Mixed news on China stimulus

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Good day. A question for readers: Will we see a significant change in consumer confidence now that a change in presidential administrations is looming? As a reminder, the University of Michigan Sentiment Index, at 70, is 40 percent below its 2022 lows, but still well below historical averages. Will there be a sea change in the next survey or two, or a continuation of the current trend? Send us your opinion: robert.armstrong@ft.com and Aiden.reiter@ft.com.

Chinese stimulus

Holders of Chinese stocks received mixed news on Friday. At the National People’s Congress meeting, the government announced a 10 trillion RMB ($1.4 trillion) fiscal package to bail out bad debts of local governments. The package itself, following the pattern of recent stimulus measures, is disappointing. The Shanghai and Shenzhen CSI 300 stock index and the RMB fell slightly on the news:

Bad debt is a problem for China. Chinese local governments, which cannot issue their own bonds, have traditionally used financial vehicles similar to investment companies to borrow money; After the real estate market crashed, many provinces were no longer able to use land sales to pay off those loans, resulting in “hidden” bad debts that do not appear on their official balance sheets. The debt swap will limit financial risks and free up spending capacity, at a time when many local governments have cut public services. But the size of the relief is relatively small. From Tianlei Huang of the Peterson Institute:

The impact of this package on the immediate economic situation will be limited. [Finance minister Lan Fo’an] estimates that local governments will save around 600 billion RMB [$83bn] in five-year interest payments. [Rmb120B, or $17bn] each year is too small to make a difference. . . the actual expenditure [by the local governments] So far this year, almost 3 trillion RMB. [$417bn] less than the budgeted amount [for] this year.

10 trillion yuan is probably not enough to make a lasting dent in the hidden debt problem. While Lan said there is about RMB 14.3 trillion ($2 trillion) in debt hidden in provinces’ balance sheets, the IMF put the figure at RMB 60 trillion in a report. last year. On top of that, the 10 trillion yuan figure is not exclusively made up of new commitments. While RMB 6 trillion of new debt will be issued for the debt swap facility, RMB 4 trillion is debt that was already available to local governments for related purposes.

Without stronger stimulus, the chances of the economy reaching the government’s 5 percent growth target this year remain low. But there may be more in the future. The Finance Ministry meeting in October set out four objectives for the stimulus, of which resolving hidden local debt was the first (followed by boosting bank lending, stabilizing the housing market and supporting consumers). While we are not sure that they will continue to be implemented in the order announced, the statements made by Lan imply that the government will meet the other three objectives.

Markets have been eager to learn details about the stimulus. The timing of this package, just after the US election, suggests that the Chinese government was waiting to find out who would win the White House before making heavy financial commitments. And the scale of this package raises the possibility that the government is saving its fiscal power to respond to the Trump administration’s eventual policies toward China. A more concrete and substantial fiscal package may soon emerge.

(Reiter)

regional banks

Regional banks rallied furiously after Donald Trump’s election. The KBW regional bank index, which has performed terribly for years, is 12 percent higher than the day before the election. Does this make sense?

The reasons to be optimistic about the banks under the new administration are something of a surprise. Lighter regulation should help somewhat, although Basel “end-game” capital rules have already been relaxed. The Consumer Financial Protection Bureau’s cap on credit card late payment fees, currently in legal limbo, appears likely to disappear now, helping issuing banks. And it seems bank investors never believed Trump’s own promise to cap card interest rates at “around 10 percent.”

Lighter merger regulation will certainly help big banks in their merger advisory operations. But it could also help the regionals. Consolidation among midsize banks makes economic sense in an industry dominated by a few large players. But it’s not clear – at least to Unhedged – that merger rules were the biggest bottleneck to consolidation. The problem, instead, has been getting the management teams of acquisition targets to give up their prestigious and well-paid jobs. This is what made the 2019 merger of BT&T and SunTrust, creating Truist, so notable.

More important is Trump’s impact on interest rates. If Trump is believed to mean high deficits, low taxes, and high growth, all of that suggests the Fed will keep short-term interest rates relatively high. And high – but not too high – short-term rates are good for banks. Below is a graph of the US banking industry’s net interest income compared to the policy rate:

The magnitude of changes in net interest margins is much smaller than the magnitude of changes in the Federal Reserve’s policy rate. But remember that very small changes in net margins create large differences in banks’ net income. And while many banks have revenue streams that are not sensitive to rates, for regional banks interest margins matter.

At the same time, the old cliché that banks borrow short-term and lend long-term still persists. This would suggest that bank margins are better when the yield curve is steep. To the extent that a given bank has a significant amount of long-term mortgage or bond assets on its balance sheet, this may be true. But over the past five years, the relationship in the industry has been almost the opposite of what the cliché would suggest (note that this chart is quarterly, so it doesn’t capture the recent steepening of the yield curve):

But here comes the strange thing: financial reality and market perception are different. One long-time banking analyst pointed out to us that while the yield curve is not particularly important to regional banks’ earnings, buying regional banks when the curve steepens is “turning off your brain.” Whether it matters to earnings or not, bank stocks are rising on an ever-steeper curve. Here is the KBW regional banking index and the Treasury curve:

The relationship is sloppy in details, but it’s clear that big moves in the curve move bank stocks.

So a key question for regional bank stocks is whether the curve will continue to steepen; If not, the nascent rally could stall. Many economists have argued that Trump’s policies are generally inflationary. If that is so, and the Federal Reserve has to tilt its policy against it, the curve may remain flat. But Trump and his policies are known to surprise people.

A good read

In vote.