Finance
KKR says China’s real estate correction may only be halfway done
High-rise buildings are illuminated at night in the West Coast New Area of Qingdao, East China’s Shandong province, on March 22, 2024.
Nurphoto | Nurphoto | Getty Images
BEIJING — China’s real estate troubles are likely far from over and industry problems need to be addressed quickly if overall GDP growth is to pick up significantly, according to a report released Thursday by global investment firm KKR.
That’s one of the two key takeaways from a recent trip to China by the firm’s head of global and macro asset allocation, Henry H. McVey. It was his fourth visit in just over a year.
“A fundamentally overbuilt real estate industry needs to be addressed — and quickly,” he said in the report, which counts Changchun Hua, KKR’s chief economist for Greater China, among the co-authors.
“Second, confidence must be restored to drive savings back down,” McVey said, noting that would spur consumers and businesses to spend on upgrading to higher quality products, as Chinese authorities have promoted.
Real estate and related sectors once accounted for about one fifth or more of China’s economy, depending on the breadth of analysts’ calculations. The property industry has slumped in the last few years after Beijing’s crackdown on developers’ high reliance on debt for growth.
Based on comparisons to housing corrections in the U.S., Japan and Spain, China’s “housing market correction may be just halfway complete” in terms of its depth, the KKR report said.
“Both price and volume must come under pressure to finish the cleansing cycle,” the report said. “To date, though, it has largely been a contraction in volume.”
While KKR’s report didn’t provide much detail on expectations for specific real estate policy, the authors said more action by Beijing to improve China’s real estate sector “could materially shift investor perception.”
Amid geopolitical tensions, the country’s property market slump and drop in stocks have given many foreign institutional investors pause about China investing.
“According to some of our proprietary survey work, many allocators have considered reducing China exposure to 5-6%, down from 10-12% today at a time that we think fundamentals in the economy are likely bottoming,” the KKR report said.
Much of official Chinese data to start the year beat analysts’ expectations.
Chinese officials have said the real estate sector remains in a period of adjustment, while Beijing shifts its emphasis toward manufacturing and what it considers “high-quality development.”
Authorities have also released policies to promote financial support for select property developers, while many local governments — though not necessarily the largest cities — have significantly relaxed home purchase restrictions.
Real estate’s drag to moderate
KKR expects a modest slowdown in China’s GDP growth to 4.7% this year, and 4.5% next year, with real estate and Covid-related factors halving their drag on the economy from 1.4 percentage points in 2024 to a 0.7 percentage point drag in 2025.
“Our bottom line is that: with the ongoing [property] correction as well as some potential further policy support, we think the drag to [the] overall economy should moderate a bit over the next few years,” McVey said in a separate statement. He is also chief investment officer of KKR Balance Sheet.
Catering, accommodation and wholesale are set to modestly increase their contribution to growth in the next two years, while digitalization and the shift toward more carbon-neutral, green industry are expected to remain the largest drivers of growth, according to the report.
For investors, the report said a more important development than China’s GDP increase would be whether authorities could make it easier for businesses and households to tap capital markets.
“Repairing soft spots in [the] economy, especially around housing, will ultimately improve the cost of capital, and will also allow new consumer companies to access the capital markets likely at better prices if real estate and confidence are doing better,” McVey said in the statement.
Beijing in March announced a GDP target of around 5% for this year. Minister of Housing and Urban-Rural Development Ni Hong said last month that developers should go bankrupt if necessary and that authorities would promote the development of affordable housing.
Recent data have pointed to some stabilization in the property sector slowdown. The seven-day-moving average of new home sales in 21 major cities fell by 34.5% year-on-year as of Monday, better than the 45.3% drop recorded a week earlier, according to Nomura, citing Wind Information.
Compared with the same period in 2019, that sales average was only down by 27.8% as of Monday, versus a 47% drop a week earlier, Nomura said, noting most of the improvement was in China’s biggest cities.
Consumer outlook
KKR said most of its local portfolio is in consumer and services companies, whose business reflect how Chinese people in the middle to higher income range are spending modestly to upgrade their lifestyles.
“Top line growth is solid, margins are holding, and consumers are spending on less conspicuous items such as ‘smart homes,’ pets, and recreational activities,” the report said. “Domestic travel is also strong.”
Retail sales rose by a better-than-expected 5.5% year-on-year in January and February, boosted by significant growth in Lunar New Year holiday spending.
Longer term, KKR still expects that China can follow historical precedent in changing policy to be “more investor friendly.”
“While our message is not an all-clear signal to lean in,” the report said, “it is a reminder – using history as our guide – that, if China does adjust its domestic policies to be more investor friendly (especially as it relates to supply side reforms), this market could rebound significantly from current levels.”
WASHINGTON – The Federal Reserve on Wednesday lowered its key interest rate by a quarter percentage point, the third consecutive reduction and one that came with a cautionary tone about additional reductions in coming years.
In a move widely anticipated by markets, the Federal Open Market Committee cut its overnight borrowing rate to a target range of 4.25%-4.5%, back to the level where it was in December 2022 when rates were on the move higher.
Though there was little intrigue over the decision itself, the main question had been over what the Fed would signal about its future intentions as inflation holds steadily above target and economic growth is fairly solid, conditions that don’t normally coincide with policy easing.
In delivering the 25 basis point cut, the Fed indicated that it probably would only lower twice more in 2025, according to the closely watched “dot plot” matrix of individual members’ future rate expectations. The two cuts indicated slice in half the committee’s intentions when the plot was last updated in September.
Assuming quarter-point increments, officials indicated two more cuts in 2026 and another in 2027. Over the longer term, the committee sees the “neutral” funds rate at 3%, 0.1 percentage point higher than the September update as the level has drifted gradually higher this year.
“With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive,” Chair Jerome Powell said at his post-meeting news conference. “We can therefore be more cautious as we consider further adjustments to our policy rate.”
“Today was a closer call but we decided it was the right call,” he added.
Stocks sold off following the Fed announcement while Treasury yields jumped. Futures pricing pared back the outlook for cuts in 2025 to one quarter point reduction, according to the CME Group’s FedWatch measure.
“We moved pretty quickly to get to here, and I think going forward obviously we’re moving slower,” Powell said.
For the second consecutive meeting, one FOMC member dissented: Cleveland Fed President Beth Hammack wanted the Fed to maintain the previous rate. Governor Michelle Bowman voted no in November, the first time a governor voted against a rate decision since 2005.
The fed funds rate sets what banks charge each other for overnight lending but also influences a variety of consumer debt such as auto loans, credit cards and mortgages.
The post-meeting statement changed little except for a tweak regarding the “extent and timing” of further rate changes, a slight language change from the November meeting.
Change in economic outlook
The cut came even though the committee jacked up its projection for full-year gross domestic product growth to 2.5%, half a percentage point higher than September. However, in the ensuing years the officials expect GDP to slow down to its long-term projection of 1.8%.
Other changes to the Summary of Economic Projections saw the committee lower its expected unemployment rate this year to 4.2% while headline and core inflation according to the Fed’s preferred gauge also were pushed higher to respective estimates of 2.4% and 2.8%, slightly higher than the September estimate and above the Fed’s 2% goal.
The committee’s decision comes with inflation not only holding above the central bank’s target but also while the economy is projected by the Atlanta Fed to grow at a 3.2% rate in the fourth quarter and the unemployment rate has hovered around 4%.
Though those conditions would be most consistent with the Fed hiking or holding rates in place, officials are wary of keeping rates too high and risking an unnecessary slowdown in the economy. Despite macro data to the contrary, a Fed report earlier this month noted that economic growth had only risen “slightly” in recent weeks, with signs of inflation waning and hiring slowing.
Moreover, the Fed will have to deal with the impact of fiscal policy under President-elect Donald Trump, who has indicated plans for tariffs, tax cuts and mass deportations that all could be inflationary and complicate the central bank’s job.
“We need to take our time, not rush and make a very careful assessment, but only when we’ve actually seen what the policies are and how they’ve been implemented,” Powell said of the Trump plans. “We’re just not at that stage.”
Normalizing policy
Powell has indicated that the rate cuts are an effort to recalibrate policy as it does not need to be as restrictive under the current conditions.
“We think the economy is in really good place. We think policy is in a really good place,” he said Wednesday.
With Wednesday’s move, the Fed will have cut benchmark rates by a full percentage point since September, a month during which it took the unusual step of lowering by a half point. The Fed generally likes to move up or down in smaller quarter-point increments as its weighs the impact of its actions.
Despite the aggressive moves lower, markets have taken the opposite tack.
Mortgage rates and Treasury yields both have risen sharply during the period, possibly indicating that markets do not believe the Fed will be able to cut much more. The policy-sensitive 2-year Treasury yield jumped to 4.3%, putting it above the range of the Fed’s rate.
In related action, the Fed adjusted the rate it pays on its overnight repo facility to the bottom end of the fed funds rate. The so-called ON RPP rate is used as a floor for the funds rate, which had been drifting toward the lower end of the target range.
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