China Facing Growth Dilemma

The shift in the debate over China’s growth outlook illustrates just how far expectations have been pared back for this once-juggernaut of the world economy.

After a succession of dismal economic reports, nobody expected green shoots in second-quarter GDP numbers, which came in on target, slowing to 7.5%.

Instead, the focus is on how big the full-year slowdown will be, as China grapples with structural reform and economic rebalancing.

Somewhat more troubling is that even China’s leaders seem unsure.

In recent days, China’s Finance Minister Lou Jiwei spooked investors by reportedly saying growth may well fall below 7% for the full year. Over the weekend, however, there was a belated correction by the Xinhua news agency: Minister Lou had been misquoted and stuck to China’s official 7.5% target after all.

Before this correction, Premier Li Keqiang had already offered reassurance, saying growth must not fall below a minimum rate required to ensure labor-market stability.

This was enough for analysts at Bank of America to revive talk of stimulus or a “Li Keqiang put” to pep up growth. They argued that Li needs a stable growth environment before he can impose much-discussed industry reform.

Suggesting that Beijing can backstop growth is not exactly a new argument, but it now sounds somewhat back-to-front.

If there was one lesson from China’s stuttering performance so far this year, it is that growth will keep sliding without reform.

After all, more of the same credit stimulus was tried when Premier Li’s administration first took office. While this initially worked, the growth spurt soon faded. In the first quarter, record credit creation produced only slower growth, inflation and further falls in producer prices.

Last month, worries intensified that excessive credit may be doing more harm than good. The June spike in interbank rates looked to be a clear sign credit — estimated at 200% of GDP — has reached unsustainable levels.

Analysts at Macquarie said China faces a growth dilemma: Will it sacrifice short-term growth through reform in exchange for more sustainable long-term growth?

They argue reform must come first because it’s the corporate sector causing the slowdown in China’s economy.

These problems are threefold: subdued return on assets, ever-rising leverage and high interest rates. For growth to recover, these first need to be fixed.

Together, these three issues have reduced the effectiveness of monetary policy by requiring fresh liquidity to repay existing debt.

They are also at the heart of the dilemma for policy makers, which Macquarie calls the “asymmetrical impact of money on growth.” While more money now doesn’t lead to much faster growth, less money remains quite detrimental to growth. In fact, we have seen increasing reports in recent days of tightening credit leading to job cuts, as companies seek to preserve cash.

Given such a difficult scenario, it is hardly surprise China’s leaders appear less confident they can meet growth targets.

This has left analysts increasingly grappling for policy clues.

The take-away from the recent, apparently orchestrated spike in interbank rates was that China’s leaders were ready for more austere-looking reform.

This even led to new moniker, “Likonomics,” to describe the policy of Li Keqiang, which was taken to mean: no stimulus, deleveraging and structural reform.

But perhaps Macquarie’s policy description is more appropriate — simply a “muddle through” mixture of reform and fine-tuning measures.

Its base case is one where reform is not strong or timely enough to offset the downtrend of growth. Last week, it downgraded its growth forecast to 7.3% for 2013 and 6.9% for 2014.

The reform debate is always contentious, as it involves the Communist Party relinquishing its grip on the economy. Financial reform in particular introduces new risks, and we have already seen that these can have unintended consequences.

Recent moves to internationalize the yuan by encouraging trade settlement also ended up facilitating massive speculative currency bets through fake trade-invoicing in Hong Kong.

What’s more, the attraction of this yuan carry trade was enhanced by another de-facto deregulation measure — interest-rate liberalization through wealth-management products, which offered better returns than bank deposits.

The government has now clamped down on both illegal trade invoicing and growth in wealth-management products, which may well mean liquidity will tighten further.

Despite this, China still appears to be still pushing ahead with reform. Last week, it announced a new free-trade zone in Shanghai, which will promote cross-border commodity and capital flows, promising more deregulation in interest rates and foreign-exchange markets.

Last Friday, it also extended the Renminbi Qualified Foreign Institutional Investor scheme (RQFII) to London and Singapore — previously, the program was limited to just Hong Kong — and also raised the limit on how much can be invested.

For investor sentiment to improve, it would help if reform came quicker, so the market can get more clarity on what it might look like. After all, it is not inconceivable markets will pay more for slower, higher-quality Chinese growth.

- By Craig Stephen

Home-equity Lines Bedeviling Americans

Despite all the seemingly positive news surrounding the housing market and consumer credit this week, at least one subset of homeowners is still struggling: those with home equity lines of credit.

In 11 of the 13 loan categories tracked by the American Bankers Association — including car loans, personal loans and bank-issued credit cards — delinquency rates actually fell in the first quarter of this year, according to data released Tuesday. But delinquency rates rose in two categories. One of those was home-equity lines of credit, which saw delinquencies rise to 1.91%, from 1.85% the previous quarter (the other was mobile-home delinquencies, which increased slightly). The rise in delinquencies among home-equity lines “could continue on for a while,” says Keith Gumbinger, vice president of HSH.com, a mortgage information site.

Most home-equity lines, for instance, allow borrowers to make interest-only payments for the first few years of the loan. But after that period, borrowers have to start paying down the principal. Faced with a much higher monthly payment, many borrowers are becoming overwhelmed, says James Chessen, the ABA’s chief economist.

Plus, some of those homeowners took out their home-equity lines of credit during the boom years, between 2003 and 2007, when property values were mostly rising, says Chessen. And with many of their mortgages underwater, or worth more than the sale price of their homes, many borrowers are unable to refinance, which would normally give them more time to make payments, he says. Adding to the pain is the fact that interest rates are starting to climb higher, which can potentially raise monthly payments for people with adjustable-rate mortgages.

To be sure, many banks are more willing to lend — including through home-equity lines of credit — as the job market improves and consumers become better at managing their debt, says Chessen. But for the homeowners who are nearing the end of interest-only periods and are worried they won’t be able to afford the higher monthly payments, there may be ways to avoid falling behind.

Some borrowers may get a break from another lender if their bank isn’t able to refinance the loan, says Chessen. And they should approach their lenders as soon as they expect they might start to struggle with their payments, he says. “The sooner you talk to them, the more options you may have,” says Chessen.

Homeowners should be upfront with their lenders about any financial difficulties and ask the bank to restructure the loan in a way that might make the payments more manageable, says Gumbinger. Because banks often carry home-equity lines directly on their books and would need to coordinate with another lender to foreclose on a property—when mortgages and home equity lines are not issued by the same bank—they may be willing to help a borrower out, he says. “You are not necessarily in as weak a position as you think,” he says.

For instance, some lenders might be willing to delay the start of the payment period slightly, says Gumbinger. Borrowers who know they will be on better financial ground in six months to a year might be able to request an extension, he says.

Borrowers can also ask for a longer repayment period, extending the time over which the loan must be paid back from, say, 10 years to 15 years, which could lead to smaller monthly payments, he says. And some banks may also be willing to lower the interest rate on the loan, says Gumbinger.

Treasury Bonds Rally on Retail Sales

Treasury bonds rallied Monday as a disappointing consumer-spending report eased fears that the Federal Reserve may taper bond buying in September.

In late-afternoon trade, the benchmark 10-year Treasury note was 13/32 higher in price, yielding 2.554%. The 30-year note rose 22/32 to yield 3.608%. Bond prices rise when their yields fall.

Buyers propped up the bond market following a 0.4% gain in U.S. retail sales last month, weaker than 0.8% forecast by economists. Additionally, retail sales for May were revised lower to post a 0.5% gain from 0.6% previously reported.

"The retail data was softer than expected and any such evidence supports a Fed that remains fully engaged in providing monetary stimulus for the economy," said Adrian Miller, fixed-income strategist at GMP Securities LLC. "If the data is not indicative of building growth, that will support bond prices with yields pulling back."

Fears of the main buyer pulling back from buying Treasury bonds have been the key reason behind the months-long selloff in Treasury bonds.

The Fed has been buying Treasury bonds and mortgage-backed securities at a pace of $85 billion a month since the start of 2013, aiming to keep bond yields low to stimulate consumer spending and business investments.

The 10-year yield had surged from this year's low of 1.61% on May 1, climbing as high as 2.756% on July 8, the highest level since August 2011.

Anxiety over interest rates had eased over the past week following comments on July 10 by Fed Chairman Ben Bernanke. Since his comments, the yield has been capped below 2.75%. The 10-year yield fell by 12 basis points last week, the most on a weekly basis in three months.

The Fed chief reassured investors that the central bank is not in a rush to taper its bond-buying program and that a pullback on the program doesn't mean a shift into raising interest rates.

Mr. Bernanke is scheduled to testify before lawmakers on Wednesday and Thursday and investors will parse his comments on the outlook for the bond-buying program.

"No one knows what the Bernanke will say this week but the money is on the dovish side," said Thomas Roth, executive director in the U.S. government bond trading group at Mitsubishi UFJ Securities (USA) Inc in New York.

Wall Street Close Sets New
Record Highs

After a slow start Monday, benchmark stock indexes closed at record highs again, pushing further into uncharted territory as more better-than-expected second-quarter earnings were released.

The Dow Jones industrial average closed up 19.96 points, 0.1%, to a record 15,484.26 boosted by a 2% gain in Citigroup shares -- one of the 30 blue-chip components in the index.

The broader Standard & Poor's 500 index posted its eighth straight day of gains for the second time this year, closing up 2.31 points, 0.1%, to 1,682.50. And the tech-laden Nasdaq composite index ended up 7.41 points, 0.2%, 3,607.49.

And the widely followed small-cap Russell 2000 finished up 6.78 points, 0.6%, to a record 1,043.30.

Investors are seeing a number of second-quarter earnings surprises to the upside and are also feeling more secure after weaker-than-expected economic reports on retail sales in June and business stockpiles in May. Those reports suggest that the Federal Reserve will be able to hold off for the time being on reducing its massive monthly bond purchases aimed at keeping interest rates low and boosting job creation.

"The general bias to the market is up," said David Kelly, chief global strategist at JPMorgan Funds. "You can see a clear path to economic growth in the United States."

On Friday, the Dow closed 0.02% higher at 15,464.30, the S&P 500 advanced 0.3% to 1,680.19 and the Nasdaq composite added 0.6% to 3,600.08.

In energy trading, benchmark crude for August delivery rose 13 cents at $106.46 a barrel in electronic trading on the New York Mercantile Exchange. The contract gained $1.04 to $105.95 in New York on Friday, driven higher by continuing tensions in Egypt and a sharp drop in U.S. crude stockpiles.

In government bond trading, the yield on the bellwether 10-year Treasury note fell to 2.56% from 2.61% Friday.

Citigroup led other bank stocks higher after the New York-based bank reported second-quarter earnings that were stronger than Wall Street's expectations Citi shares closed up 2% to $51.81.

Boeing, another Dow component, soared 3.7% to close at $105.66 after an analyst at Sterne Agee recommended buying the stock. Boeing slumped 2% Friday following a fire on an Ethiopian Airlines Boeing 787 parked at London's Heathrow airport.

In Europe, Britain's FTSE 100 index closed up about 0.6% to close at 6,586.11, the German DAX ended up 0.3% at 8,234.81 and France's CAC 40 finished 0.6% higher at 3,878.58.

Global markets were shored up as a slowdown in China's economic growth wasn't as sharp as feared.

Asian stock markets traded slightly higher on Monday on China's GDP. Hong Kong's Hang Seng rose 0.1% to 21,303.32. South Korea's Kospi rose 0.3% to 1,875.16. Japan's financial markets were closed for a public holiday.

The world's second-largest economy grew 7.5% from a year earlier in the second quarter, slowing from the previous quarter's 7.7%, but still strong enough to suggest China will meet Beijing's 7.5% growth target for this year.