Evergrande: Risk-off tone for APAC, a USD win-win scenario, bad for AUD

The open could be in for a risk-off ride to start the week due to China's embattled developer, Evergrande, being on the brink of default. 

The potential fallout of Evergrande could have contagion implications that spill outside China’s financial market borders, especially for the commodities markets. 

Here’s how bad its problems are, and what’s in store for investors in the open:

The world’s most indebted property developer, Evergrande, is now snowed under an expanding debt of $300 billion, with more to come this month the developer said last week. The sales have dried up. 

Banks no longer will lend to the property giant, a conglomerate that has far-reaching integration with global financial markets. Rating agencies have repeatedly downgraded the firm, citing its liquidity problems and the share price of the firm has been in heavy decline this year. 

Overall, Evergrande's stock fell close to 90% from its all-time high levels, and over 80% since the beginning of this year. The company’s dollar bond’s price has also dropped over 70%. However, the bonds of Evergrande’s real estate counterparts are also dropping sharply, and signalling a potential crash. 

Evergrande Bailout in the offing?

The major risk to the markets may not be what the company owes to banks, as the company is considered to be too big to fail; It is hard to apply normal free-market logic to a bankruptcy of a company in a market that is actually completely under the control of the government. The government is expected to bail out the company, albeit indirectly, and order for a change-over at the management. Therefore, this news may only be a short term impact on risk appetite this week.

However, there is still some $158B of accounts payable to domestic as well as global suppliers of materials and resources that are outstanding. A lot of companies could go bankrupt if they’re not paid. Therefore, the contagion risk is what investors will be concerned about and may well position accordingly, bracing for impact as markets open this week. 

In an announcement on Wednesday, the Chinese Housing Ministry confirmed that Evergrande would not be making interest payments to banks scheduled for Monday. This too will raise the uncomfortable possibility that Evergrande’s woes could spread into the Chinese banking system this week, with potentially far-reaching consequences.

Overall, the uncertainty will be the driver and Evergrande's debt situation might have greater implications than we can anticipate at this moment in time. What is very clear, is no matter whether the Chinese government intervenes, either directly or indirectly, the Chinese economy will suffer the ramifications.

There are some 1,300 projects in over 280 cities at risk which equates to $310 Billion of debt of a firm that is responsible for over 123,000 direct employees which do not include a lot of independent construction workers who are hired for each of their projects.

Moreover, it is apparent that Evergrande is not the only Chinese developer at risk.

AUD could be hit hardest

Looking further afield, Australia is the first nation that comes to mind considering the amount of iron ore trade that is done between the two nations and not to mention how much the Chinese are invested in the Australian property market. 

As by far the world’s largest importer of iron ore by an enormous margin, any significant reduction in Chinese demand would have significant ramifications for the Australian economic income from iron ore operations and for the federal budget. (Every $US10 the price of iron ore falls nominal GDP decreases by $6.5 billion and the budget coffers are drained of $1.3 billion, that is according to the 2021-22 federal budget).

Meanwhile, Aussie real estate market would also feel the heat. If Chinese investors who own Australian property are forced to liquidate their assets in order to cover bad debts, some suburbs with a high proportion of Chinese ownership could see a significant increase in the number of properties on the market.

In a scenario where a protracted crisis unfolds within the Chinese property sector, the Australian economy that is already struggling due to the covid lockdowns will be thrown into more scrutiny by investors. Overall, this will give even more problems for the Reserve Bank of Australia to worry about. 

Investors are going to be concerned for the APAC market which could mean more confidence in the US as a safe haven. For forex traders, this likely means a weaker Aussie and a stronger US dollar for the open.

AUD/USD and AUD/JPY could be heavily impacted in the opening sessions and longer depending on the Chinese Communist Party leadership's resolve. The Global Times, a media that directly reflects the stance, position, and opinion of the Chinese government, said that Evergrande was "not too big to fail". A disorderly default on Evergrande's obligations could spell disaster for global markets and directly impact AUD lower for longer. 

AUD/USD daily chart, the bearish playbook

AUD/USD closed at a critical market structure on Friday and left a Doji candle. However, with such news as this, there are prospects for a stronger US dollar which could tip the price of AUD/USD over the edge, extending the current bearish impulse.

A break of support near 0.7260 opens the risk of a downside extension. A restest of this current support as resistance in the future could be expected to fen-off initial bullish breakout attempts. Therefore, this resistance could potentially lead to a further decline in the pair towards the 0.71 figure and below. 

AUD/JPY daily chart

The price has already corrected a significant portion of the prior daily bearish impulse. Therefore, it is already poised for a downside continuation: