Risk-on sentiment returns as Evergrande concerns dull
19:08, 21 September 2021
US risk sentiment is reversing Tuesday after a substantial sell-off in both equity and debt markets as concerns of a Lehman Brothers-like impact on the global market abate.
Market participants took their chips off the table as news that Shenzhen-based Evergrande – China’s second-largest property developer by sales – is expected to miss a $83.5m (€71.1m) interest payment coming due Thursday on its mounting $300bn of debt.
That news rattled financial markets Monday as the S&P 500 fell 1.7% for its worst day since May and the US corporate bond market effectively shuttered with eight expected blue-chip borrowers opting to stand down amid the volatility.
However, the market consensus has coalesced around the idea that China would likely step in if Evergrande's failure held the potential to derail the country's economy, according to a note from Bank of Montreal (BMO) analysts obtained by Capital.com.
"(Monday’s) underperformance in credit reflected the growth of global concerns, and was led by sectors most tied to economic productivity," BMO credit analysts wrote. "While uncertainty remains the theme with respect to Evergrande, sentiment appears to have improved overnight."
Government intervention
Investors are convinced China would step in to bail out the company if the worst-case scenario were to play out and threaten widespread losses to China’s financial system. The company has $131m in interest payments coming due by the end of the month, and if those are not paid within 30-days, it would trigger a default.
"If one piece of Evergrande's debt is allowed to default, it would trigger questions about all of their remaining debt from investors and the government doesn't want a wider crisis like that," said Andrew Collier, managing director of Hong Kong-based Orient Capital Research.
Indeed, the risk-on tone is back in the market as the S&P 500 is mildly back into the green on Tuesday and gave those eight blue-chip corporate borrowers confidence to move forward with the deals they previously postponed.
“(On Monday,) folks took down risk while trying to get a better read on the direct and indirect consequences of the Evergrande situation,” David Knutson, Schroders' head of integrated research for the Americas, told Capital.com. “Today, it looks like the 'all clear' call has been made – the primary is open and folks are looking for risk.”
Last resort
There are many steps the company itself can take before the government intervenes in that way.
For example, Evergrande could sell units not connected to its core residential real estate business, then begin to sell more core functions of the business to third parties, according to Iris Pang, ING's chief economist of Greater China.
Additionally, bonds can be restructured and banks can extend deadlines on interest payments to help digest the hit to the financial system. For those reasons rating agency S&P is not expecting the government will need to intervene.
"We believe Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy," S&P wrote in a note this week. "Evergrande failing alone would unlikely result in such a scenario."
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