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The last 7 days have seen the unstoppable ‘sure-thing’ one-way bet of the decade appreciation trend of the Chinese Yuan reverse. In fact, the 0.95% sell-off is the largest since 1994 (bigger than the post-Lehman move) suggesting there is clear evidence that the PBOC is intervening.
The fact that this is occurring with relatively stable liquidity rates (short-term repo remains low) further strengthens the case that China just entered the currency wars per se as SocGen notes, intending to discourage arbitrage inflows. For the Chinese authorities, who do not care about the level of their stock market (since ownership is so low), and specifically want to tame a real-estate bubble, thisintentional weakening is clearly aimed at trade – exports (and maintaining growth) as they transition through their reforms. The question is, what happens when the sure-thing carry-trade goes away?
BofA notes the puzzling divergence between Yuan fixings and short-term liquidity,
The turn of the Chinese New Year brought the People’s Bank of China (PBoC) back into action – it not only restarted repo operations to withdraw liquidity, it actually did it at a much higher rate. The 7d reverse repo rate at which the PBoC injects liquidity is 75bp higher than a year ago, a move considered by the market as a 75bp rate hike over the last year. The new 14d repo (liquidity withdrawal) rate is set at 3.8%, 105bp higher than the rate when 28d repo was last conducted on 6 June 2013. Based on a simple framework, this move is equivalent to another 35bp rate hike (Rate corridor, Chinese style, 18 February 2014).
The puzzle is that both money and bond markets nearly totally ignored such an operation. The 7d repo rate is now fixed nearly 200bp lower since 10 February. Such a massive liquidity improvement in the face of the PBoC’s liquidity withdrawal is puzzling, since by 10 February most of the cash used during Chinese New Year should have flowed back into the financial system already.
The FX market move also begs the question as to why liquidity improved over the last couple of weeks. Generally, the onshore repo rate rises as the RMB weakens against fixing; a normal development because FX outflow dries up liquidity. However, the move in February turned things upside down. Look at the sharp divergence between rates and FX
Which leaves 2 possible reasons for the divergence…
It is due to the seasonality of outflows, as this year could be made worse because the onshore rate was much higher before the Chinese New Year. As a result, banks might have borrowed more offshore, helping the RMB to appreciate. After the New Year, this flow reverses and pushes the RMB down. This explains why the CNY leads the CNH in spot selloff. It is also consistent with the large January FX purchase position of CNY466bn. The trouble with this explanation is that as the money flows out, the onshore rate should rise, not drop.
A more popular theory or suspicion puts the PBoC behind the move. As the PBoC buys more USD, it creates natural liquidity in the CNY, leading to much lower repo rates. This explanation is consistent with CNY leading the move, as CNY and CNH spots moved much more than forward, all suggesting a domestic investor-driven rather than foreign investor-driven endeavor. The trouble with this explanation is that the market will have difficulty proving it one way or the other without the central bank explicitly admitting it.
As SocGen notes, the latter makes more sense…
In just short seven days, the once unstoppable appreciation trend of the yuan is reversed. The USD/CNY spot has depreciated by 0.8% since 17 February and the USD/CNH has weakened by more than 1.1%. As for the causes, there is clear evidence of intervention from the People’s Bank of China. We think that the recent yuan move is intended to discourage arbitrage inflows. If short-term capital inflows abate, the depreciation will probably halt.
Ending the inexorable carry trade…
The yuan appreciated by nearly 3% against the greenback and 7% against in nominal effective exchange rate terms in 2013. Over the same period, China’s FX reserves added another $500bn, despite the repeated talk from officials that China has had enough reserves. These seemingly contradictory messages and signs, in our view, suggest that the PBoC never really wants too much yuan appreciation, especially if it is driven by short-term speculative capital inflows.
Which is crucial…
The yuan possesses the very two qualities of a carry trade currency: high onshore interest rates and a gradual but steady appreciation trend. The first quality is partly caused by the Fed’s easing policy and partly by the PBoC’s reluctance to ease domestic liquidity conditions out of concerns over debt risk. This condition is unlikely to weaken significantly in the near term. However, the PBoC is capable of altering the second condition and it seems that it is doing exactly so by reversing the appreciation trend and pushing up the volatility of the yuan.
If we are right about the reason behind the surprising deprecation of the yuan, what will follow next?
– Band-widening? Maybe, but as we have argued before, what matters is how the PBoC manages the currency. To make real difference, we think that the next step in yuan reform should be bolder: the PBoC should move from daily to weekly (or even monthly) setting of the reference rate, while at the same time widening the currency band.
– More depreciation? Probably not much more. Although the central bank does not like too much capital inflows, too much outflows will not be its choice either. The monthly FX position data are something to track for any change in the capital flow direction. A timelier indicator is the spread between CNH and CNY spot rate. If the offshore rate stays persistently weaker than the onshore one by a certain margin, that will be a sign of capital outflows. Then the PBoC will most likely choose to stabilise the yuan again.
The end-result is a concern:
Should the RMB weakening last a while longer, the cross border carry arbitrage flow which has been massive could reverse and lead to higher repo rates. Such a flattening force is a real threat, especially when the PBoC has shown no sign of lowering the repo rates in its operations.
But this certainly will not please the Japanese (trying to devalue and manufacture their own recovery) or any other beggar thy neighbor nation. Welcome to the Currency Wars China… (and we warned here, prepare for more carry unwind and a potential risk flare).
Potential asset deflation is a risk, as the carry trades diminish/unwind. Property prices are at risk – the collateral value for China’s financial systems. This is not a dire projection – it simply seeks to isolate the US QE as a key driver of China’s monetary policy and asset inflation, and highlights the magnitudes involved, and the transmission mechanism. Investors should not imbue stock-price movements and property price inflation in China with too much local flavor – this is mainly a US QE-driven story, in our view.
And lastly, as a bonus chart, we thought the correlation here was interesting…
Goodbye Dollar, Hello Yuan
You know what’s it like, the driver stands there in front of the car that has just hit you up the back while looking at something happening down the street rather than checking on you hitting your breaks…and yet, he says “sorry, but you stopped too quickly, it wasn’t my bad driving”. Why is it that people just refuse to admit the truth even where it comes up and slaps them in the face? It’s exactly the same with the Death of the Dollar. Denial is the first stage in the mourning process that people go through when they have lost a loved one. Yes, just the mere fact that there is many an American out there who is actually denying this means that the Dollar is lying feet up on its back, six feet under already today. They are simply, in denying the fact, espousing the 7 stages of bereavement. The Dollar is dead. Today it’s Australia that will be sending flowers to the Americans.
ASX, the Australian Stock-Exchange operator and the Bank of China announced today that they are going to provide a Yuan settlement service between the two countries by the end of the first half-year 2014. China represents the biggest trading partner for the Australian market and trading in Dollars has no sense today. Transactions have been increasingly made in Yuan rather than the Dollar over the past few years. This new agreement comes just after last October’s agreement between the Eurozone and China and the currency-swap deal.
For all of those out there that will be screaming from the rooftops that China is slowing down, that the economy is under-performing (incidentally, they are still performing way better than any of us in the western world) the Chinese currency is one of the top traded currencies today in the world, and Australia has just said they don’t care if the economy is slowing down. The reason why the deal has been struck is because they are looking at China in the long-term view.
Since September 2013, the Yuan has been in the top ten of tradable currencies, according to research carried out by the Bank of International Settlements. The Yuan saw a jump from 17th position in 2010 to 9th place in 2013. There may be a slow-down in the economy and there may be problems with the structural reforms undertaken by the government, but in the long-term the Yuan will be traded more and more. The Australians are proving that today.
The financial market reforms have been centered on liberalization of the capital account and the convertibility of the Yuan. The only countries that offer complete convertibility at the moment are the USA, Japan and Australia.
Certainly the shadow-banking problems are far from over. There will be more that come out of the woodwork in the coming weeks. It is estimated that 40% of the 10 trillion Yuan in trust products that are used in shadow banking will mature in 2014. That means that we could be in for a lot more examples of the $126 million-worth of products issued by Jilin Province Trust that defaulted on the repayment to investors over the past couple of weeks after having made loans to the failing coal company Shanxi Liansheng Energy (at the same time as 6 other trusts also made loans of up to 5 billion Yuan to this company that was already bankrupt and dead). 80% of trust-product principal is going to be repaid to investors between 2014 and 2016. That could spell trouble.
Bailing out trust investors continually will bring about problems of financial stability of the country. But, in the long-term there is the belief that the Yuan will succeed. All of that is true, but the Dollar may well be dead completely, and buried, before the Yuan fails.
In the process of acceptance of bereavement, the next stage after denial will be anger. Then the US will enter the period of bargaining with the rest of the world to try to save its place somehow on the international scene. Once it has been through the penultimate stage of depression (oh, no! Not again!), it will finally accept. But, for the moment, they shall just keep on denying lock, stock and barrel. The rest of the world, like the Australians, are seeing to it that the Dollar dies a quicker death than it would perhaps have normally done.
Remember it’s not the value of the Dollar that is important or whether or not the Yuan can be a valued asset in the world to trade with, it’s the perception that we, as consumers and countries, actually have of that currency. The Australians are showing that the Yuan has just been perceived as possibly of greater value than the Dollar.
Tissue to dry your eyes?
Proud Scots have made Britain great, so we have nothing to fear from any continuation of the Union, writes Brian Monteith
The demand from Yes campaigners for the No campaign to be more positive and offer a positive vision of Scotland’s future has been repeated so often that it has now become a tiresome cliché. It is all the more ironic then that the greatest advocates of the positive case for Scotland remaining in the United Kingdom are in fact Yes campaigners and politicians themselves.
We see it all the time by the way advocates of independence define what they mean. We shall retain the Queen as our head of state instead of being offered the choice to become a republic. We shall, they insist, remain members of the European Union instead of being offered the choice to be like Norway, Iceland or Switzerland and limit ourselves to being European trading partners. We shall apply to join Nato to have a mutually assured defence structure that will involve exercises with the RAF, Royal Navy and British Army regiments instead of being neutral and outside any military alliance.
We are still being told we shall have a currency union although it can now be seen that it is absolutely beyond the power of the SNP to deliver it formally. We are also told that we shall maintain our social union despite the fact that charging the thousands of English, Welsh and Northern Irish students for university fees is not only illegal within the EU but is also certain to create a significant grievance in the continuing UK if we do not charge Germans, Greeks or Spaniards the same fees.
So there we have it: being in the United Kingdom has given us many strong and positive advantages. We have a highly stable and well respected constitutional monarchy that provides a reassuring and unifying stability, while politicians come and go and fall in and out of fashion.
We have been members of the European Union for some 40 years and Nato for more than 60 – bringing openness, economic growth, democracy and security to which other nations have aspired and queued up to join.
Our own common currency provides a means of exchange redeemable throughout the land that suits us better than using a foreign coinage and gives us a flexibility in the world economy that is the envy of so many nations that made the mistake of joining the euro.
And we have a social union that after not just years or decades, but centuries of wars, battles, and bloody invasions (by either side), has encouraged us to migrate, intermingle, forge familial bonds and establish through perseverance and endeavour great successes in commerce, culture, science and politics. There are communities, even towns south of the Border, that are thought of as being essentially Scottish. The extent to which our social union became possible in the United Kingdom, despite further civil wars where Scots themselves were divided, is taken for granted nowadays, just as the huge role we played in establishing what was to become the British Empire and then latterly the Commonwealth is often forgotten.
Some intentionally provocative and disrespectful nationalists like to call the Union flag the butchers’ apron, conveniently avoiding the fact that if there were indeed any butchers, they were as likely to be Scots as anyone else. Key events in our British history, such as the Battle of Trafalgar, had a disproportionately large number of Scots while we all know the names of great Scots who helped shape the modern world.
The idea we are so subservient, passive and lacking in confidence within our great social union as to be unable to lead men to make the greatest of sacrifices, discover the unknown, develop new ideas, forge new enterprises, build lasting and enviable institutions – and yes, run our country, the United Kingdom of Great Britain and Northern Ireland – because we are Scots and not born to do so is the worst example of the Scottish cringe.
Was I dreaming when that Scottish son of the manse, Gordon Brown, became British prime minister and was widely accepted at the time by an English-dominated Labour Party? Brown was hardly born to run the country.
Maybe I imagined that Anthony Charles Lynton Blair, that humble bungalow lad from Paisley Terrace nestling in the shadow of Arthur’s Seat, became the Labour Party’s longest-serving prime minister and the only person to lead that party to three consecutive general election victories. He was hardly born to run the UK: the second son of Leo, an illegitimate child of two English actors who was adopted and raised by a Glaswegian shipyard worker James Blair. Such are the bloodlines of our social union that has seen Scotsmen and women go on through their own endeavour to achieve great things and be accepted north and south of the old Border.
Did Alistair Darling not follow Brown as chancellor, was the late Robin Cook not Foreign Secretary and did George Robertson and John Reid not hold high Cabinet rank along with many other Scots? Would John Smith – that Dunoon Grammar School lad – not have become prime minister but for his untimely death in 1994?
Then let us not forget Edinburgh’s George Watson’s boy Malcolm Rifkind, hewn from Jewish Lithuanian immigrant stock – hardly a traditional Scottish background – who rose to become Foreign Secretary and Defence Secretary. Or how about John Cowperthwaite who, in the 1960s, made Hong Kong what it is today?
And it doesn’t just end there, for Scots in Britain are hardly shrinking violets in other fields – from Govan’s Alex Ferguson in sport, who managed possibly the best-known football team in the world, to Stonehaven’s John Reith, who built the BBC into the envy of the world. Neither they nor many others like them – the list is as inspiring as it is long – were born to run or shape British institutions, but they had the opportunity and the Union made it possible.
It is this social union that I fear for most. As we now see that the continuing UK can and will have different interests from Scots and Scotland – and has every right to pursue them – new grievances will tear us apart. What’s positive about that?
As if Russia did not already have enough worries, with the security issues associated with the Sochi Olympics and the growing unrest next door in Ukraine, it now faces severe downward pressure on its currency. Any currency crisis flirts with economic opportunity and political disaster at the same time. The falling ruble can address some of Russia’s structural economic shortcomings, but only if other financial resources are made available in the process.
Russia is not alone in seeing its currency plunge. Turkey, South Africa, Argentina and Thailand have all experienced precipitous declines in their respective currencies since the beginning of 2014.
A common refrain runs through all these cases. The end of the U.S. program of quantitative easing and foreign investors’ rapid retreat from emerging markets has jolted the currency market, creating uncertainty in its wake. Throw in Russia’s low growth rate, high levels of capital flight and endemic corruption and one has all the conditions for a perfect currency storm.
January was a particularly bad month for the Russian ruble, with the currency falling more than 6 percent against the euro-dollar basket. The ruble rebounded a bit in early February, but it has again resumed its downward trend, with many experts speculating that the currency has yet to find its bottom.
The currencies of Russia’s post-Soviet neighbors also are in freefall, most notably in Ukraine, where currency controls have been introduced to save the hryvnia from total collapse. Kazakhstan, meanwhile, preemptively devalued the tenge by 19 percent in an attempt to keep its economy—and its exports—competitive.
To date the Russian government’s response to its currency woes has been reasonably restrained, unlike during the 2008-09 crisis when the Central Bank quickly went through $200 billion in reserves to defend the ruble. Russia currently possesses almost $500 billion in foreign exchange reserves. So to the extent that Russia has a rainy day fund, it is not raining hard enough, from the Central Bank’s perspective, to justify a major intervention to slow the ruble’s slide.
A falling ruble, in fact, solves several problems for the Russian government while setting the stage for a potential economic recovery. President Putin made several big campaign promises in 2012, especially in terms of increased social spending, that put significant strains on the Russian budget last year. Since the Russian government can make these payments with cheaper rubles, the burden on the budget has shrunk.
The decline in the ruble’s value also presents opportunities for Russian exporters, since their products naturally become more competitive abroad as the ruble declines. Though it appears unlikely that most Russian companies are in a position to profit from this changing dynamic, Russia’s wheat exports are up dramatically thanks to the declining ruble.
Russia brings other advantages to this crisis as well, including a balanced budget and a steady stream of hard-currency earnings that are not tied to value of the ruble, thereby allowing the state to replenish its coffers at a consistent rate. So one can clearly identify the scenario where Russia not only survives this devaluation but theoretically comes out in a better place than where it started.
But not all currency crises have happy endings. A weaker ruble portends a lower standard of living for many Russians. The specter of inflation further hovers over Russia as its citizens invariably will now chase after imported consumer products with cheaper rubles.
But the big unknown is whether Russia is flexible enough to benefit from the current financial crisis. As the ruble weakens and the price of labor and other inputs fall, Russia should be in a position to replace expensive imports with more affordable Russian-made goods. Such substitution occurred after the 1998 currency crisis and ultimately contributed to Russia’s sustained recovery.
Yet today, it remains an open question whether Russia possesses adequate financial and human capital to spark such business investment. Over the past decade, Russia’s entrepreneurial spirit has been snuffed out through excessive government regulation, corruption, and the steady rise of state-owned enterprises. The legal environment is so suffocating that Russia may not have sufficient reserves of entrepreneurs willing to assume the risk and invest in the Russian market.
Russia also still suffers from disastrous capital outflows. More than $60 billion dollars left the country last year for various destinations in the offshore banking system—and this money is exactly what Russia requires to buy equipment and otherwise invest in domestic business in order to take advantage of the falling ruble. Yet there is no sign that this money is returning onshore any time soon, especially if the government continues to talk about taxing Russian offshore companies doing business in Russia.
No supplemental investment means no sustained economic turnaround and the growing likelihood that a falling ruble will mirror a weakening economy, as opposed to reversing it. And as recent events in Argentina and Turkey suggest, such a development is a recipe for political failure. In both of these countries, a collapsing currency has fueled speculation as to the long-term prospects of their leaders. President Cristina Fernandez and Prime Minister Recep Tayyip Erdogan are floundering, in part because to address the currency crisis means to question the very economic policies that have sustained their popularity during their many years in power.
President Putin has not had to face this choice as of yet, but that day of reckoning may be approaching if Russians realize that basic Western consumer goods, foreign travel, and other perks of Russian capitalism are now beyond their reach.
Russians have weathered several currency crises over the past thirty years; so far, no one is shouting that the sky is falling. However, a currency crisis that is not contained could easily spill into politics, something that Putin wants to avoid at all costs. If the latter occurs, then it will be officially raining in Russia, and money will be no obstacle in any attempt to stabilize the ruble.
Will Pomeranz is the acting director of the Kennan Institute for Advanced Russian Studies at the Wilson Center in Washington D.C.
Image: RIA Novosti archive, image #978876 / Alexey Kudenko / CC-BY-SA 3.0
Following the 20% devaluation of Kazakhstan’s currency on Tuesday, the nation has quietly drifted into a very un-safe scenario. As the following clip shows, tanks and Humvees are lining the streets around Almaty as stores are closed and food is running desperately short. Local accounts note that the people are growing increasingly indignant. At a mere 192bps, the cost of protecting Kazakhstan sovereign debt from default (or further devaluation) seems cheap in light of this.
Tanks and Humvees lining the streets around the largest city in Kazakhstan…
Kazakhstan CDS remain notably cheap…
With only $24.5 billion left in FX reserves after valiantly defending major capital outflows since the Fed’s Taper announcement, the Kazakhstan central bank has devalued the currency (Tenge) by 19% – its largest adjustment since 2009. At 185 KZT to the USD, this is the weakest the currency has ever been as the central bank cites weakness in the Russian Ruble and “speculation” against its currency as drivers of the outflows (which will be “exhausted” by this devaluation according to the bank). The new level will improve the country’s competitiveness (they are potassium heavy) but one wonders whether, unless Yellen folds whether it will help the outflows at all. The Kazakhstan stock index is up 12% on the news…
The tenge, introduced in 1993 after the breakup of the Soviet Union two years earlier, weakened the most against the dollar last month since July. Kazakhstan devalued its currency by 21 percent in February 2009, as the biggest energy producer in central Asia spent billions of dollars to support the economy and bail out its biggest lenders following the collapse of Lehman Brothers Holdings Inc.
“The devaluation was a surprise for many people, considering the central bank’s assurances that the exchange rate is stable,” Damir Seisebayev, director of the analytical department at ?? Private Asset Management in Almaty, said by e-mail. “But you have to be realistic. What is the tenge? It’s the ruble rate multiplied by five. This is a tested formula.”
The Kazakhstan Stock Exchange gained 12 percent after the announcement, data on the bourse’s website show.
So it must be great news, right? Just as Venezuelan stock holders…
“The move reflects a combination of factors, including the steady deterioration in the current-account position, worries over the impact of weak growth in Russia and the ruble’s managed depreciation,” Tim Ash, chief emerging-markets economist at Standard Bank Group Plc. in London, said in a note today.
Sometimes, perhaps all too often; investors, traders, economists, and mainstream media anchors miss the forest and see only the trees (growing to the sky or crashing to the floor). To provide some context on the markets, we present the first of three posts of long-term chart series (and by long-term we mean more than a few decades of well-chosen trends) – stock, bond, gold, commodity, and US Dollar prices for the last 240 years…
American Markets Since Independence
The Gold Price
The Crude Oil Price
The US Dollar
H/t @Macro_Tourist for these increble charts
Of course, as we have noted in the past, Nothing lasts forever… (especially in light of China’s earlier comments )
It has gone from being one of the world’s wealthiest nations to a serial defaulter, but can it get back on track?
Counting the Cost Last updated: 08 Feb 2014 04:56
|Argentina was once the world’s seventh richest country. But economic mismanagement by successive governments has left the country looking down the barrel of another default.
Since the 1980s, Buenos Aires has defaulted three times on its debts – most famously, perhaps, in 2001 when it refused to pay the creditors of its $95bn debt. Since then it has essentially been shut out of international markets.
To service its debt, Argentina started using central bank reserves. But the peso has been devalued by almost 20 percent, leading to spiralling inflation as a toxic cocktail of uncertainty and speculation drives prices through the roof. And Argentinians are feeling the pinch:
“We are in bad shape,” says mother of six Cynthia Cabrera. “With what my husband makes loading trucks at the vegetable market, we can’t survive. I have to ask the grocer to give us credit. We live day to day. Here we either eat at midday or at night; I can’t afford two meals now.”
So, what will it take for the government to get the country’s economy back on track? And can it come soon enough?
A double-edged economic sword
When a central bank raises interest rates, it increases the value of its currency, curbing inflation, cooling the economy and attracting investors seeking higher returns.
Lowering interest rates, on the other hand, devalues a currency, making it less attractive to investors, but easier for businesses and consumers to borrow money and spur economic growth.
Some forces, however, are beyond the control of central bankers, especially those presiding over emerging economies vulnerable to sudden shifts in foreign investment. Political unrest or disappointing economic news at home or in key trading partners can trigger a flight of capital from emerging markets.
For six years, the Federal Reserve’s low interest rate policies have pushed investors into emerging markets such as Turkey, Brazil, Argentina and South Africa where they could earn more for their money.
Many have profited handsomely from fast-growing industries feeding China’s insatiable demand for raw materials, but a slowdown in China’s manufacturing combined with Fed stimulus unwinding has spooked emerging markets investors. In recent weeks, they have cashed in their chips for dollars, leaving a glut of devalued local currencies and while that makes exports more attractive, it also raises the frightening spectre of runaway inflation.
Counting the Cost examines this double-edged economic sword.
Europe’s lost generation?
Unemployment is the millstone of this financial crisis, and particularly so amongst 15 to 24 years old. About one-in-four young people in the European Union are unemployed. In the US it is only slightly better at 16 percent.
In the UK alone, youth unemployment cost almost $8bn in 2012, and according to consultancy firm McKinsey, 27 percent of employers have left ‘entry level’ jobs unfilled because they could not find anyone with the necessary skills.
So, how can youth unemployment be tackled? And has it created a lost generation?
Keep those dominoes steady… steady… and nobody exhale:
- UKRAINE IMPOSES LIMITS ON SOME INTERBANK FX OPERATIONS
- UKRAINE TIGHTENS RULES ON COPRORATE FOREIGN-CURRENCY PURCHASES
- UKRAINE CENTRAL BANK CITES HRYVNIA VOLATILITY ON FX MEASURES
There is of course, good news:
- UKRAINE CENTRAL BANK SAYS INTERBANK LIMITS ARE TEMPORARY
Just like in Cyprus.