The Chinese Yuan is slipping against the USD. The onshore yuan (CNY) fell more than 200 pips to hit 7.1280/USD at one point today, the weakest level since October last year. Whilst the PBOC want nothing less than a disorderly devaluation of the currency, they have been very clear they wish to detach from the importance of the “7 level”. A weaker currency would be desirable at present in order to boost exports and support the manufacturing sector, which is hit from the collapse in global demand. The weaker oil price allows for a weaker currency without raising the price of China’s import bill at present also. However, one to watch on the risk radar. This as a disorderly move would serve a second punch to weakened risk asset markets and no doubt spark another heavy risk off wave, particularly in the current fragile environment. A markedly weaker CNY would also add to the near term deflationary pressures and commodity collapse as global demand has fallen off a cliff via COVID-19 containment measures.
Banks as a bond no more – suspended dividends may be another frontier for risk off moves. The panic deleveraging of Q1 may be past, but according to survey data many retail investors remained invested or added to holdings as equities quickly sold off. Another downdraft for risk assets or a wave of dividend cuts could be a prompt for retail selling, particularly for pensioners reliant on dividends for income. Regulatory pressure is mounting for banks to suspend dividends in favour of maintaining strong capital positions in the face of mounting bad debts. Following restrictions on dividends implemented in the past week by the ECB and BOE, the RBNZ are the latest to stop dividends for lenders under its jurisdiction. Australia’s banks fell in trade today as the mounting scrutiny presents increased uncertainty for the investment case and regulatory burden. Although widely expected to slash dividends, a suspension would be a blow to investors who thrive of the traditionally high yielding sector, and even more so now with savings rates having been slashed in the past 12 months as interest rates have been cut to record lows.
In Australia, recent rate cuts from the RBA will pressure net interest margins and the impending certainty of a recession sees risks of credit losses rising. Many businesses in Australia have never had to grapple with a recession, let alone the unprecedented nature of the present health crisis which has completely shut down parts of the economy. The dent to economic activity will also see reduced business conditions and therefore credit worthy loan demand. However, for the Australian banks the biggest risk looming on the horizon is the property market given the high exposure to residential mortgages. Household debt to income ratios across the nation are well above OECD averages, at approximately 2x household income. This debt is serviceable whilst unemployment is low. But as Australia’s unprecedented streak of economic growth fizzles out, a rise in unemployment will be the catalyst for reversing the nascent recovery in the housing market. Sales will also begin to decline with the ban on home inspections and auctions. Although on the upside, the option to defer mortgage repayments for six months will lend a degree of support and reduce fire sales. Moreover, given the economy is reliant upon maintain every Australian being heavily levered and long property, as instability risks mount and prices begin to decline further policy support measures would be expected.
As downside risks for the property market mount, this scenario would see a larger hit to bank earnings and increased credit losses, and a continued de-rating of bank share prices. With the above in mind, the rich dividends for major Australian banks will be unsustainable. Therefore, the prospect of dividend cuts later this year is certain even without the regulatory input. However, there is no doubt a growing risk that Australian regulators will follow suit with global peers, which would prompt another blow for the bank stocks if Australian regulators moved ahead with suspending dividends.
Another one to add to the radar, China have shutdown movie theatres again and postponed high school exams further, Henan province have also entered the Jia county into total lockdown. If actions speak louder than words, it appears the risk of a second wave of infections in China is mounting. A clear risk to the assumption that activity will bounce back by 2H20.
If we do not know how long major economies will be shutdown or whether there will be a second wave of infections that prompts another round of containment measures, then it becomes near on impossible to present reliable forecasts. Of course, we can assign probabilities and make educated guesses, but each relies on a series of assumptions that inevitably render the outcome no better than the original assumptions.
A key problem being for many including policymakers, we are flying blind, particularly as there is little real-time data available and the sudden stop to economic activity is unprecedented throughout modern developed world economies. The broad range in analyst and economists’ forecasts for the hit to EPS growth and GDP highlight the level of uncertainty that prevails. Even the virology experts and epidemiologists are unsure how quickly the enacted containment measures will work. This makes the task of estimating the depth and duration of the hit to economic growth and earnings near on impossible at this stage, adding to the angst in financial markets as participants struggle to price risk.