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Fears of contagion from China sell-off collide with worries over UK consumers
Thursday 23 Sep 2021 Author: Ian Conway

The abrupt recent sell-off in global markets may have seemed to have come out of nowhere, but problems had been brewing for months and it only needed investors to blink for prices to turn down.

Fears over inflation, tightness in the supply chain and a subsequent slowdown in growth have bubbled below the surface in developed markets all summer. These were joined this month by worries over the health of heavily-indebted Chinese property firm Evergrande, which we flagged in early August.


While investors’ attention was focused on Chinese tech stocks and the authorities’ increasingly aggressive scrutiny of their operations, in the background property giant Evergrande, the biggest issuer of high-yield bonds in Asia, looked to be sliding towards insolvency.

This week its shares fell to an 11-year low, bringing their year to date loss to more than 85%, wiping out around HK$200 billion of investors’ money. However, there are fears Evergrande’s bondholders and lenders could face even greater losses if the firm defaults.

The developer’s 8.25% US dollar bond due next year is trading at 25% of its face value, suggesting there is just a one in four chance of investors getting repaid, while interest payments on two more of its bonds due today (23 Sep) looked unlikely to be met as we went to press.

Debt rating agency S&P Global said the firm is ‘on the brink of default’ and will only be rescued by Beijing if there is ‘a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy’.


Already, shares and bonds in other Chinese developers have slumped, as have the high-yield bonds of non-property related Chinese firms, and even some high-grade dollar bonds have fallen sharply.

Shares in blue-chip Chinese firms such as Ping An, the country’s largest insurer and a heavily-weighted stock in most regional exchange traded funds, have also suffered in the fall-out from Evergrande.

Analysts at Citigroup believe the Chinese government will take action to buy the company time and engineer a managed restructuring of its debt, to avoid a systemic collapse, but in the process some banks may have to go to the wall.

The longer-term implications are that growth in the property sector – and by extension the construction sector – will be closely controlled, meaning demand for raw materials such as iron ore, copper and aluminium will slow.

According to analysts at Liberum, the Chinese property sector accounts for 20% of global steel demand, 20% of copper demand and just under 10% of aluminium demand, which means, in their words, Evergrande is ‘potentially a big deal’ for commodities.


Here at home, investors have been unsettled by the rising cost of food, fuel and now heating their homes. The latest blow is a spike in natural gas prices caused by a combination of low storage levels, a lack of wind-generated power and a drop in imported electricity.

Gas prices have soared 250% this year as a harsh winter last year put pressure on supplies, while this summer has been the least windy since 1961 according to the Met Office. Compounding this, a fire at a substation in Kent knocked out the interconnector which supplies nuclear-generated electricity from France.

As a result, 15 million consumers are facing a hike of 10% or more in their energy bills from next month as big suppliers whack up their prices. Meanwhile, small suppliers who promised consumers cheaper bills are going out of business as they haven’t been able to pass on higher prices.


The problem doesn’t end there, however. High gas prices have led a major chemical firm to close two of its UK fertiliser plants, halving the amount of high-grade CO2 the UK produces.

This impacts the food industry where the gas is used in the production of chicken and pork and in packaging fresh and frozen food for supermarkets, giving products a longer shelf life. It is also vital for the hospitality industry as it is used in soft and alcoholic drinks and in dispensing beer in pubs.

The Food and Drink Federation has warned the effects of the CO2 shortage ‘may be felt through the end of the year and particularly over Christmas’.

The medical sector also uses CO2 for surgery and to store drugs, which has raised the spectre of the roll-out of Covid booster jabs and vaccinations for teenagers being delayed.


Economists fear that consumers, who are already feeling the pinch from rising food and energy prices, will rein in their spending if they are worried about higher bills and a ‘winter of discontent’.

It is possible for millions of individual ‘micro’ decisions to have a major effect on the ‘macro’ outlook. If confidence takes a knock, that feeds through to the economy and ultimately to the stock market, resulting in the kind of sell-off we have just witnessed.

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