Tuesday, December 28, 2010

China's Real-Estate Frenzy

Here is a good op-ed in today's Wall Street Journal ("China's Real-Estate Frenzy") that highlights the growing real estate bubble forming in China. After experiencing a modest correction during the summer, pricing and activity appear to be back in an upswing. However, as yesterday's 25bps interest rate hike demonstrated (building on the first 25bps hike in October), Chinese government officials are slowly waking up to the realization that they need to do something before things get really out of control. One interesting point highlighted in the article is that there are no property taxes in China. As such, the carrying costs for holding an empty apartment are negligible. In order to curb speculative activity, I think Chinese officials should implement some sort of property tax, even if modest.

Here are some other good highlights from the article:

Last week I sold an apartment in Beijing for more than 2.5 times what I paid for it five years and three months ago [more than a 20% IRR!]. When I asked the buyer why he was optimistic about real estate, he explained that land was limited in Chinese cities and government policies would keep the market going up.

Housing prices in the U.S. peaked at 6.4 times average annual earnings this decade. In Beijing, the figure is 22 times.

In the past, when China could depend on growing export markets, technocrats in Beijing were able to keep speculative frenzies in check with periodic crackdowns...But this time nobody is listening. Local governments and banks have set up off-balance sheet vehicles to conceal loans and keep the spending boom going. Fitch Ratings estimates that not only did banks exceed the central bank's 7.5 trillion yuan ($1.1 trillion) cap on lending for this year, they made an additional three trillion yuan of these shadow loans.

When a government loses control of monetary policy, inflation follows. A few months ago, only the scariest "China bears" predicted 6% inflation for next year; now the People's Daily is admitting it may reach those levels "in some months."

Thursday, December 23, 2010

Germany Not Immune to Europe’s Contagion

Here is a good article from today's FT ("Germany not immune to Europe’s contagion") that highlights the mounting pressures facing Germany. Although on a standalone basis, Germany should be fine, its banks are highly exposed to contagion risks in Europe's periphery. The article posits that if Spain should default, German yields (which are currently under 3%) could rise sharply higher. Further, German CDS spreads have recently hit new highs (excluding the time period surrounding Lehman's bankruptcy) and the ultra-safe swiss franc has been steadily climbing against the euro. Here are some of the highlights from the article:

The very idea that Germany could be caught up by contagion from the eurozone debt crisis seems risible. Its benchmark interest rates, those for 10-year Bunds, trade below the equivalent levels for the US, UK and France.

Yields of just shy of 3 per cent for 10-year money hardly smack of trouble. Inflation is unlikely to cause problems soon, unlike in the UK and potentially in the US thanks to quantitative easing. It also enjoys a sizeable current account surplus, meaning it is not at the mercy of foreigners for financing, unlike many in Europe. In short, its bonds are still seen as the safe haven of at least the eurozone.

Nonetheless, the whispers are starting against Germany. Yields have risen by more than half a percentage point since their lows in October. Unlike the corresponding rise in US yields, which many see as the result of higher growth expectations, few are touting higher output as a reason for Bunds spiking.

Instead, the markets are firmly putting the blame on the prospect of contagion and in particular the fear that Germany could end up coughing up to bail out most of the so-called periphery of the eurozone.

Pimco, one of the world’s largest bond investors, which by chance is owned by Allianz, the German insurer, has for several months privately been warning that German yields could shoot up once the price of the various European rescue schemes are factored in. Germany’s exposure should remain manageable if the crisis stays restricted to Greece and Ireland (and probably poor Portugal, the next in line for a bail-out).

But the 50-100 basis points question for Germany is what happens to Spain. Should it need a bail-out – and its yields continue to hover close to euro-era highs – then Germany is on the hook for tens of billions of euros more and its yields could well shoot up.

Wednesday, December 8, 2010

China's Inflation Is A Monetary Phenomenon

Here is a good chart from todays WSJ (“China's Inflation Is a Monetary Phenomenon”) highlighting the growth in China’s M2 since 2002 and the recent surge in food inflation. As demonstrated in the chart below, M2 growth peaked last November at approximately 30%. Given that inflation generally lags M2 growth by 12-18 months, we are now only starting to see the effects of last year's massive lending binge work their way through China's CPI data.

A big theme for the year ahead will be how aggressive China and other emerging market central banks are in tamping down inflationary pressures that are clearly bubbling up in their economies. Should central banks accelerate their recent tightening measures, we could see global economic growth fall well short of the more bullish forecasts starting to gain sway with investors (though the lagging effect of these actions suggests this will be more of a 2H 2011/1H 2012 problem).

For a similar article on the inflationary pressures building up in Brazil see another article from today's WSJ - "Inflation Dilemma Looms for Brazil's Rousseff."

On the campaign trail, Ms. Rousseff promised to lower Brazil's sky-high interest rates. But in order to tamp down inflation, Brazil's central bank is getting ready to raise rates, not lower them, economists say. Central bank directors are meeting Wednesday to discuss potential rate increases. Many Brazilian economists expect the country to boost its 10.75% interest rate—among the highest in the world—by the end of January at the latest....

Inflation picked up as Brazil's government took on more debt to boost spending after the global financial crisis. The stimulus helped Brazil weather the downturn. But two years later, the stimulus spending has juiced up Brazil's natural growth rate of around 4.5% to a China-like 7%, creating inflation along the way.

"The inflation issue requires a policy response," says Marcelo Carvalho, who follows Brazil at BNP Paribas in São Paulo.

Brazil's Finance Minister Guido Mantega, who is set to remain in his job once Ms. Rousseff takes office, said this week that the federal government will introduce a series of inflation-fighting spending cuts.

Wednesday, December 1, 2010

Eurozone Bond Spreads Blowing Out

Here is a great chart from yesterday's Financial Times highlighting the growing credit crisis in the euro zone. The bottom left graph clearly demonstrates how credit spreads have blown out over the last few months. As investors turn their attention to the next dominoes to fall, Spanish bond yields have risen to approximately 300bps wide of German yields. Even more concerning is that Italian bond yields have blown out to 210bps wide of German yields (the highest spread since the euro came into effect). While Ireland and Spain both entered the credit crisis with very low government debt to GDP ratios (less than 30% for Ireland and less than 50% for Spain), the FT reports that Italy's sovereign debt to GDP will be about 118% by year end. On the positive front, Italy's banks remain far healthier than those in Ireland and Spain, though the country faces significant refinancing risk in 2011, with Eur300bn of total debt (sovereign plus bank) maturing during the year. Out of this 300bn, approximately 1/3 of it is due in the first three months. While equity markets continue to rally in the US, investors ought not to dismiss the contagion risks spreading throughout Europe.