You know that the summer holidays have started when there is more traffic news than general news on the radio. That holiday mood has, however, not reached the financial markets yet. Incoming quarterly earnings reports tell us how much costs have increased, and analysts start to take down their – elevated – earnings estimates for the remainder of the year. Having said so, we stay constructive on equities given our assessment that a hard landing can be avoided and the resulting stock market valuation.

Central banks in focus

Will central banks focus more on tackling inflation or take account of the recession risks resulting from higher energy spending? On Thursday, we will learn the European Central Bank’s (ECB) elaboration on this issue. The broad consensus calls for a 0.25% hike, and our economists even consider a 0.5% hike as adequate. Given that Italian bonds were under pressure even before the ECB started to hike rates, it will be most interesting to see how the central bank will stabilise this bond market. Volatility will remain elevated ahead of the ECB meeting.

It was a clear decision by the US Federal Reserve to dampen demand with higher interest rates to fight inflation. In this regard, China is one step ahead and delivers support for its property market, after having slowed that crucial part of the economy for a long time with administrative and monetary measures. The latest support comes after a rising number of homebuyers who reportedly refused to service their mortgage on properties that have been purchased but not completed. Stocks have greeted the support with decent gains.

Number of the week

Why is there increased urgency for China’s authorities to act?

The concerns over homebuyers’ refusal to pay mortgages on unfinished pre-sold residential projects have hit both banks and developers’ equities and bonds last week. The number of projects involved has swelled from under 30 as of 11 July to over 200 as of late last week. Based on a sample of 24 cities, 9% of gross floor area sold in 2021 is now facing completion risks, as developers struggle to build and deliver projects on time due to financing challenges.

For the overall system, we estimate that a total of over RMB 600bn of mortgages may be at risk should homebuyers cease payments on all of them, which is equivalent to 1.65% of outstanding mortgages as of end 2021. 

While the impact is manageable for now, a surge in mortgage defaults would raise banks’ non-performing loan (NPL) ratios from their exposure to mortgages and to distressed property developers.

Furthermore, this may also aggravate developers’ liquidity woes, and the situation could worsen if the banks choose to withhold pre-sales proceeds from developers or tighten mortgages as they turn more cautious.