There are plenty of warning signs flashing on the state of global markets.
But for Australia, one of the most concerning ones comes from China.
China is Australia’s largest trading partner. The data in May showed that Australia exported $102 billion worth of goods to China over the previous 12 months.
China’s rapid growth has driven a voracious appetite for Australian resources. This is largely what kept Australia from dropping into recession following the global financial meltdown in 2008. Though that didn’t stop the ASX from plunging 50% in value.
Like much of the world, China’s growth miracle owes much of its magic to debt. Lots and lots of debt.
China’s debt levels are at a record high
Analysts have been warning about China’s ballooning debt for years. To date, the forecasts of a financial implosion have proven premature. But all the while Chinese corporations have been piling on more and more debt, largely in the form of corporate bonds.
It’s these corporate bonds that may well be the canary in the coal mine for what’s ahead.
As Bloomberg reports:
‘China is zooming to a record year of corporate-bond defaults, with the 2018 total already more than three-quarters of the previous high even before an expected economic slowdown bites.’
You can see the perilous position of the local Chinese bond market in the chart below:
Source: Bloomberg / Dagong Global Credit Rating
To add to indebted companies’ woes, interest rates are heading up.
The RBA may be steadfastly holding rates at record lows. But when interest rates go up in the US or other major markets, there is a ripple effect across the globe.
China’s AA- corporate bond yield is now at 6.99%. That’s up from about 4.6% in mid-2016.
That’s a tidy return for lenders…assuming the corporation whose bonds you bought isn’t one of the growing number to default. But it’s not making servicing their cumbersome debt levels any easier for Chinese companies.
What would a trade war mean for China?
And then there are the trade tensions, stoked by US President Donald Trump, which show little sign of easing. The Chinese have promised not to fire the first shot in any escalation towards a full-scale trade war. But Trump has made no such commitment.
And the ripple effect for Chinese companies if things heat up could look more like tsunamis.
As Bloomberg notes:
‘An escalation of trade tensions could add to defaults in China’s financial system, which is already in the midst of a deleveraging campaign, according to JPMorgan Chase & Co…
‘Consumer demand and the wider economy are likely to weaken and that “may translate into worse credit quality down the road,” [Jing] Ulrich, [JPMorgan’s vice chairman for Asia Pacific] said…’
The last thing China needs as it struggles to transition its economy from production driven to consumer driven is weaker domestic consumer demand. Especially if its largest trading partner — the US — is slapping tariffs on its exports.
Watch this space.
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