Fitch Ratings says the recent pattern of trade flows in Asia suggests that the sharp decline in world trade growth in the second half of 2018 was primarily due to the slowdown in domestic demand in China rather than the direct impact of tariffs associated with increased US-China trade tensions.
Fitch Ratings latest chart of the month shows that exports to China from a selection of other large economies in Asia have slowed much more sharply than their overall exports. Since intra-Asian trade flows are much less likely to have been affected by the tariff measures imposed by the US and China, this points to weakening domestic demand in China as a key driver of the slowdown. China’s year-on-year import growth (in nominal US dollar terms) turned negative at the end of 2018, despite rising import prices. This was the first decline since 2016 and reflects a slowdown in domestic investment and private consumption.
The US and the Eurozone have also seen their export growth to China
falling more rapidly than total exports. Germany in particular has been
hit hard by declining auto sales in China, although, for the Eurozone as
a whole, exports have also been affected by declining sales in the UK
and Turkey. US exports to China have fallen very sharply in recent
months but these bilateral flows have been distorted by tariff measures,
including possible front-loading of trade flows in mid-2018 ahead of
anticipated further tariff hikes and the subsequent payback. The
evidence from Asia suggests the outlook for Chinese domestic demand will
be a key driver of global trade in 2019.
Eurozone (EZ) GDP growth now looks likely to slow to just 1% this year according to a report published by Fitch Ratings‘ Economics team. The deterioration in growth prospects and declining inflation expectations will prompt the ECB to consider restarting asset purchases.
Economic activity data from the EZ has deteriorated more
sharply than other parts of the world in recent months and has delivered
the biggest negative surprise relative to market and Fitch’s own
expectations.
“While numerous transitory factors are partly to
blame, these cannot explain the breadth and depth of the slowdown.
Rather, we believe that the slowdown has been primarily the result of
deterioration in the external environment as net trade turned from a
tailwind to a headwind,” said Fitch’s Chief Economist, Brian Coulton.
The
domestic slowdown in China has, we believe, played a particularly
important role here. Germany’s greater trade openness and larger
exposure to China leave the largest European economy’s expansion more
vulnerable to China’s domestic cycle and import demand. This is
underlined by Germany having seen the biggest deterioration in activity
data among the EZ economies – despite a healthy domestic economy with
few of the imbalances that typically spark an abrupt downturn in
domestic demand. Furthermore, the deterioration in manufacturing
Purchasing Managers’ Indices (PMIs) since last summer has been greatest
in countries with a large auto export sector, dragged down by the first
decline in global car sales since 2009 and the first fall in vehicle
sales in China for several decades.
The weakening in EZ
external indicators has not been matched in the domestic economy. Labour
market performance remains strong supporting household income growth,
monetary policy remains supportive, bank lending conditions are easy and
credit to households and businesses continues to grow. Only in Italy
have we seen evidence of private sector borrowers reporting somewhat
tighter credit availability. Fiscal policy is also being eased in the EZ
and should be supportive of growth in 2019. Private sector debt ratios
have improved significantly since 2012 in Italy, Spain and Germany.
EZ
growth should recover through the course of 2019 as the policy response
in China helps to stabilise its economy from the middle of the year,
one-off impediments to growth in Germany unwind, and EZ macro policy is
eased. However, early indications for 1Q19 and the profile of our China
forecast mean that there will not be much of a pick-up in EZ quarterly
growth before 2H19.
This suggests that EZ growth in 2019 is
likely to be around 1% compared with our December 2018 GEO forecast of
1.7%, a substantial cut. Both Germany and Italy will see similar
revisions, with 2019 GDP growth now forecast at around 1% and 0.3%
respectively. Even with this lower forecast, downside risks remain from
an escalation in global trade tensions, a deeper slowdown in China, a
disorderly no-deal Brexit or increased uncertainty related to domestic
political tensions.
The sharp deterioration in growth prospects
and falling inflation expectations are likely to result in renewed
monetary stimulus measures from the ECB.
“We had already been
expecting the ECB to delay the start of its policy normalisation -both
interest rates and balance sheet reduction – but we now believe it will
seriously consider restarting QE asset purchases relatively soon,” added
Robert Sierra, Director in Fitch’s Economics team..
We also
foresee the ECB announcing a one- to two-year long-term refinancing
operation (LTRO) in March to replace the existing TLTRO2 programme,
which matures from June 2020. The rationale for a new targeted LTRO
(TLTRO) is less convincing in light of improved conditions in the
banking sector, but the ECB will want to avoid an unwarranted tightening
in credit conditions by abruptly withdrawing liquidity facilities.
Fitch Ratings has affirmed the ratings of Australia’s four major banking groups: Australia and New Zealand Banking Group Limited (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank Limited (NAB) and Westpac Banking Corporation (WBC). At the same time it has revised the outlook on NAB’s Long-Term Issuer Default Rating to Negative from Stable. The Outlook on CBA’s Long-Term Issuer Default Rating remains Negative, while it is Stable for ANZ and WBC.
The
rating review focuses on the Australian-domiciled entities within each
group and therefore does not encompass their overseas subsidiaries.
NAB
The revision of the rating Outlook to Negative reflects the risk that NAB’s focus on remediating issues and changing culture means its ongoing operations may not receive sufficient management time, resulting in a weakening of NAB’s earnings relative to peers. Management changes may make this task more difficult in the short-term. The affirmation of NAB’s ratings reflects Fitch’s expectation that the bank will maintain its strong company profile in the short-term, which in turn supports its sound financial profile.
The Royal Commission into Misconduct in
the Banking, Superannuation and Financial Services Industry and NAB’s
self-assessment on governance, accountability and culture identified
shortcomings within its management of operational and compliance risks,
culture and governance. These were not aligned to what Fitch had
previously incorporated into its ratings and resulted in a revision to
our score for management and strategy, which also remains on negative
outlook. NAB continues to have robust risk and reporting controls around
other risks, including credit, market and liquidity risk, as reflected
by its conservative underwriting standards and very high degree of
asset-quality stability.
Fitch expects NAB’s asset quality and
loan losses to display a very high degree of stability through business
cycles, but could be more volatile than that of some domestic peers due
to NAB’s greater business and corporate exposure.
Capitalisation
and leverage are maintained with solid buffers over regulatory minimums,
but ratios are at the lower end of those of domestic peers. However,
these are likely to trend towards domestic-peer levels as NAB progresses
towards meeting the Australian Prudential Regulation Authority’s
“unquestionably strong” capital requirements by the 1 January 2020
implementation date. Additional capital requirements should be met in an
orderly fashion given the bank’s strong market position and capital
flexibility, with its capital position likely to be bolstered by the
announced partial conversion of its NAB convertible preference shares
into ordinary equity and slower forecast loan growth. The bank’s
earnings and profitability are moderately variable over economic cycles
and it remains reliant on offshore wholesale funding. Sound liquidity
management provides some offset to this risk.
ANZ
The affirmation of ANZ’s ratings reflects the bank’s strong company profile and simple business model in its home markets of Australia and New Zealand, which support its financial profile. The bank’s strong market share across most products provides a higher degree of pricing power relative to smaller peers and allows it to generate strong and consistent operating returns through the cycle.
Australian
household debt is still high relative to international peers, meaning
households are susceptible to a sharp increase in interest rates or
rising unemployment. The risk of external shocks also remains prominent
in light of the geopolitical environment and potential impact on global
growth. However, none of these scenarios are in Fitch’s base case.
The
ongoing execution of ANZ’s simplification strategy supports the rating,
as it is likely to reduce complexity, provide greater focus on key
markets and improve the bank’s overall risk appetite. The focus on
remediating and rectifying issues identified in various inquiries,
including the royal commission, means there is a risk that the bank’s
ongoing operations do not receive sufficient management focus, resulting
in a weakening of its credit profile.
ANZ’s asset quality is
likely to deteriorate modestly in 2019. Earning pressure should continue
due to more modest loan growth, continued pressure on net-interest
margins, rising funding costs, a probable rise in impairment charges and
further remediation and compliance costs. ANZ maintains solid buffers
over regulatory capital minimums and its common equity Tier 1 (CET1)
capital ratio was the highest of Australia’s major banks as of September
2018. These buffers are likely to trend toward domestic-peer levels as
asset sales are completed and capital returned to shareholders. There is
a reliance on offshore wholesale funding, similar to other Australian
major banks, but liquidity is managed well.
CBA
The affirmation of CBA’s ratings reflects Fitch’s expectation that the bank will maintain its strong company profile in the short-term, which in turn supports its sound financial profile. The Negative Outlook reflects challenges in remediating shortcomings in operational and compliance risk management that contributed to a number of conduct and compliance issues over more than a decade. Management’s focus may be diverted from ongoing operations when rectifying these shortcomings and increased compliance costs might manifest in weaker earnings, particularly in relation to domestic peers.
CBA’s remediation of these
shortcomings is on track, but the process is only at an early stage and
is complex. There have been significant changes in the last two years to
the bank’s management and board, who appear committed to rectifying the
outstanding issues. The group is also in the process of exiting its
life insurance and wealth management operations, which may also distract
management from core operations. Successful completion of the
remediation and asset divestments without a significant erosion of the
bank’s franchise would support the current ratings. The remaining
operations after the asset divestments will focus on traditional banking
operations in Australia and New Zealand.
CBA retains a
market-leading position in Australian retail banking despite these
issues and has invested heavily in technology to combat the looming
threat of digital disruptors. The group continues to maintain
peer-leading profitability, while asset quality is sound and capital has
continued to improve. There is a reliance on offshore wholesale
funding, similar to the other Australian major banks, but liquidity is
managed well.
WBC
WBC’s strong company profile supports its ratings. The bank’s market share provides it with some pricing power relative to smaller peers in Australia and New Zealand and allows it to generate strong and consistent operating returns through the cycle, although in the short-term, we expect these to be affected by a challenging operating environment. In addition, WBC has been less affected by conduct-related issues than its domestic major-bank peers, meaning earnings may come under less pressure than for peers despite weaker system growth prospects. Nevertheless, WBC may still be susceptible to legal action from regulators and customers.
Partly
offsetting the risks from high household debt is WBC’s loan
underwriting, which Fitch believes is conservative in the global
context. WBC has progressively tightened its underwriting for mortgages
and commercial exposures, particularly property development, over recent
years. This was driven in part by the regulator, mainly in relation to
mortgages. The bank’s loan book is highly collateralised and we expect
its asset quality to remain a strength relative to that of international
peers, although loan impairments could rise modestly in 2019 from the
current low levels.
WBC is unlikely to have difficulties to
achieving “unquestionably strong” capital targets set by the regulator
before the 2020 deadline – its CET1 capital ratio was already above the
minimum at end-September 2018. Offshore wholesale funding reliance
remains a weakness relative to many similarly rated international peers,
although satisfactory liquidity management and diversification of
funding helps offset some of this risk.
A spike in market volatility during fourth quarter 2018 dragged down overall capital markets results for the five major U.S. trading banks including: Bank of America Corporation (BAC), Citigroup, Inc. (C), The Goldman Sachs Group (GS), JPMorgan Chase & Co. (JPM) and Morgan Stanley (MS), according to the latest report from Fitch Ratings.
“Market
volatility can be a boost to trading revenues; however, too much
volatility in fixed income sales outweighed strength in equity trading
and advisory revenues this quarter,” said Julie Solar, senior director,
Fitch Ratings. “Too little volatility results in fewer trading
opportunities, but too much keeps investors on the side lines.”
Total
debt underwriting revenues fell 24% from the year-ago period,
reflecting volatility, particularly impacting the high-yield market.
Fitch expects that some volume was financed directly by commercial
banks, which reported very strong commercial and industrial loan
(C&I loan) growth trends in 4Q18.
However, despite a
challenging final six weeks of the year, record earnings during the
first part of the year contributed to the highest full-year results
since 2009. Capital markets revenues for the five banks included in this
report totalled $107 billion in 2018, approximately 4% higher than in
2017, aided mainly by a significant increase in equity sales and trading
revenues.
M&A activity in 4Q18 increased a considerable 37%
versus last year, buoyed by a significant rise in M&A completions
and continued strength from the technology and healthcare sectors.
Several banks noted that deal pipelines remain strong, although down on a
linked-quarter basis.
“Even with a strong backlog of deals,
continued volatility and market sentiment could impact banks’ ability to
bring transactions to market, and the IPO pipeline may also feel an
impact from the prolonged government shutdown as the SEC was unable to
review pending IPOs for several weeks. 2019 is off to a strong start and
the first quarter is typically the strongest of the year, but it is
unclear how investment banking revenues could be impacted,” added Solar.
Global government debt reached USD66 trillion (converted at market exchange rates) at end-2018, nearly double its 2007 level and equivalent to 80% of global GDP, according to Fitch Ratings‘ new Global Government Debt Chart Book.
Developed market (DM) government debt has been
fairly stable in US dollar terms, at close to USD50 trillion since 2012.
In contrast, Emerging market (EM) debt has jumped to USD15 trillion
from USD10 trillion over the same period, with the biggest increases in
percentage terms being in the Middle East and North Africa (104%) and
Sub-Saharan Africa (75%), though these regions still have comparatively
low debt stocks, at less than USD1 trillion each.
“Government
debt levels are high, leaving many countries poorly positioned for
financial tightening as global interest rates begin to move higher,”
said James McCormack, Global Head of Sovereign Ratings at Fitch.
While
there are only 11 sovereigns rated ‘AAA’, they account for about 40% of
global government debt, virtually unchanged over the last two decades.
The US (AAA/Stable) is by far the world’s most indebted government in
dollar terms, with consolidated general government obligations close to
USD21 trillion. US debt is going up by about USD 1 trillion per year. To
put that into perspective, the total debt stocks of France (AA/Stable),
Germany (AAA/Stable), Italy (BBB’/Negative) and the UK (AA/Negative)
were all in the range of USD2.4 trillion-USD2.7 trillion at end-2018.
Consistent
with the dominance of ‘AAA’ sovereigns, 93% of global government debt
carries an investment grade (BBB- or higher) rating. The ‘A’ category is
the second-largest, as Japan (A) and China (A+) are the second- and
third-largest government debt markets, with outstanding stocks of USD12
trillion and USD6 trillion, respectively.
The number of
sovereigns rated in the ‘B’ category (or lower) has increased sharply in
recent years, as several ‘BB’ commodity exporters were downgraded as
they struggled with the correction in commodity prices, and the
exceptionally low interest rate environment attracted new, less
creditworthy, sovereigns to capital markets for the first time. Even so,
sovereigns in the ‘B’ category (or lower) account for 28% of the rated
portfolio but only 3% of global government debt.
There has been a
steady deterioration in the credit quality of government debt in recent
years. In DMs, the average rating (weighted by the sovereigns’ debt
stocks in dollar terms) of outstanding government debt was just under
‘AA’ at end-2018, losing one notch since 2011. In EMs (excluding China),
the average rating at end-2018 was slightly below ‘BB+’, its lowest
since 2005.
Estimated effective interest rates faced by
governments (calculated as interest payments divided by the debt stock)
have drifted lower since 2000 in all regions and rating categories. The
lowest effective rates by rating are found in the ‘A’ category, largely
reflecting conditions in Japan, and the highest effective rates by
region are in Latin America, as has been the case since 2010.
“In
2018 there were more upgrades than downgrades but, based on where we
have negative rating outlooks, we believe 2019 looks less favourable,
especially for the Latin America and Middle East and Africa regions,”
added McCormack
“Common themes that have driven sovereign ratings
in the last few years will dominate again in 2019, including tightening
sovereign financing conditions, commodity price fluctuations and
political and geopolitical developments. Slowing economic growth in some
countries may bring fiscal concerns back to the fore, particularly
given the high starting positions with respect to government debt,” said
McCormack.
Three defaults in recent months have highlighted the risk of broader disclosure and governance problems among Chinese corporates, as well as the variable quality of local auditing, says Fitch Ratings. Shandong SNTON Group Co. (Snton, RD), Reward Science and Technology Industry Group Co. (Reward, RD) and Kangde Xin Composite Material Group Co. (KDX, WD) all defaulted on moderate amounts relative to their reported cash holdings.
Corporate defaults are usually driven by insufficient
liquidity, but these companies’ stated cash balances cannot explain the
non-payments. Snton was sued by the Hebei Bank Qingdao Branch on 25
September for CNY139 million, which included defaulted principal of two
drawn facilities. It had a reported cash balance of CNY4 billion at
end-June, of which we estimate roughly half was unrestricted, which
should have provided a significant buffer against default. It was also
able to raise CNY400 million through domestic bond issuance in 1H18,
suggesting normal access to the domestic funding market, despite
generally tight credit conditions.
Reward failed to repay CNY300
million of commercial paper on 6 December, despite having CNY4.9 billion
in cash – just CNY548 million of which was restricted – at end-June
2018, and CNY4.2 billion at end-September, according to its management
accounts. KDX failed to repay CNY1 billion of commercial paper on 15
January. It had reported available cash of CNY15 billion and a net cash
position in September.
These companies did not show other
typical signs of distress prior to the defaults. The rise in Snton’s
leverage in 2017 was above Fitch’s expectations and drove our downgrade
of the company’s rating in May 2018, but its FFO net leverage of around
3.5x at end-June 2018 did not indicate an unsustainable capital
structure. Reward’s FFO interest coverage was over 3.5x in 9M18, while
KDX was around 5x in 1H18.
The defaults call into question the
actual availability and amounts of reported cash balances. The three
companies reported their restricted cash balances in line with Chinese
accounting standards – China GAAP – which mandate similar disclosures on
cash encumbrances to international standards. It is unclear if there
were less formal restrictions in place, such as agreements with lending
institutions to keep sums in designated accounts to support facility
access. In any case, Reward and KDX confirmed to Fitch shortly before
their commercial paper due dates that their holdings of realisable cash
were sufficient to meet obligations.
Uncertainty over the
accuracy of the companies’ books and disclosure of pertinent information
is ultimately related to governance and accounting quality. Governance
issues – often challenging to uncover – have been a factor in Fitch’s
ratings on Reward and KDX. Reward’s ratings have been constrained by its
low transparency as a private unlisted company with concentrated share
ownership. The company changed auditor and re-issued its 2017 accounts
due to disclosure and accounting problems flagged by the regulator.
KDX
is listed on the Shenzhen Stock Exchange (SSE), but an apparent problem
with its disclosure of concerted party arrangements at shareholder
level prompted an SSE investigation, which hampered access to funding
and prompted our downgrade in December. Snton’s case demonstrates
unpredictable financial management. It failed to repay domestic bank
loans, but has continued to service onshore bonds.
All three
companies are audited by domestic accounting firms. International bond
investors have become more receptive of Chinese issuers choosing not to
hire one of the “Big Four” international accounting firms over the past
decade. However, the quality of domestic auditing is variable. It is not
unprecedented for domestic audit firms to be reprimanded for
shortcomings. The auditors of Snton, Reward and KDX have previously
received reprimands, albeit not for their work on these companies.
Fitch Ratings says the outlook for global growth has been dented by a series of recent weak data releases, but not dismantled. The broad contours of the agency’s December 2018 Global Economic Outlook (GEO) forecasts for 2019 – with above-trend growth in the US and policy easing preventing growth dipping below 6% in China – still look intact. The eurozone outlook has weakened more significantly but some recovery in growth in 1H19 still looks likely after a very disappointing 4Q18.
A string of weak data releases since the GEO was released in
early December have raised market concerns about the risk of a sharp
downturn in global growth in 2019. Most dramatically, business sentiment
in the manufacturing sector has seen a widespread deterioration across
multiple geographies. Fitch’s economics team’s latest chart of the month
shows the (unweighted) average manufacturing Purchasing Managers’ Index
(PMI) for the 20 economies covered in the GEO and suggests that the
upturn in the global manufacturing cycle seen from 3Q16 petered out in
2H18, consistent with the slowdown also seen in world trade through
2018.
A string of weak data releases since the GEO was released in early December have raised market concerns about the risk of a sharp downturn in global growth in 2019. Most dramatically, business sentiment in the manufacturing sector has seen a widespread deterioration across multiple geographies. Fitch’s economics team’s latest chart of the month shows the (unweighted) average manufacturing Purchasing Managers’ Index (PMI) for the 20 economies covered in the GEO and suggests that the upturn in the global manufacturing cycle seen from 3Q16 petered out in 2H18, consistent with the slowdown also seen in world trade through 2018.
This deterioration in the global manufacturing cycle has its roots mainly in the slowdown in growth in China, which became evident from the middle of last year and followed earlier credit tightening. China’s share of world GDP has continued to grow rapidly in recent years and its domestic economic cycle now has much more pronounced effects on the rest of the world than in the past. The current slowdown in China is substantial – particularly when measured in terms of nominal GDP growth, which peaked at nearly 12% y/y in early 2017 and likely fell below 9% y/y in 4Q18. Moreover, the latest slowdown has been reflected in consumer spending to a greater extent than in the past, including in car sales, which recorded a 4.3% decline last year. China accounts for around a third of global car sales and it seems likely that global auto sales – a key component of world manufacturing – declined last year for the first time since 2009.
However, our 2019 forecast for
China’s real GDP growth of 6.1% still looks achievable despite recent
weakness in the data. Retail sales, industrial production, profits and
trade growth have all fallen further since early December but fixed
asset investment growth has recovered in the last three months with
infrastructure investment – which led the initial slowdown – returning
to positive y/y growth. New housing starts also continue to grow
robustly. Moreover the latest credit data showed tentative signs of
stabilisation with aggregate financing to the real economy (adjusted to
exclude equity and include local government bonds) growing 10.3% in
December compared with 10.4% in November. This followed several months
of much larger declines in the annual growth rate.
Policy in
China has been eased further with the recent cut in banks’ required
reserve ratios and the authorities’ commitment to tax cuts and
supporting infrastructure spending has become more vocal in recent
weeks. Our current baseline forecasts also assume that US tariffs on
USD200 billion of Chinese imports will rise to 25% in early 2019, a
shock that may be avoided if trade talks make further progress.
Manufacturing
indicators in the US have also deteriorated but private sector demand
still looks robust and ‘now-cast’ estimates of 4Q18 GDP based on high
frequency data are pointing to annualised growth of around 3%, roughly
in line with the December GEO. Strong job gains and rising nominal and
real wage growth continue to support the consumer and lead indicators of
business investment suggest prospects are still for decent growth in
2019, albeit at a slower rate than in 2018. The tightening in financial
conditions has been modest and the Fed now looks likely to raise rates
in 2019 by less than the three hikes predicted in the December GEO. The
Federal government shutdown could take a toll on growth in 1Q19 but for
now our working assumption is that fiscal policy continues to provide
support to US domestic demand growth in 2019 as a whole.
There is
a more material threat to our 2019 eurozone growth forecasts. Eurozone
PMI’s have seen the largest falls in recent months and this has been
corroborated by weak ‘hard’ industrial production data in the large
member states. The December GEO forecast that 4Q18 GDP would rebound to
0.5% is not supported by the incoming data – instead this now points to
another quarter of very subdued growth similar to the 0.2% expansion
seen in 3Q18.
However, a number of temporary factors – including
disruptions to car sales and production related to new emissions
standards, weather related complications to domestic trade flows in
Germany and social protests in France – have likely played a part in
weak eurozone activity in 2H18. This suggests that some recovery in
sequential growth should be seen in 1H19. Tightening labour markets and
rising wage growth should also remain supportive of consumer spending.
Nevertheless the slowdown in world trade and fading credit impulse now
look likely to see eurozone growth heading back down towards potential
(estimated to be below 1.5%) more quickly than previously expected. The
possibility of a no-deal Brexit adds further downside risks. The weaker
activity outlook reinforces our expectation that the ECB will likely
modify its forward guidance on interest rates soon and possibly consider
other accommodative moves related to bank financing.
Fitch published their Global Home Housing And Mortgage Outlook for 2019. The story appears to one of falling values in some major centres and more uncertainty economically and politically. For Australia, they expect a national peak-to-trough home price drop of 12% in Australia with Sydney and Melbourne posting larger declines in 2019.
They say overheated home prices in several major cities have been a key theme in recent years. But prices fell or stalled in 2018 in Melbourne, Stockholm, Sydney, Toronto and Vancouver due to government actions to reduce foreign purchases, macro-prudential measures and/or stretched affordability. Fitch Ratings forecasts home prices to fall in Australia and Sweden in 2019 before stabilising in 2020, modest corrections in China and South Korea, and stalled growth in Canada. We have also seen regulators actively managing markets through the tightening and loosening of lending rules.
High Household Debt Amplifies Risks
Fitch says household debt-to-GDP ratios are at or over 100% in Australia, Canada, Denmark, the Netherlands and Norway, and over 85% in New Zealand, South Korea, Sweden and the UK. High household debt makes the wider economies more vulnerable to shocks in the financial sector and borrowers more exposed to downturns. Household debt growth has stalled in Denmark and the Netherlands due to affordability constraints and regulatory intervention. The household debt-to-GDP ratios in Australia, Canada and Norway have stabilised after sharp growth while they have continued to grow in China and South Korea, albeit at a slower pace.
Political Uncertainty Affects Housing
Fitch highlights several cases of political risks in the report, including Brexit, a political appointment to oversee Fannie Mae and Freddie Mac, and new governments in Latin America. Their impact varies: our no-deal Brexit scenario analysis suggests price drops in the UK and much slower price growth in Ireland while uncertainty is already contributing to price falls in London; less government participation in the US mortgage market could increase mortgage pricing and lead some lenders to reduce product offerings; in Brazil, there is uncertainty regarding the new government’s ability to enact market-friendly policies that would support home price growth.
Cracks Appear in Economic Growth Outlook
Fitch notes in its Global Economic Outlook that cracks are starting to appear in the global growth picture, with China and the eurozone slowing, further rate increases expected in the US, stubbornly low core inflation in the eurozone and Japan, and the dollar’s strength putting pressure on emerging markets.
These factors contribute to Fitch’s view that economic growth is slowing, albeit to a moderate degree and in many cases from a position of strength. However, our macroeconomic outlooks to 2020 for the 24 countries in this report are still mainly stable or improving, which supports our mostly stable housing and mortgage market evaluations.
Arrears Concerns Beyond 2020
Fitch does not forecast material increases in arrears in 2019 and 2020 for any country in the report. We expect the impact from weaker growth and generally slow mortgage rate rises to be relatively benign. But there is downside pressure in the medium term from rising rates, fading fiscal stimulus in the US and weaker growth in China, in the context of still high global debt. A faster-than-expected tightening in global financial conditions could worsen mortgage performance.
Mixed Impact from Rising Rates
The speed of mortgage rate rises will vary with North America expected to post the fastest increases and Japan and the eurozone the slowest. The impact will depend on whether mortgages have long-term fixed rates and the macroeconomic backdrop. Highly leveraged markets with large numbers of variable-rate loans, such as Australia, Norway, Sweden and the UK, could see marked deterioration in loan performance should rates rise quickly. Markets with long-term fixed-rate loans, such as Belgium, France, Latin America, the Netherlands and the US, may see lenders gradually increase their appetite for higher-risk borrower and loan characteristics as their profitability suffers and competition intensifies.
Price Declines Set to Continue In Australia
Fitch forecasts a national home price decline of an additional 5% in 2019 before above-trend GDP growth and strong net migration should stabilise prices in 2020. The peak-to-trough decline of 6.7% as of December 2018 has been driven by lower investor demand reflecting macro-prudential limits on interest-only and investment lending, and tighter enforcement of lending standards.
They expect price declines to continue at a similar pace in 2019 in Sydney and Melbourne, where larger falls have occurred (peak-to-trough declines of 11.1% and 7.2%, respectively, as of December 2018). The most expensive quartile of properties has experienced the largest declines with falls of 9.5%.
GDP Growth Supports Performance
They forecast loans in arrears over 90 days to increase slightly to 70bp by 2020. Properties in possession will take longer to sell as home prices fall, so loans will remain delinquent for longer. Early-stage mortgage arrears (30 to 90 days in arrears) will be broadly stable in 2019 at 60bp even though lenders have modestly raised mortgage rates for investment and interest only loans despite no policy rate increases. Mortgage performance will be supported by slowing but still solid economic growth, decreasing unemployment and only gradually rising policy and mortgage rates. Risks remain, stemming from the highest household-debt-to-GDP ratio in this report at 121% as of 2Q 2018.
Credit Growth to Remain Low
Housing credit growth is projected to ease further in 2019 to 3.5% from 5.1% yoy growth in October 2018. This is due to tightened macro-prudential limits and a more conservative interpretation of regulatory guidelines for mortgage servicing in light of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Fitch believes the commission’s final recommendations, due in February, may further reduce credit availability.
Investment loan origination has been hit by a limit to investment loan growth of 10% (introduced in 2014 and removed in July 2018 for lenders that can prove they have met regulatory requirements for the past six months) and a limit of interest-only origination to 30% of new lending (introduced in 2017 and removed from January 2019 for lenders that have met regulatory requirements for the past six months) along with foreign investor levies and taxes from state governments.
The continuing U.S. government shutdown highlights the periodic weakness in its budget policymaking, Fitch Ratings says. Shutdowns have not directly affected the country’s ‘AAA’/Stable sovereign rating but can signal that disputes on other issues are a constraint on fiscal policymaking.
The partial federal government shutdown that began
Dec. 21 is now the longest since October 2013 (the longest shutdown
lasted three weeks in 1995/1996). President Trump’s refusal to sign
temporary spending bills that did not include USD5.6 billion for border
wall funding and which included appropriations for other programs
exceeding those in the president’s budget triggered the shutdown.
When
and how the government will reopen remains unclear. The advent of a new
Congress on Thursday saw a similar spending package passed by the House
of Representatives, where the Democrats now have a majority. The
package did not include additional wall funding, is opposed by the Trump
administration and will not be taken up by the Senate. Some Republican
senators have advocated passing a continuing resolution to reopen the
government.
U.S. fiscal policymaking coherence can be weak
relative to peers. The policymaking process at times has entailed
shutdowns (there were two short-lived shutdowns earlier in 2018) and
debt limit brinkmanship.
Shutdowns are much less of a risk to
sovereign creditworthiness than debt limit impasses. The partial nature
of the current shutdown, affecting around 25% of the federal government,
should limit its economic impact, although this will increase depending
on its length.
Nevertheless, the ongoing shutdown suggests that
the current arrangement of political forces, following November’s
midterm elections that resulted in a divided Congress, limits policy
consistency. It also makes it unlikely in the near term that medium-term
fiscal challenges, such as rising mandatory spending will be addressed.
The main implication for our U.S. sovereign credit view will
depend on whether we feel this shutdown foreshadows a more pronounced
destabilization of fiscal policymaking, including brinkmanship over the
debt limit, which happened in October 2013. The debt limit is due to
come back into force in March, although the Treasury would have several
months during which it could operate under extraordinary measures. We
view the risk of a failure to lift the debt limit in time to prevent a
U.S. federal debt default as remote. House Democrats’ adoption of a new
version of the so-called Gephardt rule, linking debt limit suspension to
the approval of budget resolutions, could make debt limit impasses less
likely.
Evidence of greater dysfunction in fiscal policymaking
could still contribute to negative pressure on the U.S. rating. This is
especially the case as deficits continue to increase (pro-cyclical
fiscal stimulus in 2018 helped widen the federal deficit in the fiscal
year Sept. 30 by 17% to USD779 billion) at a time when growth is likely
to slow.
Democratic control of the House reduces the prospect of
additional, large tax cuts over the next two years, although spending
consolidation is also unlikely. Policies enacted by the new Congress
could influence U.S. fiscal outturns, although we expect relatively
limited impacts on our deficit forecasts. These include plans to
reintroduce the ‘PAYGO’ budget rule mandating that any changes to
legislation affecting mandatory spending do not increase budget
deficits. Democrats have also said they will amend the rule that
requires a three-fifths majority in the House of Representatives to
raise income taxes.
Credit risks across many sectors are rising with a looming cyclical deterioration in credit conditions and global debt at near-record levels, says Fitch Ratings. However, the macroeconomic conditions and the sector breakdown of leverage in developed markets differ significantly from the last downturn in 2008. We expect governments and non-financial corporates to be at the center of any coming storm for credit conditions.
Since 2007, aggregate financial sector and
household debt as a percentage of GDP globally has remained roughly
steady according to data from the IIF. In contrast, governments and
non-financial corporates have seen their debt rise significantly, up 27
percentage points (pp) and 16 pp, respectively. These sectors’ capacity
to manage a macroeconomic slowdown accompanied by tightened financial
conditions will thus be challenged.
Government debt/GDP ratios
have increased substantially across most large and developed economies
since 2007, leaving some sovereigns heavily exposed in the event of a
future economic downturn with potential negative rating implications. A
turn in the global credit cycle characterized by tighter financial
conditions is more likely to be felt by emerging markets in the short
term, which will face heightened volatility and capital flow disruption.
Non-financial corporates were not a primary source of risk
during the last financial crisis. However, corporate leverage has risen
markedly since then, enabled by low rates, rising equity valuations and
the expansion of non-bank lenders. In addition, corporate borrowers have
largely used this funding to expand shareholder returns and M&A,
which have far outstripped capex. This has already driven negative
rating trends for U.S. corporates over the past two years, despite
relatively strong economic growth during that time. Ratings distribution
in the U.S. corporates portfolios has changed significantly since the
pre-crisis period, with ‘BBB’ category rated issuers rising relative to
higher investment-grade categories.
Compared to sovereigns and
non-financial corporates, banks in developed markets are in a more
robust and resilient position compared to the last financial crisis.
Capital levels and liquidity are significantly stronger, owing to a wave
of regulatory reform, while reduced risk appetite and smaller loan
portfolios have led to a significant reduction in banking assets as a
proportion of GDP. While banks have retrenched, higher risk lending
activity has moved into less visible areas of the non-banking financial
system. This could increase uncertainty for the financial market heading
into a downturn while adding to risks from the interconnectedness
between non-bank financial institutions and the rest of the financial
market.
