Potential ripple effects of China’s credit risk
Kathy Jones, Chief Fixed Income Strategist at Charles Schwab, joins Yahoo Finance Live to discuss the U.S. economy, outlook on the Fed taper, and the China credit risk.
Video transcript
AKIKO FUJITA: Let's bring in our guest, Kathy Jones, Chief Fixed Income Strategist at Charles Schwab. Kathy, it's good to have you on this Friday in what has been a really volatile week. We're talking about all the headlines out of China. We haven't even touched on the Fed just yet. Give me a sense of how you're processing the choppiness that we saw this week, and as we go into next week.
KATHY JONES: Yeah, I think we're coming out of sort of a mid-cycle slowdown in the economy. And there were some concerns, obviously early in the week, about the China Evergrande situation and if there would be a ripple effect or some contagion and that kind of pushed yields down. And as that got resolved or at least looks like it's going to be under control, then yields started to move up. And of course, we had the Fed meeting. I don't know that what the Fed told us was terribly surprising, but I do think it's recognition that rates are going to move up. The Fed is going to pull back on its bond buying, and it's going to eventually raise rates. And that's giving a lift to bond yields.
AKIKO FUJITA: Yeah, we have seen the bond yields push higher since that decision came down. I want to get back to the China issue, Kathy, because I think you're right, that in many ways we saw the huge sell-off on Monday in reaction to what happened over in China. Investors now kind of processing and saying, OK, well, Evergrande specifically may not be a contagion risk, and yet there's still a lot of unanswered questions around the property space in China and what a broader economic slowdown's likely to mean. Same question I asked our earlier guest, how significant is the credit risk out of China?
KATHY JONES: Yeah, I think the credit risk is, certainly for a US-based investor, is not that great. So the amount of dollar bonds that say Evergrande has in the EM Index is pretty small. And so I don't know that the exposure is so big, but we do know that there are credit issues in China, particularly in the property sector, which has been a place of a lot of speculation, a huge amount of leverage. And now what we're seeing, is the government use its influence in its policies to say, hey, you know, we want to crack down on this.
Now they've been cracking down on Evergrande for quite some time, so it shouldn't be a huge surprise that this has happened. But I think that's all the short-term stuff. I think the long-term question is, as China, is China rotating from this rapid growth model to a more mature model with less leverage, less dependence on cheap labor, et cetera? And that is a significant change, and that could have ripple effect longer term in terms of growth in the global economy. We may not get that supercharged highly leveraged Chinese growth that we've been used to for the last 20 years or so.
AKIKO FUJITA: Kathy, going back to the Fed decision and what we heard from Jay Powell, you said you don't feel like we learned a whole lot. It does feel like this was by far the clearest messaging we've gotten from the central bank in terms of how they're looking at the tapering process. The timeline's still a big question. What do you think the market is pricing in? And you think there's a bit of complacency there.
KATHY JONES: Yeah, I think the market, now we have more clarity. It looks like they will announce, barring some big surprise, they will announce the official tapering at the November meeting, and probably start soon thereafter. There's no reason to announce it and wait any period of time. So as long as conditions are pretty good in the economy, we look for a start in November.
They have the number of Fed officials, including Powell, have indicated that they'd like to finish it up by the middle of 2022. That's a pretty brisk pace, so that's going to happen fairly quickly, as long as the economy is in good shape. The question down the road is, when do they start hiking rates? And we think as long as the economy is in decent shape, late 2022 will be the first rate hike, a lot of people think it'll be a bit later. And obviously, it's going to depend on how the economy evolves. But we're fairly optimistic on the economy. We think inflation's going to continue to be on the strong side. So we think the Fed moves sooner rather than later, which means late 2022.
AKIKO FUJITA: Kathy Jones, good to talk to you on this Friday. Chief Fixed Income Strategist at Charles Schwab.
