Why will the housing market lead the recovery in consumption this time?

Changes in the Mechanism Brought About by the New Policy on the Sale of Existing Homes

The real estate sector has rebounded in recent days, as shown in the chart below, with the real estate index rising by over 8% in five trading days. This is because the market is circulating various real estate policies.

Interestingly, the food and beverage sector only rose by 1.13% during this period.

This phenomenon contradicts historical experience; in the past, when there were policy expectations for the real estate sector, the food and beverage sector would also perform well.

So, which mechanism change caused historical experience to become invalid? The existing home sales policy implemented on August 28th.

The new policy has led to a change in the direction of urban growth. Before the August 28 policy, cities grew horizontally, and the real estate industry could bring a lot of real estate development investment, making it easy to boost the volume in a short period of time. However, after the August 28 policy, cities grew vertically, and the investment brought by the real estate industry became more diversified, making it difficult to boost the investment volume in a short period of time.

In other words, before the new policy, the main impact of real estate policies was on quantity, that is, real estate development investment would increase significantly; however, after the new policy, the main impact of real estate policies is on price, that is, the increase in risk appetite, and then the increase in risk appetite will drive the volume of retail sales, making the transmission mechanism more roundabout.

Generally speaking, consumer stocks are not picky eaters; their performance depends on the volume of domestic demand, which mainly includes three parts: 1. retail sales; 2. real estate investment; and 3. infrastructure investment. However, the August 28th policy disrupted the cycle of "real estate policy → real estate investment → consumer stocks".

Therefore, the recovery of consumer stocks can only rely on the remaining two aspects: either the growth rate of retail sales stabilizes and rebounds, or the "six networks" are implemented and infrastructure investment accelerates.

Structural domestic demand policy: Stabilize the housing market first, then stabilize consumption.

This year, the external environment has been extremely harsh, and domestic demand has faced two major constraints: 1. Crude oil prices have doubled; 2. The yield on two-year US Treasury bonds has soared.

1. Crude oil prices doubled

2. The two-year US Treasury yield hit a new high of 4.78%.

Faced with this series of external shocks, we adopted a structural domestic demand policy: first stabilize the housing market, then stabilize consumption.

In fact, the strategy to stabilize the housing market is a combination of measures: on the one hand, guiding the appreciation of the RMB; on the other hand, maintaining low policy interest rates. This will not only lead to a large inflow of overseas RMB back to China, but also keep the opportunity cost of housing market investment relatively low, meaning that the rent-to-price ratio in first-tier cities is much higher than the money market fund interest rate.

1. The value of CNH has increased by nearly 4% this year;

2. The interest rate on one-year certificates of deposit remains low.

This measure has effectively supported the price of second-hand homes. As shown in the figure below, the Shanghai second-hand home price index has risen for seven consecutive months.

However, external pressures have focused on the consumer sector. As shown in the chart below, the RMB swap rate has climbed from 1.61% at the beginning of the year to the current 3.14%, an increase of nearly 153 basis points.

This has significantly dampened domestic consumption. Consequently, we have observed that the growth rate of retail sales has remained sluggish.

The seesaw relationship between the housing market and consumption

The reason why many people are pessimistic about the housing market is because they have observed the sluggish consumption. They subconsciously believe that the sluggish consumption will lead to a lack of sustainability in the housing market recovery.

However, they overlooked one point: the relationship between the housing market and consumption is multifaceted; there is a seesaw relationship between them, and even more so, the relationship between the two is one of cost and result.

This relationship has deep roots, stemming from our current unique economic system—China's financial system exhibits significant financial repression. Song Zheng's 2011 paper, "Growing Like China," provides a very clear theoretical framework for this issue.

In the traditional Ramsey model, the impact of interest rate cuts on consumption is uncertain because interest rate cuts produce both substitution and income effects. However, with the introduction of financial repression, the impact of interest rate cuts on consumption becomes unidirectional, as interest rate cuts will transform consumption into other forms, either domestic investment or the country's trade surplus.

For example, China has approximately 350 trillion yuan in M2. A 1% reduction in interest rates is equivalent to a reduction of 3.5 trillion yuan in interest income, accounting for 2.5% of GDP. It's important to note that this doesn't mean some residents' interest income decreases while others increase, and that residents' total income remains unchanged (ps: this is the narrative of the traditional Ramsey framework). Due to the existence of financial repression mechanisms, interest rate cuts lead to a reduction in the net burden on the production sector, which either translates into corporate investment or a trade surplus.

Given the existence of financial repression, China's monetary policy has its own unique underlying logic:

1. Consumption is a policy resource itself, a reservoir;

2. The essence of interest rate cuts is to consume resources and protect more important investments and exports;

3. The essence of raising interest rates is to accumulate resources and divert positive external shocks to the household sector for savings;

As shown in the diagram above, there is a seesaw relationship between investment and consumption. When the central bank raises interest rates, investment is converted into consumption; conversely, when the central bank lowers interest rates, consumption is converted into investment.

Faced with the rapid rise in the two-year US Treasury yield (ps: a severe external shock), if the central bank had moderately raised the one-year certificate of deposit rate, the RMB swap point would not have risen so quickly, thus preventing a rapid decline in the growth rate of retail sales.

In other words, when faced with external pressure, the central bank makes choices, and "investment takes precedence over consumption" is a conditioned reflex.

Therefore, we should not be too pessimistic about the current sluggish growth rate of retail sales. We sacrificed the growth rate of retail sales in exchange for the recovery of the real estate market under the harsh external environment.

So, under what circumstances should we feel pessimistic? Even if we suppress the growth rate of retail sales to around 0%, we still haven't observed a recovery in the housing market.

In conclusion, if we treat the growth rate of retail sales or policy interest rates as a resource, we can better understand the relationship between the housing market and consumption.

1. It is wishful thinking to expect good results without paying a price; this is equivalent to saying that we are facing a smooth external environment.

2. It is normal to pay a high price and get a good result; this is the baseline scenario.

3. The worst-case scenario is spending a lot of money but not getting good results, which means that we are facing a terrible external environment;

Conclusion

In summary, we can identify two potential paths for the recovery of domestic demand:

1. Slow path

Despite the continued adverse external environment, we will continue to maintain our policy mix of "RMB appreciation + low policy interest rates".

This policy mix can drive the recovery of the housing market, which in turn will boost risk appetite and ultimately lead to a recovery in consumption.

The reason this recovery path is slow is that risk appetite has only one source—the recovery of the housing market; retail sales do not provide any risk appetite at all.

2. Fast path

A symmetrical, fast path requires positive changes in the external environment, the most important of which is a significant drop in the two-year US Treasury yield. Clearly, this necessitates a recession in the US.

Once the two-year US Treasury yield falls, the RMB swap points will also fall rapidly. The pressure on the consumer sector will be significantly reduced, allowing retail sales growth to rebound quickly.

In this scenario, the recovery of the housing market and the recovery of consumption will resonate, ultimately leading to a full recovery of domestic demand.

The reason this recovery path is so rapid is that risk appetite has two sources: first, the recovery of the housing market; and second, the recovery of consumption brought about by the improvement of the external environment.

Finally, by combining the slow and fast paths, we arrive at the conclusion that the housing market will inevitably lead the recovery of consumption.

The fundamental reason lies in the temporary absence of domestic investment: First, the new policy of August 28th has dashed hopes for real estate development investment; second, the explosive growth of investment in the "six-network" fund will take time.

This article is sourced from: Canghai Yitugou

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