Real estate crisis and economic policies from the US to China

PODCAST: Is the Economy Heading Towards a Crisis? - Discussion on Inflation, Interest Rates, and Recession Potential

In today's podcast, Steve and Linh Hà talk about:

• What is the current inflation situation and the direction of the FED?

• Where does the potential for an economic crisis come from?

• How is the economic recession in China and Europe?

Last week, the minutes of the Fed's May meeting (FOMC Minutes) conveyed a rather hawkish message from this world's largest economic regulatory body. The attitude of the members is: disappointing inflation reduction progress + policy may not be tight enough.

But the longer the Fed keeps interest rates high, the greater the risk of a larger economic recession. And the first sector threatened in the current high interest rate environment is the commercial real estate (RE) sector in the US: where office rental demand is declining and capital market tensions are at a climax!

Meanwhile, on the other side of the Pacific, the world's second-largest economy, China, is still struggling with the overall dire situation following the real estate bubble crisis nearly 3 years ago. Government efforts have only revived a small portion amid the collapse of this world's largest capitalized real estate market.

And the common point for both the US and China is: economic policymakers are still deadlocked on policy direction!

This weekend's Macro Economics column by Viet Hustler will clearly analyze the US commercial real estate market and China's residential real estate market, in the context of economic policies from these two world superpowers!

US: Commercial real estate crisis is approaching - but Fed unlikely to cut interest rates

Commercial real estate crisis escalating in the US

For the first time since the 2007-2008 Crisis, the highest-rated (safest) commercial mortgage-backed securities (CMBS) have also recorded significant losses: 

• Buyers of AAA bonds backed by the 1740 Broadway New York building were only repaid 74% of their investment.

  • Lower-rated bonds suffered 100% losses - investors in these bonds lost a full USD 150.5 million.

  

  • FYI: The securitization of mortgage debts into MBS

    • This event marks escalating tensions in the commercial real estate market:

• Losses for CMBS investors (even the safest rated bonds) have materialized: 

  • The delinquency rate for CMBS related to office buildings has increased much higher than the overall CMBS delinquency rate.

    

The commercial real estate charge-off rate (investors recognizing partial or full losses on investments due to unrecoverable debt) is also on an upward trend:

• It is now double the peak during Covid (2020).

  

The above tensions are due to both subjective and objective causes:

• Compared to Asia and Europe, the US post-Covid return-to-office rate is the lowest:

  • This adds further tension to the commercial real estate market.

    

• Meanwhile, the high interest rate environment makes selling commercial real estate increasingly difficult:

  

• Therefore, office commercial real estate is the most stressed RE segment currently:

  

If a commercial real estate crisis truly occurs in the US, the banking system will bear the greatest losses!

• FYI: Real estate loans account for…

  • 13% of the balance sheets of large banks and

  • 44% of the balance sheets of small local banks (regional banks).

• If the Fed and FDIC do not act in time, this could trigger a wave of bank runs due to depositors' fear - expanding the banking crisis!

  • On the Fed's side: the best solution the Fed can do is to quickly lower interest rates.

However, with high inflation and low unemployment – the Fed's equilibrium interest rate model does not allow it!!

Fed's higher-for-longer interest rate plan  

Last week's Fed May FOMC meeting minutes can only be described with one word: HAWKISH.

Among them, there are 2 main points that the Fed wants to convey to the market:

1. The progress of inflation reduction is not fast enough as expected.

2. Fed not in a hurry to cut interest rates - and proposes keeping current interest rates longer – or even raising interest rates.

Issue 1: Inflation

In the US: slow inflation decline is due to strong job growth and wages.

• Excess savings post-Covid led to strong spending in 2023

• As long as spending continues, demand continues – businesses continue to hire more labor

• More jobs created continue to boost spending.

=> This is a vicious cycle making US inflation decline very slowly

However, the good news is that excess savings in the population have been depleted and the labor market is on track to normalize:

=> The disinflation process will soon accelerate in the second half of 2024

• Read more: Labor market and consumption push back the soft-landing dream

• Especially when essential products for people become more expensive: it will prompt people to cut spending early.

  

• Of course, this only happens if there is no major supply shock!

  • But with recent geopolitical tensions, it's hard to be certain.

  • FYI: Freight rates from Asia to Europe and the US are rising again!

    

Issue 2: On interest rates and recession risk

As Viet Hustler has emphasized many times, high inflation + declining unemployment means Fed must keep interest rates high — according to the economic equilibrium model.

• Read more: Basis for Fed's interest rate decisions

However, currently, several economic models indicate that the neutral rate has cooled compared to the previous period.

• FYI: Neutral rate is the interest rate that ensures the economy is at full employment and inflation at the 2% target. 

  • Neutral rate is not observable in reality like market interest rates but is only estimated through macroeconomic equilibrium models.

• And if the actual interest rate (R_t ) is much higher than the neutral rate (R^n_t ) according to the Fed's model below:

  => Industrial output xgap_t will decline (compared to the equilibrium period)!

• Thus, recession risk is increasing at the current time:

  • Currently, the 10Y-2Y bond yield curve is still continuing to invert.

    

So when is the time for the Fed to cut interest rates?

• Viet Hustler maintains the view based on economic models:

  • Fed will cut interest rates by -25bps (from equilibrium rate) when inflation shows significant decline (PCE down ~ -20bps) and unemployment rate rises accordingly (+25bps). 

    • See reasons at: Basis for Fed's interest rate decisions

    • However, from concerns of Fed members, current interest rates may still be lower than the model's equilibrium rate (not restrictive enough).

• Below are predictions from major banks on the timing and extent of Fed rate cuts this year:

  

China: piecemeal economic policies not enough to revive damage from real estate crisis

Government efforts still too small compared to the damage of the real estate bubble to the economy

• In recent weeks, good news about the Chinese government's 1,000 billion CNY real estate rescue package has caused construction and real estate sector stocks there to surge.

  • FYI: Shares of Chinese real estate developer Vanke turn around and rise again as China rolls out the above rescue package + Vanke successfully raises 4 billion USD in investment capital.

  

• And there were quite a few economic stimulus policies implemented prior to that:

  • China's early 2024 growth stimulus policies

  • Capital market situation after the support policies.

• Many economists also believe PBOC deliberately allowed the Yuan to depreciate to boost export growth amid declining global demand:

  

However, China's government efforts to revive the real estate sector and consumption are still very small compared to the losses from the real estate bubble burst over the past more than 2 years:

• New home prices in the US continue to decline in April 2024:

  

• Leading to a plunge in home sales in China from the 2021 peak, which was ~2x higher than car market sales there.

  • This decline equates to more than -CNY 10,000 billion in lost sales in less than 3 years – 10 times the CNY 1,000 billion rescue package!

  

• Along with the decline in real estate value (traditional savings asset for many Asian households), consumer demand has also fallen accordingly:

  • Inventory levels in China reach peak:

    • Not because holding for sale due to high demand – but simply reflecting overproduction relative to demand.

  

• Despite a slight positive shift, more than >50% of Chinese enterprises reported lower-than-expected revenue in Q1/2024.

  

Stock market recovery uneven - debt market dismal

• Chinese stock market recovery mostly from Hong Kong exchange more than Mainland exchanges

  

• Interestingly, companies listed on both Hong Kong and Mainland exchanges trade at different prices:

  • The same stock traded in Hong Kong has a lower discount - while on the Mainland exchange it has a higher discount (higher risk premium).

  • This indicates investors remain concerned about the transparency and risks of Mainland exchanges.

  

• Meanwhile, the credit market is extremely dismal: lending activities post negative growth for the first time (especially non-discounted bank loans).

  • Simply due to low demand, businesses have no intention of borrowing to expand operations.

    

Policies fail to stimulate consumer spending growth

• In April, net withdrawals by residents from the banking system hit a record high of ~3.9 trillion CNY:

  • Of which 1.9 trillion USD was withdrawn by households.

    

  • Part of this money shifted to bond Mutual Funds investments — due to attractive yields on ultra-long-term Chinese government bonds.

    

• Another portion invested in the stock market:

  • Especially as Shanghai and Hong Kong stock exchanges recover + companies increase dividend payouts.

    

This is precisely the dilemma for Chinese policymakers! 

» What they must do is stimulate consumption (demand side):

• But current stimulus policies mainly target businesses (supply side) – while businesses are already overproducing.

• Meanwhile, government bond issuance and corporate dividends encourage people to invest rather than spend

=> Tình trạng này có thể càng làm gia tăng vấn đề giảm phát/ thiểu phát!

KẾT LUẬN

Môi trường lãi suất cao tại Mỹ đang đe dọa đến thị trường vốn — mà thị trường đầu tiên có khả năng sụp đổ sớm là BĐS thương mại. CMBS xếp hạng AAA có thể coi là loại chứng khoán/trái phiếu an toàn nhất trên thị trường BĐS thương mại — hiện nay cũng đã có nguy cơ lỗ vốn đối với nhà đầu tư. Đây chính là lời cảnh báo về sự bùng nổ của Khủng hoảng BĐS thương mại tại Mỹ!

Nguyên nhân cho những nguy cơ rình rập lên thị trường BĐS thương mại bao gồm từ cả phía nhu cầu thấp (do tỷ lệ trở lại văn phòng hậu Covid thấp) lẫn môi trường vĩ mô xấu do lãi suất cao khiến việc quay vòng vốn khó khăn. Và đối tượng chịu ảnh hướng lớn nhất nếu khủng hoảng BĐS thương mại xảy ra chính là hệ thống ngân hàng - trụ cột của nền kinh tế!

Ngược lại, Trung Quốc lại đang có giá trị BĐS nhà ở ngày một xuống dốc khiến người dân phải thắt lưng buộc bụng — nguyên nhân chính dẫn đến giảm phát tại đây. Sự phục hồi của thị trường vốn cũng không đồng đều và chắc chắn.

Điểm chung của Mỹ và Trung Quốc là sự bế tắc trong chính sách.

• Các chính sách của Trung Quốc hiện tại khá rối ren: chủ yếu chỉ có tác dụng lên doanh nghiệp — mà ít có tác dụng nhiều lên nhu cầu chi tiêu của người dân. Trong khi việc vực dậy thị trường chứng khoán và phát hành trái phiếu đặc biệt lại đang thu hút người dân tiết kiệm thay vì tiêu dùng!

• Còn Fed thì lại đang hawkish trở lại — đơn giản vì các thành viên Fed đang dần mất kiên nhẫn đối vời tiến trình giảm lạm phát chậm chạp. Tuy nhiên, lãi suất cao trong thời gian càng dài thì nguy cơ suy thoái sẽ càng tăng nhanh. Các ngân hàng lớn đều đồng loạt giữa nguyên quan điểm Fed sẽ phải hạ lãi suất vào cuối năm nay.

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