While Jay and his friends at the Fed
Claim when they are looking ahead
No bubble’s detected
So, they’ve not neglected
Their teachings and won’t be misled
But China views markets and sees
Their policy has too much ease
So, money they drained
As they ascertained
Investors, they need not appease
Perhaps there is no clearer depiction of the current difference between the Fed (and truly all G10 central banks) and the PBOC than the fact that last night, the PBOC drained liquidity from the market. Not only did they drain liquidity, they explained that they were concerned about bubbles in asset markets like stocks and real estate, inflating because of current conditions. Think about that, the PBOC did not simply discuss the idea that at some point in the future they may need to drain liquidity, they actually did so. I challenge anyone to name a G10 central banker who could possibly be so bold. Certainly not Chairman Powell, who tomorrow will almost certainly reiterate that this is not the time to be considering the removal of policy support. Neither would ECB President Lagarde venture down such a road given the almost instantaneous damage that would inflict on the PIGS economies.
One cannot be surprised that stock markets fell in Asia after this action, with the Hang Seng (-2.6%) leading the way, while Shanghai (-1.5%) also fared poorly. By contrast, the Nikkei’s -1.0% performance looked pretty good. It should also be no surprise that the stock markets of the APAC nations whose trade relations with China define their economies saw weak outcomes. Thus, Korea’s KOSPI (-2.1%) and Taiwan’s TAIEX (-1.8%) suffered as well. And finally, it cannot be surprising that the Chinese renminbi traded higher (+0.15%) and is pushing back to levels last seen in June 2018.
Arguably, the key question here is, what does this mean for markets going forward? Despite constant denials by every G10 central banker, it remains abundantly clear that equity market froth is a direct result of central bank policy. The constant addition of liquidity to the economic system continues to spill into financial markets and push up equity (and bond and other asset) prices. If the PBOC action were seen as a harbinger of other central bank activity, I expect that we would see a very severe repricing of risk assets. However, a quick look at European equity markets shows that no such thing is occurring. Rather, the powerful rally we are seeing across the board on the continent today (DAX +1.5%, CAC +1.1%, FTSE MIB +0.85%) indicates just the opposite. Investors are not merely convinced that the ECB will never remove liquidity, but we are likely seeing some of the money that fled Asia finding a new home amid the easy money of Europe.
If the PBOC continues down this road, it is likely to have a far greater impact over time. In fact, if they are successful in deflating the asset bubbles in China without crushing the economy, something that has never successfully been done by any central bank, it would certainly bode well for China going forward, as global investors would beat a path to their door. While that is already happening (in 2020, for the first time, China drew more direct investment than the US), the speed with which it would occur could be breathtaking, especially in the current environment when capital moves at a blinding pace. And that implies that Western equity markets might lose their allure and deflate. The irony is that a communist nation firmly in the grip of the government would be deemed a better investment opportunity than the erstwhile bastion of free markets. Ironic indeed!
However, that will only take place over a longer time frame, while we want to focus on today. So, don’t ignore this occurrence, but don’t overreact either.
In the meantime, a look at today’s activity shows that there is little coherence in markets right now. As you’ve seen, European equity markets are rallying nicely despite the fact that the Italian government just fell as PM Giuseppe Conte resigned. A few months ago, this would have been seen as a significant negative for Italian assets, but not anymore. Not only are Italian stocks higher, but BTP’s have seen yields decline another 3 basis points, taking their rally since Friday to 10 basis points! As I have often written, BTP’s and the bonds of the other PIGS countries trade more like risk assets than havens, so it should be no surprise they are rallying. In fact, haven assets all over are declining with Treasuries (+2.2bps), Bunds (+1.4bps) and Gilts (+1.6bps) all being sold today.
Recapping the action so far shows APAC stocks falling sharply, European stocks rallying sharply and haven bonds falling. Is that risk-on? Or risk-off? Beats me! Commodity prices point to risk-on, with oil rising 0.55% and most agricultural products higher by between 0.4%-1.0%.
Finally, looking at the dollar gives us almost no further information. While the SEK (-0.25%) is under pressure on a complete lack of news, and the NZD (+0.2%) has moved higher after PM Arcern explained that the country would remain closed to outside travelers until the pandemic ended, the rest of the bloc is +/- 0.1% or less. In the EMG bloc, the picture is also mixed, with KRW (-0.5%) the worst performer followed by IDR (-0.3%). Given China’s monetary move last night, this should be no surprise. On the plus side, TRY (+0.7%) leads the way followed by BRL (+0.4%), with the former benefitting from the IMF raising its GDP growth forecast to 6% in 2021, from a previous estimate of 5%. Meanwhile, the real has benefitted from the news that the BCB meeting last week contained discussions of raising interest rates from their current historically low level of 2.0%. Concern over inflation picking up has some of the more hawkish members questioning the current policy stance. Certainly, given that BRL has been one of the worst performing currencies for the past year, having declined 26% since the beginning of 2020, there is plenty of room for it to rise on the back of higher interest rates.
On the data front, this morning brings Case Shiller Home Prices (exp +8.7%) and Consumer Confidence (89.0). On the former, this reflects historically low mortgage rates and a lack of inventory. As to the latter, it must be remembered that this reading was above 120 for the entire previous Administration’s tenure until Covid came calling. Alas, there is no indication that people are feeling ready to head back to the malls and movies yet.
With the FOMC on tap for tomorrow, I expect that the FX market will take its cues from equities. If the US follows Europe, I would expect to see the dollar give up a little ground, but as I type, futures are little changed with no consistent direction. While the dollar’s medium-term trend lower has been interrupted, for now, it also appears that the correction has seen its peak. However, it could take a few more sessions before any downward pressure resumes in earnest, subject, naturally, to what the Fed tells us tomorrow.
Good luck and stay safe