We have warned a number of times that China is a ticking time-bomb (and the PBoC finds itself between a housing-bubble rock and reflationary liquidity injection hard place) but the collapse of trust in the interbank funding markets suggests things are coming to a head quickly. The problem the administration has is re-surging house prices and a clear bubble in credit (as BofAML notes that they suspect that May housing numbers might have under-reported the true momentum in the market since local governments are pressured to control local prices) that they would like to control (as opposed to exaggerate with stimulus).
MoM price momentum holds the key
Looking at past few rounds of tightening since 2010, it appears to us that the primary consideration of the government is MoM price momentum, not YoY growth in price.
70-city average primary housing price growth MoM and volume growth YoY
70-city average home price growth YoY
This makes sense because potential buyers tend to be enticed to rush into the market if they feel persistent upward price pressure. Table 1 lists the timing and measures of the tightening policies since 2007.
Why we think prices may soon jump again
We suspect that May numbers might have under-reported the true momentum in the market. Local governments are pressured to control local housing prices so some of them have resorted to short-term administrative measures, e.g., Beijing might have suspended the launch of any new projects priced above Rmb40k/sqm (China Securities Journal, June 13). More important, monetary policy remains fairly accommodating, real business returns remain unattractive, while shadow banking products appear increasingly risky. As a result, we believe that it’s a matter of time till liquidity will return to flood the housing market.
The new administration should be tougher on property
The new administration has a five-year horizon.
In our opinion, it has two options with regard to the housing market:
1) to continue to handle it with kid gloves and run the risk of a property bubble bursting just when senior officials fight for positions in the next administration; or
2) to kitchen sink it, live with pain upfront and try to implement structural reforms – hopefully by year four or five, the economy will be on the mend.
Option 2 sounds more plausible to us.
and from Credit Suisse:
This ... has heightened systemic risk in the financial system, creating policy uncertainty and has further induced market volatility. By allowing the overnight SHIBOR to spike again, the market has a legitimate reason to ask whether the central bank has the will and ability to calm the interbank market which for us brings back the memory of the US government allowing Lehman Brothers to fail.
We have a few observations to offer:
- SHIBOR hikes, or even bank failure in settling within the interbank market, happened before, with the latest events in 2011 and 2012;
- There appears to be no bank run at the retail level as depositors seem calm, at least for now;
- The liquidity crunch has occurred at the interbank market due to duration mismatch and the lack of policy response, but so far, neither have affected the real economy - large SOEs still remain cash rich while SMEs are struggling with liquidity;
- How soon the turbulence can be resolved rests on the will of the central bank;
- We believe that the State Council has the authority to stop this brinksmanship and probably has the political will to do so, should the situation go too far, but whether they can make a sound judgment on when is “too far,” only time can tell.
The length matters a lot more than the height of the rate spikes in the interbank market. We believe the elevated SHIBOR has not reached its end. The longer this lasts, the more likely that some banks may face serious liquidity issues and that would further undermine the creditability between banks, creating a chain reaction. It is our view that draining interbank liquidity at the interbank market could cause unintended consequences, at a time at which duration and risk mismatch among the banks are severe, account receivables in the corporate sector are surging, and the inflow of FX reserves is decelerating sharply.
As we noted here, while the PBOC may prefer to be more selective (option 1 above) with their liquidity injections (read bank 'saves' like ICBC last night) due to the preference to control the housing bubble, when they finally fold (which we suspect they will) and enter the liquidity market wholesale, the wave of reflation will rapidly follow (and so will the prices of precious metals and commodities).