Evergrande risk update: Markets more distracted by Fed sentiment

The graphs are telling us that everything is not ok on the Evergrade front, although it may just be a drop in the ocean. The Evergrande situation in China can still be saved and that is what the narrative has been, supporting risk appetite for the best part of last week and until yesterday. 

For some background on Evergrande, the company, the world’s most indebted property firm with $300bn in liabilities, said last week that it had come to an agreement with bondholders on a coupon payment on an onshore bond due this week. This had eased some fears of an imminent collapse. Then, on September 23rd The People’s Bank of China flushed more short-term liquidity into the financial markets than it has since late January. This was taken by markets as a sign that the government would indirectly support Evergrande through this debacle. Moreover, there is a 30-day grace period for which has been granted to the company in order to meet its debt liabilities for last week's missed deadline to meet an US$83.5m coupon payment and today's where Evergrande has a US$45.2m coupon payment due.

However, policymakers will likely uphold the bottom line of preventing systematic risk to buy time for resolving the debt risk and push forward marginal easing for the overall credit environment, which seems to now be a given. However, it is not just Evergrande that markets are starting to price in, acknowledging the risks of the downfall of Chinese tech as well as Education, Gaming and China's power supply crunch.

In other words, Evergrande is not an isolated risk for global markets. There is far more at steak, into tens of trillions US dollar, or 100% of China's Gross Domestic Product which raises the prospects of a liquidity crisis in the Chinese banking system, forcing the government to print more and more yuan, devaluing the currency against the US dollar for which the debt is denominated, making it increasingly difficult to meet the debt liabilities.

Ultimately, this can lead to systemic risks in the offshore Eurodollar market and force the value of the US dollar even higher. That spells danger to emerging markets which are already suffering from the sudden spike in US yields at the hands of Federal Reserve hawkish rhetoric and today's, from Treasury Secretary Janet Yellen, who said she expected inflation to end 2021 near 4%. Then, when you add the prospects of US infrastructure spending which will see a lot more Treasury supply driving up yields, a firmer US dollar for longer is a given.

Meanwhile, Citi on Tuesday trimmed its China growth forecast for next year to 4.9% from 5.5%, citing expected spillover from the woes of embattled property giant Evergrande, and predicted policymakers would deliver more interest rate reductions, Reuters reported. 

"The balancing between moral hazard risks and contagion risks points towards a managed restructuring," Citi's Xiangrong Yu wrote in a note to clients.

"The pressure on growth will likely trigger some restrained policy easing, including a 25bp interest rate cut in 2022E," he said, adding he now also expected an anticipated 50 bps reduction of the reserve ratio requirements to be advanced to October.