China’s property bubble at risk?; What is driving oil prices?; Greek bond yields explode as Germany states support for restructuring

Hat tip to the fine folks over at MacroBusiness Australia for these links…

China property bubble at risk?

Moody’s Investor Services downgraded China’s property sector to negative from stable citing deteriorating credit conditions over the next 12-18 months.

This comes as Chinese officials have sought to halt the rise in house values through rising interest rates and tightening bank capital requirements in an attempt to curb credit demand.  The report also indicates that falling sales and a correction in house prices are widely expected.

It appears that the Chinese government is indeed in a bind.  The average house price has pushed well beyond the capacity of the average citizen to afford it.  Yet in their attempt to rein in construction and speculation, they risk slowing GDP growth.  Furthermore, while actively attempting to gently deflate their housing market, the wealth of many speculators is put at risk.

We also found out yesterday just how potentially successful these attempts to control rising property values have been as new house prices in Beijing fell a stunning 29% month-over-month in March following a 70% slump in new house sales in February.

From a Canadian perspective, it is not yet clear whether this news is positive or negative for the Canadian real estate market, particularly those running on fumes and relying extensively on foreign inflows to sustain prices.  The tightening regulatory environment may force capital offshore and potentially into real estate in sought-after locations.  Conversely, a rapid unwinding of property prices in China will also sap wealth from those same investors looking to park their funds in Canadian real estate.

Just how this will play out remains to be seen, though I expect that it will be spun from two decisively different angles.

What is driving oil prices?

As US inflation jumped 0.5% in March on the back of rising energy, it’s worth looking at exactly what is driving the rise in oil prices.  I’ve discussed before that inflation as it is currently (and arguably erroneously) calculated can be affected by numerous other factors beyond the true lasting inflation caused by the expansion in the money supply relative to goods.  In a fascinating graph by David Wilson of Bloomberg (highlighted over at Ritholtz.com), non-commercial net positions in oil futures were compared against the rise in oil prices…


You’ll note that the recent boom in oil prices coincides with a rapid rise in net positions in oil futures.  Simply put, expectations of future oil price movements are at least somewhat responsible for recent oil price movements.

When large net long positions exist in the futures market of any commodity, it can be a sign of heightened price volatility and downside price risk.  These positions are stated in the weekly Commitment of Traders report issues by the CFTC.  In this case, the most recent surge is likely the result of expected ongoing social and political unrest in major oil producing nations.  While it would be a given that a rising threat of disruption in Saudi oil output (currently a very low risk) due to unrest would send crude skywards, the surge in net long positions seems to suggest that significant ongoing tensions are being priced into the oil market.  Any ‘disappointment’ to this view, as in reduced levels of social unrest, may well set oil prices up for a nasty fall.  Good for the consumer…..not good for the energy-heavy TSX.

Greek bond yields explode

In yet more sign that European debt woes are intensifying, Greek bond spreads over German bunds reached an unprecedented 1000 basis points today (10%) amid news that Germany would back a voluntary restructuring of Greek debt.

Greek 10 year bond yields have recently passed 13% and continue to trend higher as creditors are increasingly doubtful of Greek’s ability to repay its debt.

Should the restructuring proposal gain traction (and it’s hard to see how it won’t…they have few options remaining), the next big question is which European banks are most exposed to Greek debt and how will this affect their financial stability?

Cheers,

Ben

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19 Responses to China’s property bubble at risk?; What is driving oil prices?; Greek bond yields explode as Germany states support for restructuring

  1. jesse says:

    Take the foot off the Canadian housing market gas pedal and put it on the “other indicators” pedal and… no comments?

    It will be interesting to see how Greece defaults on its debt and how complete a default it will end up being. It is rarely the Argentine “I am simply not going to pay you back”, it is usually some clever scheme to spread out the costs with face-value haircuts, maturity extensions, and coupon reduction or skipping. Changing the bonds’ currency denomination is pretty much out, but they can also shift bonds into variable performance-based coupons. Some of the most creative people on the planet are bureaucrats working in finance departments! What method(s) will they choose?

  2. John in Ottawa says:

    I’m not keen on anecdotes, but this one struck me as significant.

    We had some of the in-laws over for dinner last night. The BIL begins a conversation saying that the Chinese are running all over the Outaouais (Gatineau, Val-des-Monts, Cantley, Chelsea, etc) with “suit cases full of money” making unsolicited offers for real estate, particularly businesses.

    He was sure these were suitcases full of illegal money.

    His story reminded me of stories from the last century when the Hong Kong Chinese were reported to be knocking on Toronto doors with cheque book in hand.

    My BIL is an ordinary working guy with no particular interest in real estate or economics, so I’ve never discussed these issues with him. His interest in the Chinese was more xenophobic than anything else. I doubt the Chinese are running around with suitcases stuffed full of money in a literal sense, but I found the conversation interesting. It is the first time a HAM story has come up over dinner.

  3. ATP says:

    Ben,

    I’ve recently started following this blog: http://www.alsosprachanalyst.com/

    The author is a London School of Economics trained native Hong Konger who describes him/herself as a former HK-based equity research analyst focusing on HK and China RE. Like you, he loves data and puts forward some logical arguments.

    Cheers.

  4. ATP says:

    Andy Xie, former Morgan Stanley chief Asia-Pacific economist, on China’s stagflation risk: http://xieguozhong.blog.sohu.com/170501521.html

    The English version can be found here: http://english.caing.com/2011-04-08/100246144.html

  5. Liam from Calgary says:

    Greece will default on their loan, little to NO effect on Canada real estate.
    Oil prices will correct in the coming month, Canadian oil companies are already discounting lower oil prices. They may correct a few percent, but the long term trend is up. This bods well for Canada.
    China’s housing will be managed by the communist party.

    The real issue is inflation and interest rates in Canada.
    If interest rates increase a quarter to half percent over the next 12 month. This will put little no no pressure on seller to list their homes.
    Ben,
    Have you considered flat housing prices for the next few years and the long term trends catch up?

    • Several times…here’s one:

      https://financialinsights.wordpress.com/2010/11/18/the-soft-landing-thesis-valid-but-highly-unlikely/

      From current levels, in order for aggregate house prices to realign with fundamentals, and assuming 2-3% wage growth, you’re dealing with the better part of a decade of stagnant growth. Not impossible, but highly unlikely given the experience of other asset classes that have strayed as markedly from their long-term means. And remember that these are aggregate numbers. The bubblier centres would be looking at the better part of two decades of negative real growth.

      I see that as a best case scenario over the next decade. If the stars align and there are no adverse economic shocks, and if interest rates rise very modestly and inventory remains tight, it may happen.

      I’d put the chances of that as an absolute maximum of 25%. The chance of sustained house price increase has to at least be acknowledged…..I’d put it at 5%. I’d weigh the odds of a more significant and rapid (over the course of several years) correction at more than 70%.

      • Liam from Calgary says:

        I agree with you on Toronto and Vancouver, but Calgary may not correct very much if any

    • John in Ottawa says:

      The Bank for International Settlements has calculated that over the past 40 years Canadian Boomers have created a demographic tail wind that contributed 20% of the increase in house prices.

      They project that over the next 40 years, Canada will have a 45% demographic head wind to overcome. That’s just over 1% per year of deflationary force that housing asset growth will have to overcome.

      Given the weakened economies in the developed world and changing demographics in most of the developed world coupled with increasing energy costs, I don’t think it would be unreasonable to project that we will spend a significant amount of time in ever longer and deeper recession. This trend has been developing since the mid-1990s. The Great Moderation is over.

      Canada blew its bubble relatively slowly and its economy is generally strong. Still, I think the general trend will be significantly slower growth going forward with the distinct possibility of actual deflation during prolonged periods.

      Keep in mind that Canada has a low birth rate and relies on immigration to grow its population. Currently, wealth is concentrated in the developed world and this is positive for immigration. However, it is projected that by 2050 65% of all wealth will be in the currently developing world. Over the next 40 years it is going to become increasingly difficult to attract immigrants.

      These strong headwinds almost guarantee that real interest rates will remain low to negative for a generation to come. Just because the only direction interest rates can go is up doesn’t mean they will go up.

      My forecast is for a long, gentle deflation across all asset classes in real terms. This is a very broad generalization that should be valid for places like Ottawa and Moncton. There will still be hot beds in jurisdictions that provide the goods, such as minerals, that the world needs going forward. But those areas will exhibit ever more volatile boom/bust economies.

      This is all a very long winded way of saying that the long term trend can’t catch up. The long term trend is zero to negative.

      • Liam from Calgary says:

        Definitely, one possibility.
        But immigration is the wild card.
        Here in Calgary, we’re experiencing a new influx of immigrants finding work in construction and the service sector. Houses in the $300,000 to $400,000 range are selling in weeks.
        I talked to numerous coworkers in there 20’s, and there looking at buying in the next few month.
        The media is doing a great job in convincing the public that it’s a good time to buy

      • John in Ottawa says:

        Calgary is an interesting town. I was there in the late 70s, early 80s. Calgary is one of those boom/bust economies. Was then, is now, will be for many, many years to come.

        What I said about immigrants isn’t a short term prognosis. Canada will continue to attract immigrants without much trouble through 2030, but we will have much more competition beyond that time.

      • jesse says:

        The deveqloping world may have 65% of wealth in 2050 but it is far from clear how that wealth will be distributed. Canada should offer opportunity for many if they are unable to receive a share that wealth adequately.

      • John in Ottawa says:

        In 2050 you will be old and I’ll probably be dead. North America will no longer look as much like “the land of opportunity” to immigrants looking for a new home. Much of the currently developing world will be developed with stable political systems.

        Sure, some immigrants will still chose Canada. But, as I said above, we will have to compete to get them. Many will chose other countries to establish new homes. Things change. If Canada had ever been particularly attractive our population wouldn’t be only 1/10th of the US.

      • ATP says:

        John,

        It’s probably me, but I don’t quite follow your logic:
        You state that “real interest rates will remain low to negative for a generation to come.” By that, do you mean inflation rates will be close to or higher than nominal interest rates? Yet you also forecast “a long, gentle deflation across all asset classes in real terms.” Am I missing something? Could you kindly elaborate?

      • John in Ottawa says:

        @ATP: Yes, if interest rates are lower than core inflation, real interest rates are negative. This is the situation in the US right now where real interest rates are, believe it or not, running about minus 5%. Of course, it is the large banks which are getting the bulk of the benefit of that through QE.

        Since the early 90s, which goes along way towards explaining the divergence between house prices and mortgage debt, we have had “targeted inflation.” That is, the central bank manipulates the bank rate in order to cause about 2% core inflation. The 2% number has been chosen in order to provide a buffer between inflation and deflation. Deflation is harder on the economy than inflation.

        It would be nice if it could all work out to 0% inflation, 0% deflation, but that is virtually impossible. Given a choice between inflation and deflation, always chose inflation, thus 2% which isn’t too onerous.

        The job of central banks is going to get very difficult over the next generation. Several economic forces are going to create strong deflationary headwinds. The central banks want to target 2% inflation. I don’t pretend to know how they are going to manage this.

        Remember, food and energy don’t count in current calculations. Something is going to have to be done about at some point in the future or the middle class is going to sink.

        Lately, the big subject in the elevators, the office, and around the dinner table is the cost of gasoline. With wages held stagnant, it is pretty hard to tell the average joe that there isn’t any inflation when he can’t fill the gas tank or the larder.

      • jesse says:

        Accepting applicants to Canada will be like advertising a job in the paper: there will be no shortage of applicants, it’s a matter of getting qualified applicants.

  6. TS says:

    Germany was the main lender to the Greeks. Germany was also the main import country to Greece. Lend Greek people German money so they will buy
    German goods. It happened throughout the European community. France is in a similar position. It worked for quite a while. The strange thing is that no one seemed to care whether the poorer external wealth creating countries ever had the ability to pay the loans back. The game is almost up.

  7. Pingback: Stocks sell off as S&P cuts US outlook; Does a drop in foreign demand for Canadian bonds signal rising fixed interest rates?; Greek restructuring would be “catastrophic” | Financial Insights

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