China may be our biggest adversary, but the health of their economy and markets are important to the U.S. They are a major trading partner and their markets contribute to overall global stability.
Chinese policymakers are finally alarmed enough to shift out of low gear to stem a deepening economic malaise gripping the world’s second-largest economy. Last week, China unleashed a series of significant monetary policy moves designed to shore up the economy, especially the property market. This includes lowering interest rates.
While it is not clear that the combination of monetary and fiscal stimulus to digest distressed assets will be sufficient to address the scale of the property bust and its hit to consumer sentiment, it is the first move in a direction consistent with stabilizing the economy.
As a result of this “whatever it takes moment,” Chinese equity prices rallied sharply and bond yields rose. But will the rally last? There is a long history of Chinese equity market surges that don’t last. However, another possible catalyst for further gains is foreign flows. One thing is certain: the surge in equity markets in China is dramatic. Last week was the biggest weekly gain in Chinese stocks in 16 years. Most Chinese stock indexes were up over 20%.
Another major hurdle to a general boom for China may be fears of a further deterioration in the U.S.-China relationship. Among the risks: a trade war with the U.S., the threat of 60% tariffs if former President Trump is elected, and China’s retaliation against U.S. companies.
Including last week’s rate cuts, a net 37 central banks have cut interest rates over the last three months. That is the most since the global financial crisis. Only three central banks are currently raising rates: Brazil, Japan and Russia.
As you would expect, stock market returns are lowest when interest rates are highest. The biggest rate declines (bullish) and biggest increases (bearish) have the most impact on equity prices. But even middling declines tend to lead to steady returns. Bottom line: a worldwide easing cycle is good for stocks.
THERE IS HOPE FOR HOUSING
Housing is such a large share of our economy it is difficult to have a strong economy when momentum in the sector is poor. July housing statistics were lousy but August showed notable improvement. Within housing starts, single-family units were very strong rising by 15.8% on a month-to-month basis.
Even with lower mortgage rates since the spring peak, the current market rate for a 30-year fixed mortgage sits 300 basis points (3%) higher than the weighted average interest rate on outstanding mortgages. This spread is higher than any other period since the early 1980s. As a result, existing homeowners are “locked in” to legacy low-rate mortgages, which means buying another home would involve a new higher mortgage rate that makes it prohibitively expensive.
The good news is that lower mortgage rates have started to drive more activity in refinancings which have more than doubled since the April peak in rates. While that may not help housing activity, it does provide a cushion to the consumers’ balance sheet.
Also, there has been some welcome improvement in affordability as mortgage rates have seen a significant decline. So far the cost of servicing a mortgage has fallen about 12%. With a further mortgage interest rate drop to 5% (not impossible), the average payment would drop 15% from here.
As the Fed continues to cut short-term rates, we are optimistic the entire yield curve will shift downward. With mortgage rates being priced off a 10-year Treasury note, we think the 10-year rate will decline given good inflation numbers and a not-too-hot economy. We think housing will be a stimulus to our economy in 2025.