Why Chinese Assets Hit the World Hard

Welcome back to SovereignBeat!

In this publication:

• Iraq pledges to maintain oil production cut to keep prices afloat

• China's property turmoil sends ripples accross the world

• India pushes for a new global trade corridor

• Equities in red territory

• The economic data is not supportive of cuts, yet

Let’s dissect

Markets Snapshot

Debt Securities

• USA: On Tuesday, February 13th, US 10-year Treasury yields surged to over 4.28%, marking the highest level in more than two months. Market shifts followed government data revealing that US inflation eased less than anticipated in January, settling at 3.1% year on year. Core inflation remained stable at 3.9%. Following the data release, the implied probability of a rate cut in May, according to futures markets, dropped from 50% to 30%, with the likelihood of a cut in March almost fully eliminated.

• Federal Reserve Bank of Atlanta President Raphael Bostic asserted that there was no rush to cut interest rates in the US, given the strength of the country's labor market and economy. He cautioned that the progress of inflation toward the 2% target was unclear, emphasizing that evidence from data, surveys, and outreach so far indicates that "victory is not clearly in hand.

• EU: The Euro Area's economy showed no growth in Q4 2023, after a 0.1% contraction in Q3, affected by high inflation, elevated borrowing costs, and weak external demand. Eurozone (euro area countries that have adopted the euro (€) as their primary currency) saw a 0.1% growth in Q4 , resulting in an annual growth of 0.5% for 2023 and marking a decline from previous years.

Equity Markets

• All three major indexes concluded the week in the red, breaking their five-week winning streaks. This seesaw market reflects the ongoing tug-of-war between persistent high inflation, signaling no imminent rate cuts, and robust economic indicators like strong earnings, reinforcing investors' belief in continued stock market growth.

Commodities

• Oil prices climbed to $82 per barrel for Brent crude, registering a slight increase of just over 1% last week. Iraq, aligning with OPEC decisions, reaffirmed its commitment to a second voluntary production cut announced in December, now additionally pledging to cap its oil production at 4 million barrels per day. Currently, the nation's exports stand at approximately 3.4 million barrels per day. In December, Iraq committed to cutting daily oil production by 223,000 barrels from January 1 to March 31, 2024, while producing 4.292 million barrels per day in the same month. Measures are also being taken to restart oil production and exports from Kurdistan, using Turkey's Ceyhan port, which had been suspended since March due to a revenue dispute.

• Shell anticipates a 50% surge in global liquefied natural gas (LNG) demand by 2040, propelled by China's shift from coal to gas and increased LNG usage in South Asian and Southeast Asian countries to fuel economic growth. However, the LNG demand projection for 2040 has been adjusted to 625-685 million tons annually, down from the initial expectation exceeding 700 million tons. Shell outlook and demand for LNG aligns with the global transition away from fossil fuels, with Europe securing long-term LNG contracts to address its energy crisis, and plans by the US and Qatar to boost shipments. The recent pause by the US on new export licenses to assess climate impacts introduces uncertainty about the future role of LNG, contributing to one of the reasons for the revised outlook.

Global Finance

China's Property Crisis Goes Global

• Facing a property crisis in China, Chinese investors and creditors are divesting global real estate assets that they hold abroad to generate cash, despite potential losses in a declining market. Consequently, a new influx of real estate assets acquired during a decade-long Chinese expansion is now hitting the markets around the world. Beijing's efforts to curb excessive borrowing have affected almost all developers, including those once considered major players.

• For instance, a Mayfair luxury project in West London collapsed into administration after a loan default, primarily owned by Chinese investment firms Citic Capital and Cindat, as reported by Bloomberg. Other Chinese developers are attempting to offload London properties at discounts ranging from 15% to 20%.

• The global commercial property market experienced its lowest transaction volume in a decade last year, introducing considerable uncertainty given the scarcity of recent sales data for valuation. The MSCI World Real Estate Index recorded an 18% decline from the beginning of 2022 to the end of 2023, indicating the direction investors anticipated property values to move.

• The rise in interest rates has driven investors to pursue higher yields. Commercial real estate yields are determined by the rental income as a percentage of a building's value, and since rental rates are often fixed for extended periods due to landlords signing long-term fixed contracts with tenants, property prices needed to decrease for yields to increase. Those landlords, without fixed contracts, shifted the rising costs of real estate debt financing, driven by higher interest rates, onto their tenants. Even more crucially, most landlords will have to inject additional capital to address the increasing loan-to-value breaches in recent years or face the risk of property seizure by lenders.

• It is worth noting that China is by no means the sole contributor to commercial real estate distress; many European and U.S. developers are forced to sell at steep discounts or face foreclosures by regional banks. China, however, stands out as a market where vendors have a significant incentive to sell quickly.

Our thoughts

• The ongoing sell-off is an attempt to assess industry challenges exacerbated by increasing borrowing costs, resulting in a global reduction of over USD 1 trillion in office property values and marking a decade-low in commercial property transactions worldwide last year. Despite lower valuations leading to a decline in sales volume in 2023, as shown on the graph, we anticipate a resurgence in numbers as some developers desperately need to enhance their liquidity.

• The surge in the supply of real estate assets during a downturn is likely to further contribute to a decline in property prices, exacerbating the existing deflationary spiral. The overall impact depends on both the market's reactions to the asset sales and the regulatory response from Beijing, as well as other countries’ governments and central banks, aiming to shield the sector from fluctuations and developers from substantial losses.

Geopolitics

India and UAE Sign a Global Trade Corridor Deal

• Indian Prime Minister Narendra Modi secured an agreement with the United Arab Emirates to advance with the development of a major trade corridor connecting India to Europe, an ambitious plan backed by the US and the European Union. Initially announced in September on the sidelines of the G20 summit in New Delhi, the corridor will span from India, across the Arabian Sea to the UAE, through Saudi Arabia, and connect via Jordan and Israel to Europe.

• Modi's meeting with UAE leader Sheikh Mohammed bin Zayed Al Nahyan in Abu Dhabi on Tuesday resulted in an agreement to kickstart the operationalization of a section of the ambitious India-Middle East-Europe Economic Corridor (IMEC). The corridor is an ambitious ship-to-rail network that aims to enhance trade efficiency and expedite the transport of goods

Our thoughts

• The agreement on the India-Middle East Economic Corridor comes amid the ongoing four-month-plus war in Gaza, which has disrupted US-backed plans to deepen integration between Israel and its Arab neighbors. The framework agreement between India and the UAE suggests that both nations are advancing the plan that will challenge China's Belt and Road connectivity strategy in global trade infrastructure.

• Modi's seventh visit to the UAE since 2015, and the third in the last eight months, highlights the deepening bilateral relations between India and the UAE. Aside from strengthening ties with the Middle East country, the president also seeks to bolster his global standing in anticipation of the upcoming elections scheduled to commence in April.

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