflation. Much of it has been based on a signalling and propaganda, including the constant refrain that things are getting much better.

Well, if they are so much better, why not stop QE and hike rates?

As Reuters adds, central banks also talk more since they rely on tools poorly understood by the public, so they also increasingly employ sophisticated computer technology to study whether their message reaches the right destination. But such feedback could also be misleading.

But the scariest thing is what he said next:

“We may one day be tempted to draft our monetary policy statements and speeches in the light of how they will be comprehended and interpreted by artificial intelligence algorithms,” Coeure said, adding that the consequences of such a mechanism has yet to be understood.

In other words, with human traders swept away from the market, in the ongoing passive revolution which has increasingly left algos and robots to make most capital allocation decisions. central banks are admitting that soon their statements will be written if not in binary code, then certainly designed to fool as many algos as possible into BTFD, since unfortunately the "keep the markets propped up" mandate has emerged over the past decade as the only one central banks truly care about. In light of this admission, the only "fake news" to be concerned about, is that created by central banks including "there is a global, coordinated recovery." Well, yes, when you inject a record $2+ trillion annualized in liquidity in 2017 and when you monetize a third of global GDP since the Global Financial Crisis, you better have at least a short-term recovery to show for it...

China"s Corporate Debt Unexpectedly Rises At Fastest Pace In Four Years, As A New Risk Emerges

Have you heard the one about the priest, the rabbi and China"s deleveraging? We forget how it goes, but it"s pretty damn funny, especially the last part after a Reuters report that following China"s repeated vows by Beijing it would reduce the country"s unprecedented sovereign, municipal, corporate and household leverage, China"s debt is not only rising, but growing at the fastest pace in four years.

It"s especially funny because for years China’s top officials have - well - lied, touting their ambitious policy priority to wean the world’s second-largest economy off high levels of debt, but there is not much to show for it. On the contrary, the debt pile at Chinese firms has been climbing in that time, with levels at the end of September growing at the fastest pace in four years.

As shown in the chart below, a Reuters analysis of 2,146 China listed firms showed their total debt at the end of September jumped 23% from a year ago, the highest pace of growth since 2013. The analysis covered three-fifths of the country’s listed firms, but excluded financials, which have seen the brunt of government de-risking and deleveraging efforts so far.

The analysis revealed that debt in the real estate sector increased the most over last five years, followed by industrials, with the share of industrials in China"s total corporate debtload going up by 3% psince the end of 2012, while relative real estate debt rose by 7%.

In September, as shown here before, state-owned enterprises also reported a much faster pace of growth in their debt, as the government quietly backstopped quasi-private companies. In addition, last month we reported that as part of China"s latest bailout of the financial sysmte, Beijing was set to buy 24% of all residential real estate offered for sale in 2017. Both mean debt would surge, and sure enough, total debt at 75 of the CSI Central SOE 100 index companies  increased by more than 27 percent from a year ago, the biggest increase in many years.

* * *

However, in addition to rising debt, there is another, even more pressing risk: rising rates. According to Reuters, debt servicing costs - i.e., interest expense - now accounts for a fourth of state-owned firms’ revenues in the last few quarters. The ratio rose to around 27% in the second quarter - the highest in at least five years - before declining slightly to 24.47% in the third quarter due to a jump in revenues. Needless to say, with China"s 10Y government bond yield  and corporate spreads blowing out to 3 year wides, traders will be especially focused on what happens to Chinese interest expense in the coming months.

* * *

There is some good news: an analysis of corporate debt showed that borrowing through the issue of bonds has fallen, however, possibly as the regulatory clampdown has pushed up financing costs.   Additionally, as noted last week, October’s data on aggregate social financing of corporate bonds showed aggregate financing of corporate bonds stood at 18.34 trillion yuan ($2.77 trillion) at the end of October after increasing 4.4% from a year ago, the lowest growth rate in two years.

China Broad Credit Growth (TSF + Local Government Bond Issuance)

Who plugged the gap? Ah yes, the infamous shadow banking sector. Per Reuters:

The gap in funding needs appeared to have been filled by off-balance sheet financing in China’s murky and opaque shadow banking sector. Cumulative total social financing, which also includes shadow banking, stood at 172.2 trillion yuan at the end of October, though the exact size of shadow banking is unknown. Total social financing for the month of October 2017 was 1.04 trillion yuan.

Then again, as some have suggested, perhaps China was just waiting for last month"s comunist congress to pass before finally committing itself to this much hyped deleveraging. As Reuters reports, China’s deleveraging push indeed appears to have intensified after the 19th Communist Party Congress in late October. In its latest salvo on the shadow banking sector, (described in in "A "New Era" In Chinese Regulation Means Turmoil For $15 Trillion In China"s "Shadows") the central bank on Nov. 17 issued sweeping guidelines to tighten rules on asset management business, which the central bank estimates is a $9 trillion market. Just a few days later, fears of the deleveraging push resulted in the biggest Chinese stock market crash in 17 months.

 

And while China’s government debt remains optically contained, at 46.9% of GDP as per latest figures from the Bank for International Settlements, top policymakers have recently raised concerns about a sharp build-up in household debt. Outstanding household consumer debt surged close to 30% since the middle of last year and reached 30.2 trillion yuan as of October.  Meanwhile, outstanding yuan-denominated property loans amount to 31.1 trillion yuan and individual mortgage loans add another 21.1 trillion yuan as of the third quarter of 2017.

There are two parting questions one should consider: the first is whether China has any hope of ever deleveraging without unleashing a depression. With total debt/GDP at 329% as of May 2017 according to the Mercator Institute, we doubt it.

 

The second is linked to the first: with China contributing an unprecedented 33% of global debt growth in the past decade, any slowdown in debt creation is sure to send an economic shockwave across the globe.

 

And one bonus question: when the IMF published the following chart in its latest Financial Stability Report, how long did it say China has left before it implodes?

 

"Daggers Are Falling From The Sky" - China Stocks, Bonds Tumble After National Congress Ends

Who could have seen this coming?

After weeks of "calm" - demanded by The People"s Party - and well-managed "National Team" ramps top "prove" how much Xi"s plan for the nesxt five years is being received, the end of China"s National Congress has been met with... a plunge in stock and bond markets.

 

 

This is the biggest drop in the Chinese market in 11 weeks...

But it"s not just stocks. The Chinese bond market is getting slammed...

China 10Y yield is up 6 days in a row (the biggest surge in rates since May) to their highest since Oct 2014...

With the Chinese yield curve now inverted for 10 straight days - the longest period of inversion ever...

As Bloomberg reports, the situation that’s existed for most of 2017 - sovereign yields rising, and corporate debt remaining relatively resilient - is at risk of cracking. As appetite for bonds of any kind dwindles and authorities roll out measures that target higher-risk investments, company securities are in the line of fire.

Now that the Communist Party Congress is over, China’s bond holders may be about to get hit by “daggers falling from the sky," said Huachuang Securities Co., referring to aggressive deleveraging policies.

 

“It’s very likely we will see a significant increase in corporate yields in the coming year," said David Qu, a market economist at Australia & New Zealand Banking Group Ltd. in Shanghai.

 

"The trigger could be tougher regulations or a default. A majority of non-bank financial institutions’ debt holdings are corporate bonds, so their selloff can lead to severe consequences. Banks are underestimating authorities’ intentions to tighten regulations.”

 

“The deleveraging campaign hasn’t even gone half way, and the risk of banks redeeming entrusted funds could surface at the end of this year," said Qin Han, chief bond analyst at Guotai Junan Securities Co. in Shanghai.

 

"The chance of a selloff in corporate bonds is increasing, which will result in a widening of their yield premium over sovereign notes."

But this is far from over, as we noted earlier, the end of China"s National Congres is also ushering in the end of "coordinated global growth"...

As Citi writes, "China’s Party Congress has concluded and Xi Jinping’s position as President has been consolidated. Given there are no standing committee members in their 50s, it suggests there are no apparent heirs for Mr. Xi, opening the door for him to stay on beyond 2022. One of the key questions in the run up to the congress was that once power was consolidated, would China accelerate its economic reforms. We think this is unlikely but do expect a moderation of growth, with data momentum perhaps set to continue to slow at its current pace. Note how China’s MCI tends to lead Citi’s macro data index for China and our MCI is still tightening."

It gets worse.

As Capital Economics writes in its China Activity Monitor note this week, the firm"s China Activity Proxy (CAP) suggests that growth in China slowed last month to the weakest pace in a year and with property sales cooling and officials continuing their efforts to rein in financial risks, Cap Econ thinks that looking ahead "the economy will slow further over the coming quarters."

CapEco"s ominous conclusion:

Looking ahead, we think growth will continue to slow over the coming quarters. The current props to growth appear shaky. With investment contracting in real terms, industrial output will probably soften over the months ahead. Property sales also look set to weaken further as the government’s purchase curbs continue to expand. This will weigh on construction before long. More generally, with tighter monetary conditions weighing on credit growth, activity looks set to weaken further.

That the past 18 months of coordinated global growth will end in China, is quite symmetric: back in January 2016, as global markets were tumbling, aborting the Fed"s plans to hike rates 4 times in 2016 and resulting in sharp economic slowdowns around the globe, it was the (still mysterious) Shanghai Accord that "saved" the world, and unleashed a burst of unprecedented, and coordinated, growth... which only cost China some $8 trillion in debt.

It will only make sense that another major Chinese event will mark the top of this economic mini cycle, and lead to the next global downturn, not to mention spike in market volatility.

China Regulator Instructs Companies To Delay Bad Results Until After Congress

In the U.S., equity markets have officially reached the phase in the bubble where fundamentals are almost entirely irrelevant and stocks trade up irrespective of whether company earnings are positive or negative...in technical terms you could say we"re in the later stages of the BTFD phase of the economic cycle. 

That said, as Bloomberg points out today, regulators in China still have to be a bit more "creative" to quell market volatility during important national events.  As such, the China Securities Regulatory Commission has sent out a notice to public companies kindly requesting that they delay their earnings report during China"s Communist Party Congress...but only if they"re going to be bad.

China’s securities watchdog has asked some loss-making companies to avoid publishing quarterly results this week as authorities seek to ensure stock-market stability during the Communist Party Congress, according to people familiar with the matter.

 

The China Securities Regulatory Commission made its requests via the country’s stock exchanges, the people said, asking not to be named as they’re not authorized to talk to the media. At least 17 Shenzhen-listed companies announced delays to their earnings reports from Oct. 20 to Oct. 24, up from three during the same period last year, exchange filings show. The CSRC declined to comment, while China’s bourses didn’t respond to faxed questions.

 

Chinese regulators have stepped up efforts to quell market volatility during the twice-a-decade congress, a highly-choreographed reshuffling of the country’s top leadership that’s expected to shape President Xi Jinping’s influence into the next decade. While the smallest equity swings in 25 years suggest government interference has worked, critics argue that China’s leaders have backpedaled on a pledge to give market forces a more central role in the world’s second-largest economy.

And, to our great shock, the strategy seems to be effective:

Of course, you can"t be too blatant in your attempts to control markets so a lot of companies have suddenly decided they need to "finish checking earnings reports" while others simply said they "have a lot on our plate to deal with" and can"t be bothered by silly regulatory filings at this point in time.

Shandong Minhe Animal Husbandry Co., which farms chickens, and Shenzhen Hifuture Electric Co., an electrical equipment maker, were among the Shenzhen-listed companies asked to withhold their results this week, the people said.

 

Shandong Minhe, which estimated a loss for the Jan.-Sept. period in an Oct. 13 filing, said on Sunday that it hasn’t finished checking the content of its earnings report and will postpone its release, previously scheduled for Tuesday, to Oct. 30. Shenzhen Hifuture, which also projected a Jan.-Sept. loss on Oct. 13, gave this explanation for a similar delay in a Sunday filing: “We have a lot on our plate to deal with.”

 

Shandong Minhe declined to comment further when contacted by Bloomberg News. The stock dropped 1.1 percent on Tuesday and is down 35 percent this year. Shenzhen Hifuture, whose shares have been suspended since January, didn’t immediately reply to an email.

 

Most of the 17 Shenzhen-traded companies that announced delays to their results had previously predicted losses or steep earnings declines, filings reviewed by Bloomberg show. Ten of the companies declined on Tuesday, while one was little changed and one rose. Trading in five of the stocks was suspended.

Of course, now that the cat"s out of the bag, we"re going to go out on a limb and suggest it might be a safe bet to go ahead and unload any company that delays earnings reports over the next week or so...just a hunch.

Unprecedented Housing Bailout Revealed, As China Property Sales Drop For First Time In 30 Months

Back in March, we explained why the "fate of the world economy is in the hands of China"s housing bubble." The answer was simple: for the Chinese population, and growing middle class, to keep spending vibrant and borrowing elevated, it had to feel comfortable and confident that its wealth will keep rising. However, unlike the US where the stock market is the ultimate barometer of the confidence boosting "wealth effect", in China it has always been about housing: three quarters of Chinese household assets are parked in real estate, compared to only 28% in the US with the remainder invested financial assets.

Beijing knows this, of course, which is why China periodically and consistently reflates its housing bubble, hoping that the popping of the bubble, which happened in late 2011 and again in 2014, will be a controlled, "smooth landing" process. 

The other reason why China is so eager to keep its housing sector inflated - and risk bursting bubbles - is that as shown in the chart below, in 2016 the rise of property prices boosted household wealth in 37 tier 1 and tier 2 cities by RMB24 trillion, almost twice the total local disposable income of RMB12.9 trillion. For any Fed readers out there, that"s how you create a wealth effect, fake as it may be. 

Unfortunately for China, whose record credit creation in 2017, and certainly in the months leading up to the 19th Chinese Communist Party Congress which started last week, has been the primary catalyst for the "global coordinated growth", the good times are now again over, and according to the latest real estate data released last week, property sales in China dropped for the first time since March 2015, or more than two-and-half years, in September and housing starts slowed sharply reinforcing concerns that robust growth in the world’s second-largest economy is starting to cool.

Property sales by floor area fell 1.5% in September from a year earlier, compared with a 4.3% increase in August and a 34% jump in September 2016, according to Reuters calculations based on official data released on Thursday. That marked the first annual decline since the start of 2015. Separately, new construction starts by floor area, a volatile but telling indicator of developers’ confidence, rose just 1.4% in September on-year, slowing from a 5.3% increase in August, according to Reuters calculations.

“The negative September sale number shows that, unequivocally, the property boom has peaked,” Rosealea Yao, a property analyst at Gavekal Dragonomics told Reuters. “We have seen some big rebounds at the end of the first and second quarter, but given how fast the sale numbers are declining, we expect no big rebound this time.”

Echoing our concerns above, Reuters writes that "real estate, which directly affects 40 other business sectors in China, is a crucial driver for the economy but also poses a major risk as Beijing looks to tame soaring home prices without triggering a crash or a sharp drop in construction activity.

The easing in property activity appeared to drag on broader growth in the third quarter, and as many economists predicted China’s GDP rose 6.8% in the third quarter from a year earlier, down from 6.9% in the second quarter. And while property investment did rise 9.2% in September, picking up pace from an expansion of 7.8 percent in August, analysts warned such investment usually lags sales trends by up to six months.

Still, as discussed here previously, while home prices have sharply softened in China"s biggest, Tier-1, cities in recent months in response to a flurry of government cooling measures, property bubbles are still a threat in other parts of the country.

A flurry of small cities have had to unveil fresh property curbs in recent weeks after speculators turned their attention to less-restricted cities that have massive overhangs of unsold houses.

Moreover, in addition to many buyers purchasing second houses on credit as Deutsche Bank pointed out last month, high prices are forcing many home buyers to take on more debt, weighing on future household consumption and leaving banks more exposed to any property downturn even as Beijing looks to rein in financial system risks. Household loans, mostly mortgages, rose to 734.9 billion yuan ($110.80 billion) in September from 663.5 billion yuan in August, despite rising mortgage rates, according to Reuters calculations. Short-term loans also soared in the third quarter, suggesting speculators may be trying to circumvent property cooling measures, economists said.

What is most concerning, however, is that the recent sharp decline takes place even as policymakers have made stabilizing the overheated property market a top priority ahead of a critical Communist Party Congress this week, reiterating the need to avoid dramatic price swings which they fear could threaten the financial system and harm social stability.

Adn while a downward inflection point in China"s housing market - which accounts for a third of China’s economic growth - is bad, what follows is far worse.

According to a fascinating new WSJ report, China"s housing downturn is likely far worse than meets the eye, as under Beijing’s direction more than 200 cities across China for the last three years have been buying surplus apartments from property developers and moving in families from condemned city blocks and nearby villages. China’s Housing Ministry, which is behind the purchases, said it plans to continue the program through 2020. The strategy, supported by central-government bank lending, has rescued housing developers and lifted the property market,

As the WSJ notes, this latest backdoor bailout "It is a sharp illustration of China’s economy under President Xi Jinping and the economic challenges he will face as he renews his 5-year term at a twice-a-decade Communist Party Congress that opens on Wednesday."

Rosealea Yao from Gavekal Dragonomics, who was also quoted above, wrote that “the government’s creativity in coming up with new ways of supporting the housing market is impressive—but it’s also an indication that it still depends on housing for growth."

While traditionally, China’s government used to build homes for families who lost theirs to development or decay, last year, local governments, from the northeast rust belt to the city of Bengbu with 3.7 million amid the croplands of central Anhui province, spent more than $100 billion to buy housing from developers or subsidize purchases, according to Gavekal Dragonomics.

In other words, the reason why China no longer has ghost cities is because the government is buying them in just as concerning, "ghostly" transcations.

The underlying structure is yet another typically-Chinese ponzi scheme:

Underpinning the strategy is a cycle of debt. Cities borrow from state banks for purchases and subsidies, then sell more land to developers to repay the loans. As developers build more housing, they, too, accrue more debt, setting up the state to bail them out again. The burden on the state rises, as does the risk of collapse.

What is astounring, is that while the government has tried other ways of filling apartments, such as offering cash subsidies to encourage rural migrants to buy in urban areas, the program is the first large-scale case of the government becoming a home buyer itself. In May, Lu Kehua, China’s deputy housing minister, said the program has “played a positive role in steady economic growth,” and called for a push to clear housing inventory as early as possible, according to an article by the official Xinhua News Agency.

Well, of course, it"s played a "positive role" - when the government itself is buying half the units it bought (see chart above), what can possibly go wrong? Well, pretty much everything if the housing market is once again headed lower and with the explicit backing and funding of the Chinese government.

Some more fascinating details on how China fooled the world into believing back in 2014 that its recently burst housing bubble had "smoothly landed" and was again recovering:

Three years ago, Bengbu’s housing prices were falling. Housing inventory in 2014 would have taken almost five years to fill at the pace of sales at the time, said Shanghai-based research firm E-House China R&D Institute. Around the same time, the Bengbu government began to gobble up homes, and it has continued to do so. The city said it bought nearly 6,000 apartments from developers last year.

 

Housing stock in Bengbu was down to four months in September, a city official overseeing the government program said in September. Home prices had increased by 15% in August from a year earlier. That exceeded the 8.2% growth across a benchmark of 70 cities compiled by the national statistics agency.

 

Beijing and Shanghai residents are used to such price surges, but it is unusual in a smaller Chinese city lacking any particular tourism or job-market appeal.

Naturally, China would rather not have details of its latest bailout program spread too far:

Bengbu officials are wary about publicizing its hand in the market for fear of driving up prices and speculative buying. “We don’t mention it as much now as in the past two years,” the city official in charge of the program said. “Prices have been fluctuating a lot, and it’s a little bit out of control.”

Since the launch of the program, which is an explicit subsidy to Chinese real-estate developers who are directly selling to the government, things have predictably normalized. In fact, the outcome has been a little too frothy:

In 2015, groups of families on government-organized apartment tours started showing up, said Ding Qian, a planner at the developer, Bengbu Mingyuan Real Estate Development. By October 2016, the developer had sold 20 blocks of finished apartments, about 10% of them paid for with government funds, Ms. Ding said.

 

“We have run out of apartments to sell,” she said. The developer has sped up construction of 42 new blocks, about 4,000 apartments, and has raised prices by 40%.

All thanks to the government, which is lending to local governments to avoid the impression it is directly involved in bailing out China"s "wealth effect":

The Bengbu official in charge of the program declined to disclose details about the city’s apartment purchases, but said the city had borrowed 10 billion yuan ($1.5 billion) of the 19 billion yuan of available credit extended by China Development Bank for housing purchases and subsidies.

 

Local governments in 2016 borrowed 972.5 billion yuan from the bank, the government’s main housing lender, nine times the level three years earlier, according to E-House China R&D Institute, which compiled data from official bank and government websites. More than half of last year’s loans went to purchases or subsidized buying, according to the official Xinhua News Agency. The rest of the loans funded housing projects built by the government.

What is most firghtening, is that despite the decline in property sales, the government’s role in the housing market continues to grow according to the WSJ, and here is a stunning statistic: Of all the residential floor space sold in China last year, 18% was purchased by government entities or with state subsidies, E-House China determined from official government data. The share could reach 24% this year, the firm said.

To paraphrase: Beijing is now the (covert) marginal buyer of a quarter of all Chinese real estate. That, in itself, is a mindblowing statistic. What is scarier, is that despite this implicit backstop, property sales are once again declining after 30 months of increases. One can only imagine the epic crash that would ensure at this moment, if - for some reason - the government bid were to be pulled, and just how spectacular the ensuing global depression would be as the rug is pulled from below the middle class of the world"s fastest growing economy.

All Hail Chinese Emperor Xi Jinping: Will He 'Make China Great Again'?

Perhaps no event embodies the unyielding abstruseness and the unforgiving hierarchy of China’s ruling Communist Party as much as its Party Congress, the government’s most important leadership conference. Attended by some twenty-three hundred delegates from across the country, it is held every five years in Beijing’s Great Hall of the People—and when the weeklong meeting finally begins, one can be certain that the crucial politicking has already concluded. What proceeds is a choreographed spectacle bearing fastidiously scripted speeches, pro-forma elections of what has heretofore been determined (a leadership reshuffle in the seven-member Politburo, the highest echelon of power), and, in the case of the 19th Communist Party Congress, which opened today, high-spirited, propagandistic posters reminding the masses that “Life in China Is Good! Everyday Is Like a Holiday!”

This is a message that Xi Jinping, who was appointed President at the previous Party Congress, in 2012, is eager to instill in a country that continues to grapple with a vertiginous pace of change and the outsize influence of politics in everyday life. Xi is almost certainly guaranteed another five-year term, if not longer. Since taking office, he has sought to launch the greatest ideological campaign since the days of Mao.

Xi has made clear from the outset, he is intent on both defining a new world order and restoring to Chinese culture its former esteem.

Yet Xi’s mission should be regarded in the context of a collective and profound post-traumatic stress disorder, the result of almost two centuries of cataclysmic events in China. For every Tang Taizong, who ushered in the golden years of the Tang Dynasty, there were many others like Empress Dowager Cixi, who usurped the throne, crippled the path of progress, and contributed to the downfall of the Qing Dynasty.

As Xi made clear today, during his three-hour address to the Party Congress, he sees this moment as “a new historic juncture in China’s development”—and himself as the man to seize it. He seems to believe that the more power he amasses, the easier it will be for him to enact the kind of monumental changes necessary to transform China into the world’s leading superpower. In this sense, he is positioning himself as a savior with a cause noble enough to justify his autocratic turn. The logic is akin to that which animated the ambition of many of the Middle Kingdom’s five-hundred-odd emperors. Sure, Xi has rerouted all tributaries of power to run upstream to him, but isn’t it in the service of rejuvenation?

Xi has also used his growing power to curb that of his citizens. Under his rule, China has become increasingly repressive. The media is censored and civil society has been muted. Activists have been silenced and human-rights lawyers arrested. More than a million officials have been disciplined. Despite paying lip service to the constitution—the Party devoted an entire plenary session during the 18th Congress to a discussion of “judicial independence”—Xi is steering the country away from the rule of law and toward the rule of the Party.

Xi’s vision for China’s future suggests a great leap backward, in which old lessons remain unlearned.

Critical Threats To 2017's Bull Market - Part 2: Over-hyped Risks?

With The Donald J. Industrial Average surpassing new record highs every day, questioning this bull market"s continued existence remains heresy outside of dark little corners of the internet.

However, continuing his series, Bloomberg"s macro strategist Mark Cudmore dares to mention a few of the more prescient "known unknowns" that could hamper the meltup for the rest of the year... and in the case of today, some that may not.

Via Bloomberg,

Overhyped market risks provide just as many trading opportunities as genuine ones. It’s crucial to delineate what matters and when.

Yesterday’s piece highlighted threats that could cause a material correction before year-end.

Today’s column argues that other oft-cited concerns can be safely ignored for the moment.

Nafta is prominent in the news and any move by President Donald Trump to abandon talks and exit the deal would have global repercussions. Still, that worst-case scenario won’t be a 2017 issue. Even if Trump jumps, he has to give six months notice and Congress will fight to keep the U.S. in.

Will China increase its deleveraging focus after the Communist Party Congress? Probably, and that may hit domestic financial assets. But officials will not want to significantly hurt the real economy and have an impressive track record of slowing growth without killing it. That reduces the risk of a spillover into world markets.

Global yields breaking higher would have major consequences. With only two months of data to go before year-end, are investors suddenly going to believe in runaway inflation though? Given the skepticism shown by the flattening U.S. curve, a one-off print will be insufficient. There’ll need to be a significant change in the trend and there’s simply not enough time left for that in 2017.

Brexit? With expectations so depressed and in the context of a two-year process, it’s not a major near-term risk. It’s a U.K.-asset story, with minimal contagion elsewhere.

Tax reform failure? It seems unfeasible for this to be resolved either way in 2017 and expectations -- at least in the market -- for a successful passage aren’t high in any case.

A Kurdistan-prompted oil shock? The region just doesn’t provide enough supply to be a game-changer -- not with U.S. shale producers ready to ramp up production whenever prices rise.

A failure to form a German majority coalition? Like Brexit, it’s a regional story. A negative that may be underpriced in local assets but not something global investors will panic about.

So, says Cudmore, excluding a Black Swan event, only North Korea, Catalonia or a U.S. government shutdown have the ability to cause a 10%+ correction in the MSCI All-Country World Index by Dec. 31... and here"s why...

North Korea Seen Moving Missiles As US Admits For First Time It Is In "Direct Contact" With Pyongyang

North Korea has again been observed moving several missiles from a rocket facility in the capital Pyongyang, according to a report late on Friday by South Korea’s Korean Broadcasting System (KBS) rising speculation that the North is preparing to take more provocative actions. The last time a similar report emerged was at the start of September, which was followed just days later by a ballistic missile launch which flew over Japan.

Officials did not say where the missiles were being moved, nor the make: according to Reuters, the missiles could be either intermediate range Hwasong-12 or intercontinental ballistic Hwasong-14 missiles, according to the report, though the missile facility at Sanum-dong has been dedicated to the production of intercontinental ballistic missiles.

As previously reported, South Korean official have speculated that the North could launch another nuclear or missile test to coincide with the anniversary of the founding of its communist party on Oct. 10, or possibly when China holds its Communist Party Congress on Oct. 18. Meanwhile, US Pacific Command revealed on Friday that the US and South Korea had recently completed their first joint short range air defense training exercise in South Korea, though it did not say when or exactly where the exercises had taken place.

Separately, on Saturday Secretary of State Rex Tillerson acknowledged for the first time that the US is in direct communication with the government of North Korea over its missile and nuclear tests – a stunning revelation considering that administration officials have until this point insisted that there has been only limited, indirect contact between the White House and the Kim regime. According to the New York Times, Secretary of State Rex Tillerson revealed as much during a speech at the residence of the US ambassador to Beijing after a meeting with Chinese leaders. Tillerson is in China on Saturday for what the NYT described as a “brief visit.”

“We are probing, so stay tuned,” Tillerson said when pressed about how he might begin a conversation with Kim Jong-un, the North Korean leader, that could avert what many government officials fear is a significant chance of open conflict between the two countries.

Tillerson wouldn’t say if the North Koreans had responded to the US’s overtures.

After noting that this was the first time a US official had confirmed that the US was directly communicating with the North, the NYT compared the secret backchanneling to a strategy used by the Obama administration to help forge what became the Iran deal – a comparison that Tillerson swiftly pushed back against. “We are not going to put a deal together with North Korea that’s as flimsy as the one in Iran,” he said. He added that the situation is different and that the North already has nuclear weapons, while Iran was still years away from obtaining them.  

“We ask, ‘Would you like to talk?’ We have lines of communication to Pyongyang – we’re not in a dark situation, a blackout. We have a couple, three channels open to Pyongyang,” he added, speaking at the residence of the US ambassador to Beijing after a meeting with China’s top leadership. He would not say if the North Koreans had responded, beyond a heated exchange of threats in recent weeks. Trump has repeatedly threatened to “totally destroy” North Korea, while the North has threatened to conduct a nuclear test over the Pacific Ocean, and to shoot down US aircraft flying in international waters if they come uncomfortably close to North Korean territory.  

"We can talk to them," Tillerson said "We do talk to them."

When asked whether those channels ran through Chia, he shook his head. “Directly,” he said. “We have our own channels.”

Tillerson added that the most important thing was to lower the tensions between the two countries.

"I think everyone would like for it to calm down."

Reactions to the admission of bilateral contacts were mixed: that the United States would be in contact with North Korea is not surprising, said Narushige Michishita, director of the Security and International Studies Program at the National Graduate Institute for Policy Studies in Tokyo, “But it sounds a little too early.”

“The timing is unexpected,” he said. “It was perfectly clear that both North Korea and the United States, and others, are in the prenegotiation bargaining process.”

Meanwhile, in Japan, where Prime Minister Shinzo Abe recently dissolved the lower house of parliament and called a snap election, the news that the United States is already in direct contact with North Korea could give ammunition to Mr. Abe’s opponents. The Japanese leader has steadfastly maintained that it is not the time for dialogue, arguing in a recent Op-Ed article in The New York Times that “emphasizing the importance of dialogue will not work with North Korea.” “Now,” Mr. Michishita added, “the opposition party members can say ‘Look, you have been talking about pressure, but the U.S. is just leaving you behind.’ ”

China Announces RRR Cut Of At Least 50 bps; First Since February 2016

In a sign that China"s ongoing attempts to delever (and decelerate) the economy may have gone a bit too far, on Saturday morning China’s central bank announced a targeted reserve requirement ratio (RRR) cut, its first since February 2016 and which will go into effect in 2018, in an attempt to boost lending to struggling smaller firms and energize China"s lacklustre private sector, Xinhua reported. 

The People’s Bank of China said on its website that it would cut the reserve requirement ratio for some banks that meet certain requirements for lending to small business and the agricultural sector. According to the PBOC, the vast majority of China’s banks would be eligible for at least a 50 bps cut to their required reserve ratio. As a reminder, the RRR is the amount of cash as a percentage of deposits that banks must park at the central bank as reserves. The current rate for major banks was set at 17.0% after the last general RRR cut that took effect in March 2016.

The PBOC explained that the reserve requirement rate will be cut by 50 bps for banks whose loans to the targeted groups account for 1.5% of their outstanding loan balance or their newly added loans for the previous year. A much higher bar is set for a further 100 bps cut: 10% of loans must be to the designated “inclusive finance” groups, the PBOC said. Banks that meet the 10%  requirement will see their RRR cut by 150 bps.

The PBOC also said the move was made to encourage more small loans - those under 5 million yuan - to small firms, loans to individual proprietors and lending that supports agricultural production, innovation, the poor and education.

As the following chart show, the targeted RRR cut which is meant to stimulate credit creation by smaller banks comes at a time when smaller bank lending has slown substantially as a result of the ongoing crackdown on shadow banking products.

While the central bank explained that the "targeted" RRR cut is a structural adjustment that does not change the country"s overall monetary policy stance, stressing that it would continue to implement "prudent and neutral" policy to guide reasonable credit and financing growth, analysts at Lianxun Securities said that "the size of the cut is big, it covers all big banks, and 90 percent of small and mid-sized banks. Conservatively we estimate 700 billion yuan in liquidity could be freed up."

Perhaps more notably, analysts observed that the cut was different from previous changes to RRR in that it was a “delayed” cut that will not go into effect until next year, which could lead to disappointment for a banking sector that has already seen significant liquidity withdrawn in recent weeks.

“Clearly, the market will be disappointed as this cut will not help ease the liquidity conditions in the onshore banking system in the short term,” Zhou Hao, a Singapore-based analyst at Commerzbank, wrote in a note after the announcement.

The RRR cut will likely not come as a surprise as China’s cabinet, gearing up for the most important Communist party Congress in 5 years starting next month, had recently flagged a possible move, saying "the government would take a number of measures, including tax exemptions and targeted reserve requirement ratio cuts to encourage banks to support small businesses."

The policy action is in line with ongoing attempts to delever the economy and encourage more targeted lending to more vulnerable sectors of the economy, even as the government tries to cut down on speculative investment in the financial sector and property and rein in a rapid buildup in overall corporate debt. However, the RRR cut is departure from the PBOC"s recent approach of setting policy using new tools such as short- and medium-term lending facilities for a similar purpose....

... as well as daily changes to interbank liquidity via reverse repo open market operations.

Lianxun Securities also said the RRR cut would help to offset negative impacts to smaller firms from strict environmental protection measures and capacity cuts, while also offering some liquidity relief to small and mid-sized financial firms. Additionally, the move comes amid increasingly more aggressive attempts by China to delever its shadow banking system, which has plateaued over the past year.

As Deutsche Bank noted several days ago, in China"s latest monthly credit data report "the financial deleveraging campaign has continued to make progresses: banking assets growth softened further; loan and TSF beat estimates but the overall credit growth actually moderated; shadow banking size was shrinking while loan growth stayed resilient. As such from the financial system’s perspective we see improving transparency and lower liquidity risks. While the deleveraging has contributed to a modestly slower economy, the growth momentum is in line with our house view."

That said, DB said that "we do not foresee policies to ease and we expect the deleveraging to carry on orderly," so one wonders how today"s significant easing will impact the German bank"s outlook on China"s economy.

Separately, to offset the shrinkage in China"s shadow banking sector, in February the PBOC extended a preferential programme that allows financial institutions that support rural finance and small enterprises to apply for a lower required level of cash reserves.  But despite still-strong credit growth nationwide, many small businesses and farmers remain in desperate need of funds and do not have easy access to ample cheap credit that state-run firms enjoy.

Also on Saturday, the central bank said it will maintain prudent and neutral monetary policy and use multiple monetary policy tools to keep liquidity basically stable. The statement, which came after the third quarter meeting of the PBOC’s monetary policy committee, said "China will continue with interest rate and exchange rate reform while keeping the yuan basically stable."

* * *

Finally, also on Saturday, China reported that its manufacturing PMI rose to 52.4 in September - more than the 51.5 expected and the highest print since April 2012 - as big factories ramped up faster than smaller ones, presumably a last piece of window dressing to show host "strong" the economy is ahead of the pivotal Communist Party meeting. The National Statistics Bureau attributed the surge to improving demand from domestic and overseas markets and to consumer-goods makers accelerating production ahead of a weeklong national holiday starting October 1. Some economists also said activity picked up thanks to production from Chinese exporters for the Christmas season and manufacturers bringing production forward to beat a government crackdown on pollution.

Ironically, as China"s official manufacturing survey, which focuses on larger SOEs, came out scorching hot, a private measurement of factory activity, which more closely tracks smaller private companies, weakened. The Caixin China manufacturing purchasing managers’ index slipped to 51.0 in September from 51.6 in August, as new orders and output increased at a softer rate than the previous month, said Caixin Media Co. and research firm Markit.

Operating conditions in China"s manufacturing sector softened in September, dragged down by the weakest rise in new business in three months and an easing in output to the lowest level since June, according to the latest Caixin Manufacturing Purchasing Managers" Index (PMI) released Saturday. The headline manufacturing PMI fell to 51.0 in September from 51.6 in August but remained above the 50 break-even mark for fourth consecutive month, according to data compiled by IHS Markit for Caixin.

Readings above 50 indicate expansion in the manufacturing sector while readings below 50 indicate contraction. The higher the PMI reading above 50, the faster the expansion in the sector. The lower the reading below 50, the faster the contraction.

The slowdown in the Caixin index -- which focuses on smaller and medium-size companies -- was in contrast to the sharp rise in the official manufacturing PMI jointly released today by the China Federation of Logistics and Purchasing and the National Bureau of Statistics. The CFLP/NBS PMI came in above expectations at 52.4 in September, the  highest level since April 2012, due mainly to robust input and output prices.

The Caixin index showed that new business expanded at a slower pace due to the weak demand. "Notably, new export work increased only marginally during the latest survey period," Caixin said.

The chart below shows the latest divergence between the two series:

Lu Zhengwei, an economist with Industrial Bank, told the WSJ that the government crackdown to curb pollution falls heavier on smaller manufacturers, which usually have poorer emissions controls, hence the divergence between the gauges. However, in light of the ongoing plunge in China"s credit impulse and the recent miss and slowdown across all major economic indicators, including industrial output, retail sales, foreign trade and fixed-asset investment, it is clear that the economy has begun to cool. 

In response, the governing State Council recommended this past week that the amount of reserves big banks must set aside with the central bank should be lowered, provided they meet certain criteria on lending to small and private businesses. Zhou Jingtong, an economist with Bank of China , said it was a good time to lower the reserve requirement for some big banks to prevent the economy from decelerating too sharply.

That"s precisely what happened this morning.