Macro and Credit - Another Brick in the Wall

"Success is having to worry about every damn thing in the world, except money." -  Johnny Cash

Looking with interest at the elections of new French president maverick Macron, in effect putting another brick in the wall of worry, hence our title analogy, we reminded ourselves of Pink Floyd's 1979 rock opera with "Another Brick in the Wall being the title of three songs set to the variations of the same basic theme:  subtitled Part 1 (working title "Reminiscing"), Part 2 (working title "Education"), and Part 3 (working title "Drugs"). Part 2 was in fact a protest song which somewhat resonates clearly with the rise of populism in general leading to Brexit and Trump's election, whereas the results so far in 2017, seems to be the reverse of what has been playing out in Financial markets in 2016 where we had a dismal first part of the year and political surprises in the second part of 2016 in conjunction with a very significant rally in all things beta in the second part of 2016. 2017 so far has seen significant records being broken for equities indices, tighter credit spreads, and record low vix, which many pundits punting towards "complacency". In our previous conversations, we have indicated that while we did remain short-term "Keynesian" when it comes to our "risk-on" feeling, hence our reduction in both our gold miners exposure and duration exposure, we believe that the second part of 2017 could play as a reverse of the second part of 2016.

In this week's conversation we would like to look at a trade which has been put forward by many pundits including Jeffrey Gundlach of DoubleLine Capital, which is the case for EM equities versus the S&P 500 from an allocation and macro point of view.

Synopsis:

• Macro and Credit - Emerging Markets vs S&P 500, the old versus the new or the new versus the old?
• Final chart - Weak loan demand tends to be associated with high volatility

• Macro and Credit - Emerging Markets vs S&P 500, the old versus the new or the new versus the old?

While many pundits have been mesmerizing at the record low level touched recently by the "fear index" VIX, we reminded ourselves a previous conversation from 2013 entitled "Long dated volatilities: a regime change". As we posited back in 2013, it seems we are clearly back in the low regime of 2004-2007, and credit spreads as of late are also a reminder of the tightness in credit we experienced firsthand in our banking days at the time. Back in our old conversation we made some interesting comments relating to Emerging Markets and volatility which, we think, from a macro perspective are still extremely valid:

"Financial liberalization, for instance in Emerging Markets, has been a good way to attract foreign investments. It has often led to a rise in volatility given investors had been reaping in the process higher daily return rates. When equity market becomes more open, there are increases in stock return volatility (on the subject see the study realised by Vuong Thanh Long, Department of Economic Development and Policies at the Vietnam Development Forum - Tokyo Presentation - August 2007).

Regime switches also lead to potentially large consequences for investors' optimal portfolio choice hence the importance of the subject." - source Macronomics, January 2013.

We also mentioned at the time that different regimes corresponds to period of high and low volatility, and long and bull market periods in conjunction with the credit cycle. At the time of our previous post we also indicated that the importance of regime change was paramount to asset allocation given:

"The relation between the investor horizon of a buy-and-hold strategy and the optimal portfolio varies considerably from one regime to the other.

• For example, in a bear regime, stocks are less favored and short-term investors allocate a smaller part of their portfolio to stocks. 
• On the contrary, in the longer run, there is a high probability to switch to a better regime and long-term investors dedicate a larger part of their portfolio to stocks. 
• In a bear regime the share allocated to stocks increases with the investor’s horizon." 

- source The Princeton Club of New-York, 27th of April 2012, EDHEC-PRINCETON Institutional Money Management Conference.

Also we mentioned at the time that retail investors had been net sellers of stocks since 2007. Yet, in recent years, it seems many have returned using ETFs as an investment vehicle of choice, shunning active management to passive management in the process.

Returning to the very subject of our conversation, there is indeed a case being made which so far year-to-date has been validated performance wise to go long EM equities versus the S&P 500. As a reminder, since the inception of the MSCI EM index back in 1988, the MSCI EM / S&P 500 ratio has experienced two significant boom/bust cycles:

Arguably there has been a significant growing gap between both indices since 2014, while the S&P 500 has been no doubt racing ahead:

- source MacroCharts.pro

With the benefit of hindsight, we can summarize those two cycles in the following way:

Cycle 1 (1988-1999)

• Boom phase (EM outperforming between 1988 and 1996): With the disappearance of the Eastern Bloc, Second and Third World countries were bound to join the First World, and mankind would reach Fukuyama’s “End of history” (1992). Trade barriers fell, stable governments became the norm, and EMs became an investible asset class. The first EM boom culminated with the 1997 Asian crisis.
• Bust phase (S&P outperforming between 1996 and 1999): As EMs were still suffering from the aftermath of the crisis, US equities were led by the first tech bubble.

Cycle 2 (1999-Now)

• Boom phase (EM outperforming between 1999 and 2011): Following the tech crash 2000, investors turned away from the new economy. The term itself became used derisively, as the tangible economy came back with a vengeance, introducing new investment themes: the commodities super cycle, stagflation, the Hubbert peak, etc.
• Bust phase (S&P outperforming since 2011): In the early 2010s, the new economy finally started to become a reality, capitalizing on the huge infrastructure investments that were made during the first tech bubble. At the same time, new technologies (fracking, clean tech, electric cars…) made the developed world less dependent on energy and raw materials.

To sum up, EMs vs. S&P is not a merely a bet on global growth but put it simply a sectorial bet:

• MSCI EMs returns are dominated by old economy industries, commodity- and more generally stuff-producing companies. EM equities are a bet on scarcity and inflation.
• S&P 500 returns are dominated by the new economy: tech, platform companies, business services etc. The S&P is a bet on innovation, deflation and creative destruction.

One might argue that EMs are not pure old economy with the significant weight of Samsung and Tencent for example. But, one might also opine that Korea and Taiwan are not really truly Emerging Markets anymore. Though our simplified interpretation doesn't match the truly "old economy", you get our point when it comes to the sectorial bias.

After its nearly 60% correction since its 2011 heights, there are currently several factors at play indicating that we could be at the beginning of a third cycle in the MSCI EM / S&P ratio.

The CRB Industrial Metals Equity Index (CRBIX Index) has had a significant rally since January 2016:

Following the same trend until recently, there were some indications that there was somewhat a revival in the Chinese materials sector:

- source MacroCharts.pro

(Correlation 0.909, R2 = 0.826, 228 months in sample).

But given our premises that EM being a sectorial bet, still dominated by old economy industries, commodity and more generally stuff-producing companies, EM does indeed appear to be a bet on scarcity and inflation. With Chinese PPI slowing down, one might rightly ask, what's the overall picture if we take into account Chinese Iron Ore spot prices?

- source MacroCharts.pro

(Correlation 0.907, R2 = 0.823, 72 months in sample).

Clearly Iron Ore spot prices are very volatile particularly given the recent clamp down on the famous Wealth Management Products (WMP) by the Chinese government but also reflects a tightening in Chinese financial conditions as well.

After all, weaker commodity prices was reflected in the latest data out of China given the  producer price index (PPI) slowed more than expected in April, falling to a year-on-year pace of 6.4% from 7.6% in March.

Regarding commodities themselves, Dr. Copper, (the PhD in economics) is something we would like to look at to get some cues on this sectorial premise of ours:

- source MacroCharts.pro

(Correlation 0.896, R2 = 0.802, 228 months in sample).

Australia’s terms of trade is also an interesting indicator of MSCI EM/ S&P ratio, due to Australia’s heavy reliance on commodities:

- source MacroCharts.pro

(Correlation 0.932, R2 = 0.869, 228 months in sample).

After all, we are seeing tighter liquidity from China in its moves to rein in leverage which could potentially weigh on economic growth as it is attempting a "controlled demolition" of the shadow banking bubble which was let loose.

Regarding inflation, the recent increase in inflation expectations hasn’t yet been factored in by the MSCI EM vs. S&P ratio:

- source MacroCharts.pro

(Correlation 0.859, R2 = 0.737, 132 months in sample).

Additionally, Chinese devaluation fears, which roiled world markets during the summer of 2015, have substantially receded since the beginning of the year:

- source MacroCharts.pro

(Correlation -0.869, R2 = 0.741, 36 months in sample).

Yet the pullback in TIPS inflation "breakeven" rates with US 5 year breakeven rates trending lower have shown that the "Trumpflation" trade has been cooling as of late. Though the recent weakness in precious metals with silver getting spanked daily can be attributed to a gradual rise in real rates we think, another manifestation of Gibson's paradox as a reminder:

"Gold price and real interest rates are highly negatively correlated - when rates go down, gold goes up. When real interest rates are below 2%, then you get a bull market in gold, but when you get positive real interest rates, which has been the case with the rally we saw in the 10 year US government bond getting close to 3% before receding, then of course, gold prices went down as a consequence of the interest rate impact." - source Macronomics

On a side note, there has never been an episode in history when Gibson's paradox failed to operate. The real interest rate is the most important macro factor for gold prices. Also the relationship between the gold price and TIPS (or “real”) yields is strong and consistent. Gold and TIPS both offer insurance against “unexpected” (big and discontinuous) jumps in inflation. The price of gold normally falls along with the price of TIPS (which means that TIPS yields rise). So to conclude our side note, gold and gold miners are not the best hedge at the moment given the negative correlation with real rates. This is clearly illustrated in the below chart from Deutsche Bank European Equity Outlook note from the 11th of May:

- source Deutsche Bank

So far in 2017, the outperformance continues to play out in favor of EM as per the chart below displaying the S&P 500 performance relative to iShares MSCI EM:

- source Bloomberg

Flow wise commodities funds according to the latest Follow the Flow note from Bank of America Merrill Lynch have seen their eighth week of inflows, however showing signs of slowing down with gold and oil prices moving lower recently. We think most of the ongoing correction in the commodity complex is tied up to the "controlled demolition" of WMP led by China. Emerging market equities have historical strong correlation to commodities, yet, investors have continued pushing emerging market equites higher.

Given the pressure on Chinese A shares, should you want to play this trade via ETFs we would agree with Bloomberg's take from the video embedded in their article  "Gundlach Says Short the S&P 500 and Buy Emerging Market ETF" from the 9th of May, that you would be better off using IEMG ETF (South Korea and no China A shares) rather than EEM ETF given the ongoing tightening pressure in China. Yet, with KOSPI rallying as well 13.6% and breaking through the 2300 at an all-time high, the rally has been significant but mostly led by Samsung. We continue to believe that overall markets are trading on expectations of structural reforms in many instances (US, France, South Korea, etc.).

In relation to Emerging Markets, if in Macro, demography is destiny, we continue to like the asset class given as shown in the recent Bloomberg graph workforces are still expanding in India, Southeast Asia, Vietnam as well has a very young population and Southeast Asia overall is offering very compelling growth prospects:

- source Bloomberg (H/T Tiho Brkan

On top of that, China's Silk Road initiative with their willingness in expanding towards the West is clearly going to spur in its surroundings economic growth and renewed demand for commodities while China is transitioning its internal imbalances towards consumption rather than domestic fixed asset investments. The long term macroeconomic impact of such endeavor should not be underestimated.

While we still believe in some continuation of "risk-on", yet we could potentially get a pullback, we are closely watching oil, being at the moment the major brick within our wall of worry when it comes to potential credit spreads widening and spillover. We continue to follow closely the credit cycle and the global credit impulse which has shown recently by China and as well from the latest US Fed Senior Loan Officer survey, continues to point towards a slowdown thanks to weaker demand as per our final chart below.

• Final chart - Weak loan demand tends to be associated with high volatility

While markets have successfully climbed the wall of worry with the French elections angst, we continue to track the slowly but surely eroding credit cycle and credit impulse. The significant performance of risky asset classes and beta in particular since the second part of 2016 in the on-going low volatility regime thanks to central banks meddling, makes us feel a tad more nervous about the continuation of the rally in the second part of the year while we are acutely aware as we wrote recently that the final inning in a credit cycle always is often associated with a final large melt-up.

When it comes to the volatility quandary, we read with interest DataGrapple's take on the subject from their blog post from the 9th of May entitled "Is volatility a thing of the past?":

"Most of the political risk is behind us in Europe. Unless his party shows very poorly during the general election next month, Mr Macron should be in a position to at least form a coalition with the center right. In the UK, there seems to be little doubt that the Conservative will secure a strong majority in Parliament in a few weeks. In Germany, whoever comes on top in the September ballot will be a member of the current ruling coalition. So the main source of uncertainty is Italy where the 5-star movement and its anti-euro stance is leading the poll, but elections should not be held this year. We know that they will take place before May 2018, but their exact date has not been set. With talks around the restructuring of the Greek debt apparently making progress, the euro area should enjoy a period respite. That is the message sent to the market by investors who are selling options, betting on a very low realized volatility up to the September expiry. The implied volatility of options with a strike 10% out of the money are trading sub 40% on all indices for the next 5 expiries." - source DataGrapple.

Have reached peaked complacency? One might wonder. Our final chart comes from Bank of America Merrill Lynch Situation Room note from the 8th of May and displays C&I Loan demand versus the VIX index which clearly shows that often weak credit demand tends to be associated with high volatility which shouldn't be that surprising given we live in a credit based world:

"Senior loan officers vs. VIX

One of the key stories we have been tracking for most of the year is the lack of loan demand in the US across the board. That was apparent in the February Senior Loan Officer Survey as well as subsequently weekly bank asset data from the Fed. Hence not surprisingly today's fresh Sr. Loan Officer Survey showed continued very negative
growth in consumer loan demand as well as deterioration into negative territory for C&I lending. It thus appears that the key post-election story continues - i.e. while optimism is high everybody is in wait-and-see mode pending details on tax reform from the new administration. The longer this lasts the greater the risk of more weakness in hard data. It appears a great contradiction to these circumstances that the VIX closed today at 9.77 - the lowest since December 1993. Weak loan demand tends to be associated with high volatility, not low (Figure 1)."

- source Bank of America Merrill Lynch

If credit conditions are tightening in both China and the US, and we continue to see a weaker tone in the commodities space, it is hard not to start worrying about weaker aggregate demand overall and not only in oil prices. Yet another brick to keep an eye on in your personal wall of worry we think but we ramble again...

"Worry is interest paid on trouble before it comes due." - William Ralph Inge, English clergyman.

Stay tuned!

Credit - The Rebel Yell

"Those who excel in virtue have the best right of all to rebel, but then they are of all men the least inclined to do so." - Aristotle 

While watching the continuation of the US political stand-off, which as we argued last week, turned out to be more of a "False Alarm" than anything else when one takes into account the rally witnessed at the end of the week in most risky assets, we thought we would play with your mind again using a dual reference in this week's chosen title.

The first reference is a music reference from our beloved musically creative 80s period, namely Billy Idol's famous 1983 hit album Rebel Yell as we believe that, when it comes to the debt ceiling and Billy Idol's lyrics from the famous song, in the end, US politicians "in the midnight hour will cry- 'more, more, more' ", when it comes to raising the debt ceiling and issuing more debt in the process.

The second reference is more historical. The rebel yell was a battle cry used by Confederate soldiers during the American Civil War. Confederate soldiers would use the yell during charges to intimidate the enemy and boost their own morale in similar fashion to today's Republicans stand-off, although the yell had many other uses....but we ramble again. 

Some pundits have recently argued that the US government shutdown was a demonstration that the United States of America had never been more divided. On that point we agree with the recent rant of our old friend and mentor Anthony Peters in his column in IFR entitled "On civil wars". This kind of comments on how the United States of America is divided today is utter nonsense:

"Sometimes I feel like screaming. This morning it was a report on the wireless which quoted a newspaper dubbing the US government shutdown as demonstration that the country has never been more divided. I challenge this piece of nonsense on two counts.

The first count is that, as a keen student of the American Civil War (1861-1865) which over four years ended the life of around one in ten of the nation’s male population and which culminated with the assassination of the President, I find it hard in any way to hold up the events of 150 years ago against the petty posturing on Capitol Hill in 2013 and to see any measurable comparisons.

The second is that it is not the nation which is divided but the politicians who eat and sleep pork barrel politics and who do not seem to give a fig for the wellbeing of any citizen who is not a member of their respective parochial electorate.

In fact, if one takes a disciplined approach to American politics, it is not a polarisation of political opinion which is prevalent but a vicious, no holds barred, cat fight for the middle ground which is the cause of much of the current problem. It brings with it one very important question and one which is taxing the minds of both John Boehner, the Republican Speaker of the House, and of the President which is whether ultimate power should be vested in the legislature or with the executive." - Anthony Peters, SwissInvest Strategist.

Therefore in this week's conversation we will discuss the "Rebel Yell" and the US version of the "Scheduled Chicken" for the US Debt Ceiling but also look more into the implications for the future "tapering" stance of the Fed under the new leadership of "Chairwoman" Janet Yellen. 

While in recent years we have been more accustomed to European politicians playing the game of "Scheduled Chicken" on so many occasions that our head hurts, it is interesting to see the contagion spreading to the US with the senseless fear of impeding default. As the wise Lucius Annaeus Seneca" once said:"Every man prefers belief to the exercise of judgment."

As put it recently by Nomura in their recent special report from the 10th of October entitled "US Debt Ceiling: Countdown to Default?", here comes the US version this time around of the aforementioned "Scheduled Chicken":

"As the US government shutdown drags into a second week, the markets are now starting to take notice of the sobering reality that this impasse will most likely go down to the wire. Complicating the situation is the near-exhaustion of the extraordinary measures being used by the Treasury to avoid crossing over the debt-ceiling limit. Given that there is over a week to go until October 17 – the critical cross-over date at which when Treasury cash-flow management becomes less predictable – key aspects of the funding markets are experiencing a more pronounced move than during the 2011 debt ceiling run-up." - source Nomura

More pronounced? At least not in the CDS space.

It was interesting this week to watch the US 1 year CDS surge to 55 bid on the 10th of October before seeing it tighten by 25 bps the next day when the 5 year CDS level was flat at 34 bps on the bid side. So much for default risk...

When it comes to politicians shenanigans, the move seen as of late on the US sovereign CDS space has indeed been much benign than two years ago as indicated by the recent Bloomberg Chart of the Day:

"Investors appear less concerned about the wrangling over the U.S. government’s budget and debt ceiling than they were two years ago, according to Barry Knapp, Barclays Plc’s chief U.S. equity strategist.

The CHART OF THE DAY tracks one indicator that Knapp used to draw his conclusion, presented in an Oct. 4 report: the cost of credit-default-swap contracts that insure against default on U.S. Treasury securities.

Last week’s closing rate of 45.5 basis points was well below a peak of 64.4 basis points in July 2011, the last time the federal debt limit was almost breached, according to data compiled by McGraw Hill Financial Inc.’s CMA unit. Every basis point is equivalent to $1,000 a year for a contract protecting $10 million of debt." - source Bloomberg.

In continuation to the US CDS signals following the "Rebel Yell", Bank of America Merrill Lynch in their note entitled "The declining duration of fiscal concerns" from the 11th of October added the following in relation to volume in the US CDS sovereign space:
"The weekly DTCC data shows a fair amount of trading supporting the widening of CDS spreads on the US sovereign we have seen recently, as 1-year spreads widened to 60bps from less than 10bps. Specifically the net position in CDS increased by about $250mm during each of the past two weeks to about $3.6bn as of last Friday. That corresponds to about a third of the typical trading volume (not changes in net notional) in the most liquid corporate names. As trading volumes most likely exceed changes in net notional, clearly US sovereign CDS contracts have been fairly liquid over the past two weeks and the widening of spreads reflects real risk taking as opposed to a lack of liquidity. Note that the net notional is still dwarfed by what we saw in 2011, while spreads are similar. 

Assuming a 90% recovery in a CDS auction on the sovereign, at 60bps buyers of protection would need to assess a default probability higher than 6% over the next year to expect a profitable trade." - source Bank of America Merrill Lynch

Arguably the "Rebel Yell" has had more terrifying effect on the 1 month TED and in the T-bill volatility space, as displayed by Nomura in their recent special note:

"Stresses have begun to show across various subsectors of the money markets. One need not look further than the extreme moves in the 1m TED spread which inverted this past week (Figure 3). The pressure sitting on the very front end of the T-bill curve remains a function of fear over owning securities that are in the “default window.” The quick spike higher in the front end after quarters of stability is also showing up in the rolling realized vol of 1m T-bills (Figure 4)." - source Nomura

Of course the consequences of the "Cantillon effects" and the surge in all risky asset prices with dwindling liquidity on banks books, have led to consequently much more risk for heightened volatility as illustrated by not only the violent surge in T-bills volatility but no doubt in the spike in 1 month bill yields as illustrated by Bank of America Merrill Lynch in their note from the 8th of October entitled "From financial to fiscal crisis":

"The more idiosyncratic concerns this time about being repaid by US Treasury was highlighted by the huge jump today in 1-month Treasury yields to 34bps, more than double yesterday’s level of 16bps as Treasury sold $30bn of new 1-month bills (Figure 4). Clearly, given the political circumstances, the likelihood of being repaid a 1-month maturity by the private sector may well exceed the likelihood of being repaid by the public sector (though both probabilities are very high). However, in the unlikely event that it really came to a public sector default we doubt the financial sector would continue to outperform – despite banks having finally recovered from the financial crisis - amid potential systemic concerns. Such concerns include liquidity and haircut requirements of Treasury collateral supporting the short term market. This perhaps explains the small spike in FRA-OIS the past two days (Figure 1)."

- source Bank of America Merrill Lynch

After all, it does seem that, courtesy of Central Banks' generosity we do live in a Bayesian world: "For subjectivists, probability corresponds to a 'personal belief'"- source Wikipedia

Like the wise Seneca, we prefer the exercise of judgment. On that sense we agree with the comments from Bank of America Merrill Lynch from their note from the 10th of October 2013 entitled "No Apocalypse Now":

"While we have recently suggested (see "Get CRASHy") that investor behavior is becoming more exuberant, right now there are two factors that we believe reduce the risk of a major market decline in coming weeks.

First, investors have already taken out substantial protection against a sharp debt-default inspired decline in equities in the form of SPX puts and VIX calls.

Second, in a classic debt default crash, the value of equities, bonds as well as the currency is simultaneously impacted. In our view a US apocalypse trade in October would require lower equities (in particular bank stocks), a lower US dollar and higher bond yields. We believe that combination would suggest investors are questioning the credit-worthiness of the US government and/or expecting inflationary consequences of QE4 (i.e. another liquidity policy response by the Fed) and a devaluation of the US dollar. Should the Fed be forced to "extend" or "magnify" liquidity and bond yields rise, in our view risk assets would likely be severly impacted.

Despite the debt ceiling situation, both inflation expectations and interest rates do not appear to be acting in an apocalyptic manner. Aside from a sharp move higher in the 1-month T-bill, fixed income markets have been very well behaved and volatility in both stocks and currencies has been low. And Washington is now piecing together a plan to extend the debt ceiling for up to 6 weeks." - source Bank of America Merrill Lynch

So if you still want to play the "Bayesian subjectivist" here comes from Bank of America Merrill Lynch note, another bout of  "Scheduled Schedule" for you to peruse:

"-As of Monday, October 7th, the Treasury had $35 billion of cash and $92 billion in debt maneuver capacity, giving the government $127 billion in cash to deal with upcoming liabilities.

-October 17th is the date specified by the US Treasury that debt capacity will run out (BofAML estimates that payment capacity will still be $70bn).

-October 31st a $6bn coupon payment is due (BofAML estimates payment capacity at that date will have fallen to $22bn).

-November 1st the payment capacity completely runs out due to large Social Security, Medicare, defense, & veterans payments of $67bn (BofAML estimates only half payments could be made).

-November 15th a further $31bn coupon payment is due and a potential default could then be announced if the debt ceiling is not raised before this date." - source Bank of America Merrill Lynch

Moving on to the subject of the potential "tapering stance" of the new "Chairwoman" Janet Yellen, back in June 2013 in our conversation "Lucas critique" we argued:
"QE tapering"soon? We do not think so. Markets participants have had much lower inflation expectations in the world, leading to a significantly growing divergence between the S&P 500 and the US 10 year breakeven, indicative of the deflationary forces at play".

The divergence between the S&P 500 and the US 10 year breakeven, graph source Bloomberg:

The correlation between the US, High Yield and equities (S&P 500) since the beginning of the year has weakened dramatically. US investment grade ETF LQD is more sensitive to interest rate risk than its High Yield ETF counterpart HYG  - source Bloomberg:

In addition to inflations expectations, shipping has always been for us, the best significant example of the reflationary attempts of our "omnipotent" central bankers. For instance, containership lines have announced 6 rate increases in 2013, but have failed to maintain the momentum because of the weak global economy and the excess capacity which has yet to be cleared in similar fashion to the housing shadow inventory plaguing US banks balance sheet, graph source Bloomberg:

"The Drewry Hong Kong-Los Angeles container rate benchmark fell 5.3% to $1,786 in the week ended Oct. 9, the lowest level since March 2012 ($1,771). This marks the 13th week in 2013 that rates are below $2,000. Rates are about 29% lower than the July 2012 high of $2,519. Even with six increases in 2013, rates are 34.1% lower yoy and down 19.3% ytd, as slack capacity continues to pressure pricing." - source Bloomberg.

Weak global economy, with weak global demand as illustrated by shipping rates as indicated by data from the World Container Index data - source Bloomberg:

"Shipping rates for 40-foot containers (FEU) fell 3.8% sequentially to $1,601 for the week ending Oct. 3, the fourth straight decline, according to World Container Index data.
Weakness continues to be driven by Asia, as rates from Shanghai to Rotterdam fell 7.3%, followed by Shanghai to Los Angeles (down 4.8%), Shanghai to Genoa (4.7% lower) and Shanghai to New York (down 3.2%) routes. Rates rose for Rotterdam to Shanghai (4.7%) and to New York (1.6%)." - source Bloomberg.

While the recent range break-out in the Baltic Dry Index is supposedly indicative of a strong economic rebound, we think the respite is temporary - graph source Bloomberg:

Some pundits as well have become more upbeat on iron-ore freight and scrapping levels as indicated in the below Chart of the Day from Bloomberg depicting fleet expansion versus ships' scrapping. We remain wary given the deflationary forces at play - graph source Bloomberg:

"The biggest rally in iron-ore freight costs since 2009 is prompting shipowners to end the industry’s biggest scrapping program in at least three decades as older vessels bring in more money.
The CHART OF THE DAY shows how rates, in blue, for Capesize ships hauling 160,000 metric tons of iron ore rose to a 34-month high of $42,211 a day on Sept. 25. Scrapping levels are in red.
Owners have paid off debt used to buy older vessels, making them cheaper to run, so they won’t opt for scrapping as long as the rally allows them to profit from the ships, according to Erik Nikolai Stavseth, an analyst at Arctic Securities ASA in Oslo. Chinese investment in rail, buildings and infrastructure will rise 20 percent this year, creating demand for another 135 million tons of steel, Shanghai-based Citic Securities Co. says. That would require 200 million tons of iron ore, used to produce the alloy, enough to fill 180 Capesizes, according to Fearnley Consultants A/S, a research company in Oslo. Capesize fleet capacity is up 75 percent since 2008, says IHS Maritime, a Coulsdon, England-based maritime researcher. “Freight rates are expected to return to profitable levels- even for older tonnage,” said Stavseth, whose recommendations on shipping company shares returned 26 percent in the past year.
“This will potentially lead to higher net fleet growth.” World trade in iron ore will grow 6 percent to 1.17 billion tons this year, with China taking two-thirds, according to Clarkson Plc, the biggest shipbroker. Earnings for Capesize carriers sailing to China from Brazil at a $40,000 daily rate assuming a voyage time of 45 days will equate to $1.8 million, spurring owners to keep trading their ships, Stavseth said." - source Bloomberg

We remain wary because we have yet to see a clear reduction in the number of ships being broken-up - graph source Bloomberg:

We remain wary because we have not seen a confirmed rebound in Chinese Iron Ore imports which are correlated to the Australian dollar - graph source Bloomberg:

As displayed in Deutsche Bank weekly Shipping note from the 7th of October 2013, Chinese Ore Inventory remains well below 2012 levels:

- source Deutsche Bank

But there are some improvements in monthly Chinese Iron Ore Imports as indicated by Deutsche Bank:

"August iron ore imports declined by 5.6% m/m, but is still up 7.2% y/y. Given recent chartering trends, we expect to see improved imports in September." - source Deutsche Bank

We have already touched on "the link between consumer spending, housing, credit growth and shipping":
"If there is a genuine recovery in housing driven by consumer confidence leading to consumer spending, one would expect a significant rebound in the Baltic Dry Index given that containerized traffic is dominated by the shipping of consumer products."

The worry for us as of late is that consumer sentiment in the US has fallen in October to a 9th month low making us questioning the strength of the rebound in shipping, as per Ben Schenkel's article from the 11th of October entitled "Consumer Sentiment in U.S. Fell in October to Nine-Month Low":
"Consumer sentiment in the U.S. fell in October to a nine-month low as the government’s partial shutdown and the debt-ceiling debate caused outlooks to sour.
The Thomson Reuters/University of Michigan preliminary consumer sentiment index of decreased to 75.2 this month from 77.5 in September. Economists in a Bloomberg survey projected a drop to 75.3, according to the median estimate.
Households are becoming pessimistic about the economy as the shutdown heads into a third week and the deadline looms for raising the debt limit and avoiding a default. Nonetheless, improved stock values and home prices have lent support to balance sheets, especially for wealthier Americans.
“Since the shutdown began, consumer sentiment has taken a hit,” Brian Jones, senior U.S. economist for Societe Generale in New York, said before the report. “The average person is sensitive to the headlines about the debt ceiling and the adverse impact of a technical default.” Projections of the 68 economists surveyed by Bloomberg ranged from 65 to 80. The index averaged 89 in the five years leading up to the economic slump that began in December 2007, and 64.2 during the 18-month recession that ensued." - source Bloomberg.

This leads us not to believe the Fed will "taper" in 2013. For 2014, we are not too sure either...That's our own "Rebel Yell".

"What is a rebel? A man who says no." - Albert Camus 

Stay tuned!

Credit - The last refuge of a scoundrel

"We love to expect, and when expectation is either disappointed or gratified, we want to be again expecting." - Samuel Johnson, English author.

While looking with interest the Fed losing its nerve or credibility in its "Forward Guidance" and generating with much abandon "uncertainties" on "Future Expectations" in regards to its "tapering" stance, we thought this week, we would make a veil reference to Samuel Johnson's famous quote:

"Patriotism is the last refuge of the scoundrel."

A scoundrel being by definition villainous and dishonorable, when one looks at the "Cantillon Effects" of Ben Bernanke's wealth effect, no doubt that the big beneficiaries of the Fed's liquidity "largesse" has benefited the most to Wall Street's "scoundrels" as so clearly illustrated by Bank of America Merrill Lynch in their recent note entitled "Tinker, Taper, Told Ya, Buy" from the 12th of September which we already displayed last week:

And if one looks at the recent inflows into the equities sphere, we wonder if equities have not become indeed "the last refuge of the yield/returns scoundrels" hence our chosen title.

"Biggest weekly inflows to equity funds on record ($26bn - Chart 1) driven by massive ETF inflows to SPY, IWM, EEM, GDX ahead of yesterday's dovish FOMC; big pre-FOMC short-covering 8th straight week of rotation/redemptions from bond funds: past 4 months $173 billion redemptions still pale in comparison to stunning $1.4 trillion inflows from Jan'09 to May'13 (Chart 2);

risk/surprise going forward is bond outflows continue despite Fed no taper (would imply Fed credibility down/risk premia up)" - source Bank of America Merrill Lynch - 19th September 2013 - The Flow Show - Record Equity Flows.

Of course, as we posited last week "Cantillon effects" describe increasing asset prices (asset bubbles) coinciding with "exogenous" liquidity induced central bank money supply. We were taken aback by Saint-Louis Fed Bullard comment:

“Using the pace of purchases as the policy instrument is just as effective as normal monetary policy actions would be in normal times,” he concluded.  “In other words, QE is an effective way to conduct monetary stabilization policy.”

We beg to differ from the Fed's view. We think not "tapering" by 5 billion as per market's expectations was a blunder and sent the wrong message. 

We agree with Bank of America Merrill Lynch from their report "Bubbling his way out of Trouble" from the 18th of September when they say the following:

"The liquidity supernova continues...and so does the Wall St. boom. In our view, the longer Main St. takes to recover, the greater the risk of asset bubbles. Equity fund inflows this week are running at record levels, investor cash levels are high, US stocks are at all-time highs and today Priceline became the first S&P 500 issue ever to trade above $1000." - source Bank of America Merrill Lynch.

This week we will therefore focus our attention to the increasing risks induced by the continued "dovishness" of our central bankers sorcerer's apprentices. 

We have long argued that the Fed is continuing on a "wrong" path and ignoring basic relationship such as Okun's law and the prolonged negative effects of ZIRP on the labor force (capital being mis-priced, it is mis-allocated to speculative purposes rather than productive purposes):

"In economics, Okun's law (named after Arthur Melvin Okun, who proposed the relationship in 1962.is an empirically observed relationship relating unemployment to losses in a country's production. The "gap version" states that for every 1% increase in the unemployment rate, a country's GDP will be roughly an additional 2% lower than its potential GDP." - source Wikipedia

To that effect we wanted to illustrate more clearly this week the "Cantillon effect" of Bullard's effective way to conduct monetary "stabilization" policy, so, we plotted on Bloomberg not only the rise of the Fed's Balance sheet, but also the rise of the S&P 500, buybacks and of course the fall in the US labor participation rate (inversely plotted) - source Bloomberg:

In red: the Fed's balance sheet
In dark blue: the S&P 500
In light blue: S&P 500 buybacks
In purple: NYSE Margin debt
In green: inverse US labor participation rate.

We think this graph clearly illustrates the Fed's conundrum in the sense that with the Fed's dual mandate of promoting "maximum employment" since 1978, it cannot promote both employment and sustain the "wealth effect" through capital growth with ZIRP. The Fed tried to increase jobs by lowering interest rates, weakening the dollar in the process, boosting exports but exporting inflation on a global scale, as well as lifting stock prices, playing on the wealth effect game.

Something will have to give.

ZIRP, we think is the main culprit. 

As reported by Soberlook.com in their latest post "Could rising rates fuel credit growth in the US?", we also agree with Deutsche Bank, that moderately higher rates would indeed improve not only lending but labor, as well as pension liabilities for corporations from a long term perspective.

"This may seem counterintuitive, but Deutsche Bank’s researches argue that "moderately" higher rates may actually improve lending. This certainly contradicts the traditional school of thought followed by the Fed, who seemingly became spooked by the recent rate spike." - source Soberlook.com

As we posited in our conversation "Alive and Kicking":

"Counter-intuitively, rising yields should benefit US companies suffering from ZIRP due to rising  Pension Funding Gaps which have not been alleviated by a rise in the S&P 500."

And a reminder from our conversation "Cloud Nine":
"If we look at GM and FORD which went into chapter 11 due to the massive burden built due to UAW's size of "unfunded liabilities", they are still suffering from some of the largest pension obligations among US corporations. Both said this week they see a significant improvement in their pension plans liabilities because of rising interest rates used to calculate the future cost of payments. When interest rates rise, the cost of these "promissory notes" fall, which alleviates therefore these pension shortfalls. So, over the long term (we know Keynes said in the long run we are all dead...), it will enable these companies to "reallocate" more spending on their core business and less on retirees. Charles Plosser, the head of Philadelpha Federal Reserve Bank, argued that the Fed should have increased short-term interest rates to 2.5% in 2011 during QE2."

If capital cannot be re-allocated to "productive" endeavors, enabling companies to focus their resources on their core business, how can labor thrive in such a ZIRP environment? Please feel free to explain us how.

In continuation to Soberlook.com's Deutsche Bank reference, from their note from the 20th of September 2013 entitled "Fed's fear of higher rates is overblown", we would like to point out some of their additional comments on the subject of higher rates:

"Higher rates are a source of strength, not weakness. To the extent that interest rates have risen on the expectation of less quantitative easing (QE) as the result of a healthier labor market, higher yields are a positive development because they reflect more robust economic conditions. The yield on the 10-year Treasury note is up about 100 basis points (bps) from its intrayear low. (Long-term corporate and mortgage rates are up by a similar amount over this timeframe.) Given that the move higher was mainly in response to better labor market data, which was the catalyst behind Mr. Bernanke’s comments that the pace of quantitative easing could begin to slow by year end, we do not believe it is currently having a deleterious impact on growth. As long as interest rates are increasing for the right reasons, in this case an improving labor market, then higher rates are a positive development for the economic outlook. Only when interest rates rise to prohibitively high levels will we begin to worry about their effect on the economy. In this case, we would be looking at long-term real yields up around 3.5% to 4%, but this situation will not happen until the Fed is actually well into a monetary tightening cycle. And even based on our above-trend growth forecast, with the unemployment rate falling to 7% by yearend 2013 and 6.4% by yearend 2014, monetary tightening is still a long way away. Thus, investors and the Fed should not agonize over the year-to-date rise in bond yields." - source Deutsche Bank.

What effectively the Fed has done in its latest blunder is to increase a probability of a much nastier bubble burst and a much more pronounce reaction from risky assets markets in the process. 

They have indeed made the problem down the line much bigger by not starting to take away the proverbial "punch bowl". We therefore agree as well with Deutsche Bank's concluding remarks:

"In conclusion, Fed policymakers refrained from taking a first small step toward policy normalization this week, as they remain fearful the economy is not strong enough to handle a slower pace of monetary accommodation. For reasons we discussed above, the backup in rates has not been significant enough to dent our expectations of an interest-sensitive led improvement in economic growth. Rates remain extraordinarily low, and if growth finally surprises to the upside later this year, a modest tapering of quantitative easing will commence. In the interim, long-term interest rates are poised to trend higher, reflecting these improving growth prospects. This runs the risk that when the Fed finally begins tapering, monetary policymakers witness a larger and more negative response than they might prefer." - source Deutsche Bank

And if history is could provide some "Forward Guidance" for US yields, we wanted to illustrate the evolution of the US 10 year yields from the 29th of September 1929 until the 29th of June 1949:

Graph source Quandl.com

Of course the key data the Fed is watching in order to start considering "dipping its toes" into normalization comes from housing as indicated by Deutsche Bank in their report:

"It would be highly unusual for builder sentiment to rise so aggressively if the sector were about to falter in the face of higher mortgage rates. The reason for this is because there is very little supply of newly constructed homes for sale and demand is recovering as the labor market normalizes and household income prospects improve. 

To be sure, higher mortgage interest rates make housing less affordable, all else being equal, but affordability is a function of house prices and income, as well. The National Association of Realtors’ Housing Affordability Index (also shown nearby) illustrates an important point in this regard. Despite the 125 basis point increase in mortgage rates year-to-date and a steep increase in home prices (10%+), housing affordability remains higher than at any point in the prior four decades—barring the ultrahigh ultrahigh levels of the past two-to-three years. 

Until affordability returns to average (or below), home buying conditions remain favorable for further improvement in prices and sales volumes." - source Deutsche Bank

Housing is indeed essential in order to assess the solidity of the "recovery" and as we reminded ourselves last week from our January conversation entitled "The link between consumer spending, housing, credit growth and shipping - A follow up":

"If there is a genuine recovery in housing driven by consumer confidence leading to consumer spending, one would expect a significant rebound in the Baltic Dry Index given that containerized traffic is dominated by the shipping of consumer products."

We therefore monitor credit and shipping very closely, but also the activity in the freight derivatives markets in order to gauge a potential rebound in global growth which seems to be anticipated as indicated by Bloomberg's recent Chart of the Day, to point to an anticipation in the global trade:

"Trading of freight derivatives is near a five-year high as hedge funds return to the market in anticipation that surging charter rates for the largest iron ore-carrying ships signal a global economic rebound.

The CHART OF THE DAY shows trading in forward freight agreements, used to bet on future shipping costs, reached the highest level since October 2008 this month, according to the Baltic Exchange, the London-based publisher of rates on global maritime routes. Hire costs for Capesize vessels jumped almost sixfold since the end of May, its data show.

Rates are rallying as China replenishes stockpiles of iron ore, a steelmaking raw material and the largest dry-bulk cargo hauled at sea. That’s drawing hedge funds and other investors back to the market, said Alex Gray, chief executive officer of Clarkson Securities Ltd., the derivatives unit of the world’s largest shipbroker. Capesize rates are still down 88 percent from the peak in June 2008.

“There’s no other commodity market out there that goes up five times multiples,” Gray said. “Freight is considered to be a very good bellwether for worldwide growth. Investors are looking at the freight market moving once again and saying, ‘Is this the beginning of something big?’”

While port congestion and delays are helping to lift rates, stronger Chinese demand can’t be ignored, Gray said. Steel production in China rose to a record 91.9 million metric tons in August, data compiled by Bloomberg show. Iron-ore imports gained to 69 million tons last month, within 6 percent of July’s all- time high, according to customs data.

Volume and open interest for dry-bulk freight swaps rose to 50,363 lots in the week ended Sept. 9, according to the Baltic Exchange. That was the highest level since the 50,445 lots tallied in the week of Oct. 20, 2008, its data showed. Daily Capesize rates as gauged by the exchange were at $29,186 yesterday, compared with $5,171 at the end of May." - source Bloomberg.

Of course when it comes to our market scoundrels and the Fed, gradually removing the "liquidity addiction" from our sugar-rushed equity markets is not going to be as easy as it was to initiate the "Cantillon effect" and its "inflationary" effects on risky assets as displayed in the below Bloomberg graph:

- source Bloomberg.

In similar fashion to QE2, QE3 triggered a significant rise in Inflation Expectations, but since the beginning of the "tapering" talks in May,  both inflation expectations as illustrated by the evolution of the 10 year US Breakeven and Gold have been sent packing, until the "untaper" time as of July which saw a significant rebound in both - graph source Bloomberg:

Of course, if you don't know where the Fed's compass is going to spin, you play the put-call parity game which is long gold (inflation and end of the dollar status) and long bonds (deflation).

Dollar index versus Gold - graph source Bloomberg:

The Fed postponing its "tap dancing" has led to a weakening of the Greenback and a bounce back of gold in the process.

On a final note, in these jitteriness, Japan has continued to shine, and we expect Japan to continue to do so to the benefit of our market scoundrels - graph source Bloomberg:

Helped by lower volatility and has indicated by tighter spreads in the Itraxx Japan - graph source Bloomberg:

For a simple reason: labor cash earnings growth - graph source - Datastream / Fathom Consulting:

"Knowledge is of two kinds. We know a subject ourselves, or we know where we can find information upon it." - Samuel Johnson, English author.

Stay tuned!

Australian Dollar, China and Iron Ore - What's behind the Aussie strength?

"It is in revolutionary periods that the culmination of previous trends and the beginning of new ones appear." - C. L. R. James, Trinidadian journalist. 

While in previous conversations we have discussed the link between China, Iron Ore and the Australian Dollar, we thought a, update was warranted given the continued strength in the Australian dollar.

Recently, China's government tightened housing market restrictions on March 1 in cities with "excessively fast" price gains.

Chinese commodities demand tends to weaken as property development slows. The Australian dollar has historically tracked the country's iron-ore exports to China - source Bloomberg:

The Australian dollar declined massively during the global financial crisis as Chinese demand fell for Australian iron ore. The currency then strengthened as exports of the commodity rebounded, coinciding with China's 4 trillion yuan ($643 billion) fiscal stimulus.


Iron ore is used to make steel, an essential material for housing development. Over the past year, as China has sought to curb housing prices, the Aussie has also tracked the relative performance of property stocks as indicated by Bloomberg.

Since June 2012, the Aussie has tended to move in tandem with the relative performance of the Chinese property sector.

Below you have the comparison between the AUD and the spread between the Shanghai Property Index and the Shanghai index - source Bloomberg:

Property stocks underperformed until March in anticipation of China's implementation of capital gains tax to cool the real estate frenzy. China's announcement of a 20 percent capital gains tax on home sales  on the 1st of March was less stringent than anticipated hence the rebound that followed. The Aussie had also fallen toward par against the U.S. dollar over the same period.

But what has been interesting has been the growing gap between the RBA's monthly commodity price index and the Australian dollar. The Australian dollar has been surprisingly resilient, as indicated by Bloomberg:

"The Reserve Bank of Australia’s decision to cut its key benchmark interest rate to a record low reflects the Australian dollar’s resilience to previous reductions and weaker commodity prices. 

The CHART OF THE DAY shows the RBA’s monthly commodity price index diverging from the local dollar by the most since the beginning of the nation’s China-fueled resource boom a decade ago. It also tracks the overnight cash-rate target that Governor Glenn Stevens and his board reduced to 2.75 percent yesterday, the lowest level since records began in June 1959. The exchange rate “has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates,” Stevens said in his 6th of May statement.

Stevens has reduced the cash rate by 2 percentage points in the past 19 months, a period when the currency has averaged more than $1.03, compared with 72 U.S. cents in the decade prior. The Aussie was at $1.0197 at 6 p.m. in Sydney yesterday. “It’s a balance between the interest rates being at record lows and the currency being high,” said Greg Gibbs, a Singapore-based senior currency strategist at Royal Bank of Scotland Group Plc. “While the currency remains unresponsive to commodity prices or interest-rate differentials, it increases the potential for rates to go lower.” Commodity prices have tumbled 21 percent from a peak in September 2011, the RBA’s gauge shows. The index “is intended to provide a timely indicator of the prices received by Australian commodity exporters,” according to the central bank’s website." - source Bloomberg

Could the reason behind the continuous resiliency in the Australian dollar due to a rebound in Iron Ore prices?

China imported 67.1 million tonnes of the steelmaking raw material in April, the third highest amount on record and up 4% from March it seems.

And, on Wednesday benchmark CFR import price of 62% iron ore fines at China's Tianjin climbed to $130.20 a tonne, up from its 2013 low of $128.10 reached last week according to Frik Els from Mining.com.

As far as inventories are concerned and as reported by Deutsche Bank in their latest Shipping Weekly from the 6th of May 2013, while inventories improved of their 1st quarter low, they remain below 2010 levels:

- source Deutsche Bank - Shipping Weekly - 6th of May 2013.

We do not think the resiliency of the Australian dollar is due to this rebound, there is, we think more to it and it has to do with two factors.

Factor 1 - Diversification of Central Banks FX Reserves:
The rebalancing of FX reserves as indicated by John Detrixhe in his Bloomberg article from the 3rd of April - Aussie to Loonie Equal Dollar in Attracting Reserves:

"For the first time, central banks are using their reserves to buy about the same amount of currencies from Canada to Australia as they are U.S. dollars in a sign that the pace of diversification is accelerating. Allocations to so-called non-reserve assets rose by $30.1 billion in the last three months of 2012, the most in a year, while those going to the dollar increased by $31.5 billion, according to International Monetary Fund data released on March 29. The $1.4 billion gap is the closest since at least 1999.

The changing makeup of reserve assets reflects the growing clout of second-tier nations as the major developed economies see a shrinking share of worldwide gross domestic product. The U.S., euro region, U.K. and Japan accounted for 52 percent of global GDP product in 2011, down from 69 percent a decade earlier, according to World Bank data. “The new money really got applied to the alternatives, Aussie and Canada, and it’s an ongoing trend,” Greg Anderson, the North America head of Group of 10 currency strategy at New York-based Citigroup Inc., said in a telephone interview. Those currencies have “better credit, higher yield. If you could, you’d probably put your whole portfolio there but they have a scale problem, you can’t do that,” he said.

A category the IMF calls “other currencies,” and which strategists say includes the Australian, New Zealand and Canadian dollars, soared to 6.1 percent of the $6.1 trillion in allocated global reserve assets from 1.8 percent at the end of 2007. The IMF calculates the share based on central-bank data. China, the world’s biggest reserve holder, doesn’t participate.

At the same time, the dollar percentage has shrunk to 61.9 percent from 64.1 percent, and the euro’s share has dwindled to 23.9 percent from 26.3 percent. The IMF said in November that it’s considering classifying the Australia and Canadian dollars as reserve currencies." - source Bloomberg

Factor 2 - Yuan-Aussie Trades:

As indicated in Jason Scott's Bloomberg article from the 11th of April, the Australian dollar cross-currency trading has been given a very big boost by the direct trading between the yuan and the Aussie which reached A$250 million on its first day   - Yuan-Aussie Trades Were A$250 Million on First Day:

"The People’s Bank of China approved Australia & New Zealand Banking Group Ltd. and Westpac Banking Corp. as market makers for the direct trading of the currencies that began yesterday, Gillard said at a press conference in Shanghai on April 8. Asia’s largest economy took about a third of Australia’s exports in February and is its major customer for iron ore and coal. The yuan gained 0.2 percent to 6.5167 per Australian dollar as of 2:32 p.m. in Beijing, according to data compiled by Bloomberg. The Australian dollar follows the greenback and the yen in being able to be directly traded with the yuan. Before the bilateral deal, cross-currency trading between the Aussie and the yuan was about A$20 million a day, according to data compiled by market participants, who asked not to be named." - source Bloomberg.

As far as the Yuan is concerned, you should watch what happens with the Yuan's trading range in the coming months because of the competitive devaluation taking place in Japan  - source Bloomberg:

"China won’t widen the yuan’s trading range for at least four months, as foreign inflows have pushed the currency near the upper end of the 1 percent daily limit, according to Australia & New Zealand Banking Group Ltd. “It would require an easing of capital inflows, or for the market to re-assess People’s Bank of China’s currency management” before the band is altered again, said Khoon Goh, a senior strategist at ANZ in Singapore. The central bank expanded the range from 0.5 percent in April 2012 after a stretch of at least 15 months during which the yuan hovered near the midpoint or tended to weaken. A change now would be an “effective revaluation” as other nations devalue their currencies, he said.
The CHART OF THE DAY shows the onshore yuan gained 3.4 percent against the dollar in the past nine months and has closed stronger than the reference rate since September. The lower panel shows the currency stayed near the maximum 1 percent above the fixing for the last seven months.
Speculation for a change was heightened on April 18 when PBOC Deputy Governor Yi Gang said the band would be widened “in the near future.” Based on the previous adjustment, the central bank probably won’t move “until the yuan is trading closer to the midpoint,” ANZ’s Goh said.
Yuan positions at Chinese financial institutions stemming from foreign-exchange transactions, a gauge of cross-border flows, rose by 1.22 trillion yuan ($197 billion) in the first three months of 2013, more than four times as much as in the same period last year. The inflows helped push the yuan to a 19- year high of 6.1723 per dollar on April 17." - source Bloomberg.

On Thursday the Yuan hit a record high of 6.1336 per dollar in morning Asian trade after the People's Bank of China (PBOC) fixed the yuan mid-point at the highest level since the 2005 revaluation.

What will be interesting to watch in relation to China and as reported by EJ Insight on the 8th of May is as follows:

"New forex position limits could tighten cash flow Starting June 10, banks in China are required to comply with new foreign exchange position limits. The State Administration of Foreign Exchange, the nation’s currency regulator, has linked the position limits to the banks’ foreign currency loan-deposit ratios.

Market analysts estimate the lenders need to buy as much as US$320 billion worth of US dollar to meet the new ratio. This could lead to tighter cash flow in the financial system and higher money rates for a short period. As a result, the central bank may keep a net cash injection via its open market operations.

On the other hand, the new measure, which is aimed at containing the influx of speculative capital, is timely and important at a time when other major economies are exercising monetary easing.

After Australia cut interest rates on Tuesday, South Korea’s central bank is likely to announce a long awaited cut today. According to official data, yuan positions at Chinese financial institutions from foreign exchange transactions rose by 1.22 trillion yuan (US$197 billion) in the first quarter."

And Korea did cut its interest rates by 25 bps. The race to the bottom is on and currency wars are indeed interesting to follow.


"The thing is to be able to outlast the trends." - Paul Anka, Canadian musician.

Stay tuned!