Mega caps comeback, China to curb loan growth, and fallout from Archegos

Is China’s lending curb a deal breaker on inflation?

Chinese banks have just reported Q4 earnings when Chinese regulators announced today that lending growth will be curbed to 11% this year the slowest increase in more than 15 years. This news comes as China is also announced the creation of its digital currency, the first for a major economy and potentially a threat to the US global reserve banking system. While the curb on lending is potentially a negative for our inflation outlook, our view is that the curb is mainly due to adequate stimulus coming from the US over the next year which will flow to China as the country exports a lot for the US economy. This will bolster growth in China regardless of domestic lending growth. In the end the ultimate catalyst on inflation will be physical constraints of metals and energy etc. The curb on lending is also wise given China’s relentless push to expand credit while the Chinese equity market has not approved the credit quality – this can be observed by the market cap to total assets ratio (see chart). This ratio expands when credit quality improves and falls when credit quality is deteriorating.

Did markets dodge a bullet on Archegos collapse?

The fallout of Archegos Capital Management is potentially losses of $7-10bn as highly leveraged total return swaps soured when Chinese technology stocks and other bets underperformed relative to benchmark equity indices in the US. Nomura and Credit Suisse are the biggest losers from the forced liquidation that started with Morgan Stanley and Goldman Sachs, with Credit Suisse announcing today $4.7bn in losses and cutting dividends while firing several key executives. What is up and down here, and is more coming?

First, it seems the risk from Archegos is contained with only downward pressure in selected positions and no contagion risks spreading to other parts of the equity market. While total return swaps have suddenly become a new word for many, they are quite simple instruments and used a lot as they are a cost-effective way of expressing relative performance between groups of equities. The biggest fallout from Archegos is that the losses came from a family office which are not heavily regulated and many failing hedge fund owners have recently transformed into family offices to avoid regulatory oversight giving more flexibility on position sizes etc. The likely result of Archegos is that prime brokerage businesses (the investment banking division that deals with large hedge funds providing securities lending and leverage etc.) will scale down risk in general and increased their scrutiny of the risk of family offices. Credit Suisse is continuing to sell large blocks of equities today in positions related to Archegos.