Fed says China’s real estate troubles could spill over to the U.S.

BEIJING — The U.S. Federal Reserve warned Monday of potential spillover from China’s real estate troubles to the U.S. financial system.

Since this summer, highly indebted developer China Evergrande has rattled global investors as the company has attempted to avoid official default. Other Chinese developers have also struggled to repay debt, adding to concerns of wider fallout in the world’s second-largest economy — roughly a quarter of which is driven by real estate.

“Stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States,” the Federal Reserve said in its latest financial stability report, released twice a year.

The report pointed to the size of China’s economy and financial system, and global trade links.

The bulk of the document discussed domestic U.S. financial conditions, from historically high stock market prices to risks from rapid growth in stablecoins — digital currency tied to a fixed value such as the U.S. dollar. Analysts downplayed the significance of the Fed’s comments on Chinese real estate.

“The nexus of the Fed’s concern is that China’s real estate activity is slowing, but the developers have large debts [and] some of them (like Evergrande) are diversified into other areas of the economy,” Paul Christopher, U.S.-based head of global market strategy at Wells Fargo Investment Institute, said in an email.

These wide-reaching links mean a slowdown in China’s housing market could ultimately lead to unemployment, a drop in Chinese stocks and deflation — which could spread through global trade channels as China cuts its purchases of goods from other countries, Christopher said.

However, he said such fallout is unlikely. “China’s government has been wrestling with high corporate debt for years, is alert and has resources to deal with the real estate sector,” Christopher said, noting authorities can still spend more to address a deflationary shock, as they have in the past.

The Fed’s latest report also analyzed the role of retail investors and social media in stock market volatility earlier this year, as well as the role of foreign investors in a sell-off of Treasurys in March 2020.

Previous financial stability reports from the Fed have mentioned China, its high debt levels and “stretched real estate prices” as risks that could spill over to the U.S.

Ilya Feygin, senior strategist at New York-based brokerage WallachBeth Capital, said the latest Fed report likely included China’s real estate difficulties “for completeness.”

“The Fed has been criticised for not seeing the vulnerability of US housing and US banks prior to 2008,” he said in an email, referring to the financial crisis at that time. “Therefore anything related to real estate and banking system risk anywhere will be scrutinised excessively.”

He did not expect the Fed’s comments to have much significance for investing in emerging markets.

However, one difference in the Fed’s latest financial stability report from prior ones was its finding that China figured prominently among concerns about risks to U.S. financial stability, according to a Fed survey of “26 market contacts” from August to October.

While persistent inflation, monetary policy tightening and vaccine-resistant coronavirus variants were of top concern for survey respondents, they were followed by worries about Chinese regulatory and property risks.

Concerns about U.S.-China tensions came next, according to the survey. A slowdown in the Chinese economy ranked last, in 13th place.

Those results differed from the Fed’s previous survey, conducted from February to April, in which the only China-related concern was tensions with the U.S. The top worry then was vaccine-resistant variants of the coronavirus.

The survey covered representatives of broker-dealers, investment funds, political advisory firms and universities, the Fed report said.

Arthur Kroeber, who helped found China-focused research firm Gavekal Dragonomics in 2002, said in an email that the Fed’s comments on China were “pretty vague and generic,” and focused on the potential impact to the U.S. primarily based on China’s large size.

“I think the risks to the US are small since the closed nature of China’s financial system means contagion is not likely to be a big problem,” Kroeber said, noting he would be more concerned about additional inflationary pressure from supply chain problems and rising export prices out of China.