There once was a firm, Evergrande
Whose ethos was just to expand
But its wanderlust
Led it to go bust
When China grew slower than planned
The aftermath now seems to be
Impacting the PBOC
They cut RRR
And could well do more
Inverse to Fed ending QE
As we begin a new week, and arguably the second to last where market liquidity will be close to its ordinary levels, the news of the day centers on the PBOC reducing its Reserve Ratio Requirement (RRR), as foreshadowed by Premier Li Keqiang last week. While the official comments are focused on the government’s efforts to insure stable growth amid concerns over the omicron variant’s spread, it appears the reality may reach a little deeper. Of more importance to market participants than the virus is the status of China Evergrande and the entire property sector in China. It now appears that there is going to be an total restructuring of that company’s debt as it defaults on its remaining obligations. Recall, Evergrande
is was the largest property developer in China, and the most highly leveraged having total debts in excess of $300 billion as it expanded its business from purely property development to interests as far flung as theme parks, a soccer club and electric vehicles. As of last night, it has notified creditors that a restructuring is on its way and that clearly has the PBOC a little concerned.
Property is the largest sector of the Chinese economy, representing more than 30%, and a key revenue source for most provinces and cities as they sell land to fund operations. Evergrande was one of the largest purchasers, and so its slow-motion demise is being felt throughout the nation. It is for this reason that the PBOC finds itself in a situation where it feels the need to add more liquidity to the economy, hence the RRR cut. Interestingly, the problems here have not stopped the Chinese government’s crackdown on its tech sector, at least on the personal tech sector, as Didi Chuxing is being forced to delist from the NYSE and looks to reestablish its shares in Hong Kong.
From a vantage point some 7000 miles away, it appears that President Xi Jinping is moving quite rapidly in his efforts to completely control all aspects of the Chinese economy. Do not be surprised to see every Chinese company listed outside Shanghai or Hong Kong to wind up moving that listing, nor to see further declines in those equity markets. Capitalism with Chinese characteristics turns out to be socialism/communism after all, at least from the definitional perspective of the state controlling the means of production. Whether this results in faster growth, or whether the rest of the world will even be able to determine that remains to be seen. However, classical economics would suggest that the more internalization and the stricter the business regulations, the slower will be future growth.
Why, you may ask, is this important? Well, first off it is reasonable to expect that ongoing liquidity injections in the Chinese economy are likely to eventually weaken the renminbi. Second, if the growth trajectory of the Chinese economy is flattening, one of the few things the Chinese will be able to do to address that is weaken the currency to make its exporters more competitive. The point is, while recent PBOC policy has been to maintain a strong and stable currency, and we have seen the renminbi appreciate more than 11% since it bottomed post-pandemic, the case for that trend to end and a weakening trend to develop appears to be growing. For asset and receivables hedgers, careful consideration must be given to managing that risk.
With that in mind, let us turn to this morning’s activity. Friday’s NFP report was mixed, with a weaker than expected headline number for jobs growth, but a much better than expected outcome in the Unemployment Rate as it appears more and more people are leaving large organizations and striking out on their own. The upshot is labor market tightness is still with us and unlikely to ease in the short run. Investors decided that was an equity market negative as it would encourage the Fed to taper policy even more quickly hence Friday’s equity sell-off. At the same time, concerns over tighter policy slowing growth seem to have bond traders flattening the curve rapidly as they fear a Fed policy mistake of raising rates into slowing growth. In other words, it’s all a mess!
Ok, overnight saw weakness in Asia (Nikkei -0.4%, Hang Seng -1.8%, Shanghai -0.5%) following the US Friday narrative, while Europe has decided things are far better this morning with rallies across the board (DAX +0.3%, CAC +0.7%, FTSE 100 +0.9%). On a relative basis these moves make sense given the terrible Factory Orders data from Germany (-6.9% in October) while UK Construction PMI surprisingly rose to 55.5. Meanwhile, US futures are a bit schizophrenic this morning with the DOW (+0.6%) looking to rebound from Friday while the NASDAQ (-0.4%) seems set to continue to slide.
The bond market, which rallied sharply Friday (Treasury yields falling 10bps) is giving back some of those price gains with the 10-year yield higher by 5.2bps this morning. European yields are also a higher, but by much less (Bunds +0.9bps, OATs +0.7bps, Gilts +1.2bps), which are also consolidative moves, just not quite as dramatic.
On the commodity front, oil continues to whipsaw with a sharp rebound today (+3.25%) although NatGas (-7.9%) is getting crushed on a combination of forecasts for warmer weather in the Northeast as well as lower LNG prices in Europe. In the metals markets, gold (-0.2%) continues to trade just below $1800/oz, neither rallying alongside inflation nor collapsing. Copper (+0.8%) seems to be following oil, but aluminum (-0.85%) and tin (-1.9%) both seem to be in a more fearful mode.
Turning to the FX markets, mixed is the best description as we have both substantial gainers and losers vs. the dollar. In the G10, AUD (+0.5%), SEK (+0.5%) and NOK (+0.5%) are leading the way higher on the back of the better commodity sentiment. Meanwhile, CHF (-0.5%) and JPY (-0.3%) are both under pressure on the same story plus the European risk appetite. In the EMG bloc, ZAR (+0.7%) leads the way with CLP (+0.3%) next as the commodity story seems to be driving thing here too. On the downside, TRY (-0.45%) continues its volatile trading while the other laggards are from both APAC and EEMEA but have not seen significant declines.
On the data front, it is inflation week with CPI on Friday the biggest number to watch. Leading up to that is the following:
|Tuesday||Q3 Nonfarm Productivity||-4.9%|
|Q3 Unit Labor Costs||8.3%|
|Wednesday||JOLTS Job Openings||10500K|
|Friday||CPI||0.7% (6.7% Y/Y)|
|-ex food & energy||0.5% (4.9% Y/Y)|
In addition to this data, we hear from the Bank of Canada on Wednesday, where expectations are for no rate movement although they have been amongst the most hawkish of the G10 central banks of late. As to CPI, while it is not the Fed’s preferred gauge, Chairman Powell clearly feels the pressure and so next week we can expect to see just how much faster they are going to reduce QE purchases…at least for now.
There are so many cross-currents driving markets right now, it is very difficult to find a specific underlying theme in the short-term. Longer term, nothing has changed my view that the Fed will halt their tapering/tightening script as soon as equity markets begin to decline a little more substantially. At that point, I feel like the dollar may come under pressure, although during the decline, it should probably rally further. Payables hedgers should be taking advantage of this relatively strong dollar as I don’t think it will last that long.
Good luck and stay safe