Archive for the ‘Asia/China’ Category

Pressure for Chinese Tightening Continues to Build:

May 11th, 2010 Michael McDonough Comments off

As the chart below illustrates, Chinese inflation has risen above levels where over the past five years Chinese authorities reacted with significant hikes in the country’s benchmark deposit rate.  Yet, Chinese authorities may delay a hike, at least for the moment, to measure the effectiveness of targeted policies at the property sector and several increases to China’s reserve required ratio, now just below the series high of 17.5% at 17.0%.   Nevertheless, even larger gains in producer prices will provide significant tailwinds to Chinese inflation in the second half; likely resulting in higher inflation and slower growth as the government is forced to react.  This outlook will likely continue to weigh on Chinese equities, with the MSCI China index already down roughly 7% since the start of the year.

Chinese Year-Over-Year Inflation Vs. Benchmark Rate

Source: Bloomberg

In the mean time, China’s real estate sector will likely continue to face the brunt of China’s ‘targeted’ tightening policies as authorities try to avoid the type of bubble experienced here in the U.S.  The MSCI Chinese real estate index has lost 15% since its introduction on March 5th.  Given mounting cost pressure—combined with a recovery in the country’s export sector—there is also a fairly good chance that the Chinese RMB will re-initiate its course of gradual appreciation.   This may become a very sensitive topic given U.S. mid-term elections and recent rhetoric between the two countries.


A Crossroad for the Eurozone’s Survival

May 9th, 2010 Michael McDonough Comments off

Europe’s rapidly escalating out-of-control debt crisis has brought about a rare occurrence, solidarity amongst its members; an elusive attribute in the European experiment.   Eurozone members, who have worked tirelessly over the weekend, appear to have agreed on creating a $645bn loan package to help defend its currency and stymie fears of Greek contagion to other countries.  It is still too early to tell whether or not Europe’s new found cooperation will be enough to restore investor confidence, but the Euro has regained some ground in Asian trading.  The true test will come in its ability to bring down skyrocketing yields for Portuguese and Spanish debt, which has come under the microscope of investors due to each countries’ weak fundamentals.  Portugal’s close mirroring of Greece just prior to that country’s breakdown may have been a major catalyst to the creation of this unprecedented loan package—along with a free falling euro.

If this package fails to bring down yields for Spanish or Portuguese debt or stabilize the Euro this situation will very quickly escalate out of control with the potential of tearing apart the Eurozone.  Many already believe the best solution for Greece with but to withdraw from the EU, and return to the Drachma, which only a few months ago would have been an unspeakable idea.  However, historically these types of programs tend to work, or at least stabilize the situation and buy more time for a more permanent solution if necessary.  Nevertheless, a bigger risk may lie ahead for Europe in the form of a double dip recession brought on by austere fiscal policies necessary to repair most member nations ailing budgets.  The EU’s weakest members, commonly referred to as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) could find it extremely difficult to survive another recession.  Think about someone who has maxed out all of their credit cards, and is about to take a large pay-cut at work.  The only difference here is these countries are indebted to more than just a few credit card companies…

The next twelve hours will be critical for Europe, however, investors mustn’t forget about the next 12 days or 12 months either as this package could prove to be a Band-Aid for a much deeper wound.

Early comments from Paul Krugman raise some good points, but aren’t promising for either Portugal or the rescue package. But, I think the precipitous drop in the euro is indicative of plunging confidence in the region, and both aspects need to be addressed simultaneously.

“I’m not encouraged by the remarks of some of the leaders, who keep talking about protecting the euro as if speculation against the currency were the problem. Actually, a weak euro helps Europe. Speculation against the debt of weak nations is another matter; will they have any real answer to that problem?”  -Paul Krugman

Krugman’s Blog


China’s Tightening Tool Box…

March 12th, 2010 Michael McDonough Comments off

The wheels of tightening may be gaining momentum in China, after February’s higher than anticipated inflation release.  High inflation leading to negative real deposit rates may entice investors to withdraw deposits and invest in more speculative assets, potentially spurring what is arguably already a bubble in the country’s housing sector.  I believe that China has been avoiding an increase in its deposit rates, at least before tightening by the U.S. Fed, in order to avoid further spikes in hot-money inflows (from investors looking to take advantage of interest rate differentials and anticipated appreciation in the RMB).  But, China’s inflation may have passed a threshold forcing the government to act.

Chinese Consumer Prices on an Annual Basis:

Source: Bloomberg

So what does further tightening in China look like?  First off we will likely see China continue removing excess liquidity through open market operations, increasing the yields and issuance of PBOC paper.  As the chart below illustrates, China has already begun this process, but thus far has proven to not be enough.

China People’s Bank of China 1Y Reference Yield:

Source: Bloomberg

China will most likely continue raising its reserve required ratio (RRR), which they have already increased to 16.5% from 15.5% since the start of the year.  I expect the RRR will move to it’s historic high of 17.5% over the next several months.

Chinese RRR:

Source: Bloomberg

A recovery in Chinese exports and inflationary concerns should reignite a gradual appreciation in the RMB, which was suspended at the onset of the global financial crisis.  (For more on this please see my recent piece on the RMB NDF curve).


Source: Bloomberg

Finally, the coup de grâce in Chinese tightening will be any hike in the country’s reference deposit/lending rates.  This would be a clear indicator that Chinese authorities mean business, and the country’s tightening cycle is approaching full swing.  Many analysts suspect we could see a hike in this rate within the next three weeks. possibly as early as next week.  Reverberations from this move would be felt globally, especially in the material and global transport sectors.  Easy money and large increments in new lending spurred almost insatiable demand from the country for raw materials for both final use and speculative purchases.  But, let us not forget, despite creating short-term volatility, these moves are necessary to guarantee China’s future economic growth.  Therefore, China’s tightening cycle will likely lead to quite a few buying opportunities both inside and outside of the country going into the future.

Chinese 1Y Deposit Rate vs. Fed Funds Target:

Source: Bloomberg


Chinese RMB Appreciation Always Seems Six Months Away (But It’s Coming)…

March 9th, 2010 Michael McDonough Comments off

Since the start of this year I have been a proponent of the belief that China will once again begin to gradually appreciate their currency as exports recover, and inflation begins to creep back into the Chinese economy.  As the chart below illustrates,  investors in the CNY NDF market appear to share this view.  But, excluding the curve from 3/10/09, significant RMB appreciation always seems to be six months away.  The magnitude of the appreciation has grown from September, but is still six months off.  In addition to inflationary fears, speculative capital inflows have buffeted China due to interest rate differentials and the expectations of eventual RMB appreciation, placing further pressure on the currency.  What I believe this data shows is that appreciation in China is inevitable, while the actual timing and magnitude remain in question.  But, I do expect we will see the Chinese government reinitialize the RMB’s gradual appreciation within the next six months.  This move will be expedited if export growth remains robust, while inflation continues to rise.

RMB NDF Curves

Source: Bloomberg


Japan Still a Big Concern; More so Than Greece?

March 1st, 2010 Michael McDonough Comments off

While all eyes remain on Greece, Japan’s fundementals continue to weaken, and in some instances look worse than Greece.  There are of course numerous technical and economic differences between the two nations; however, I do not believe Japan’s current deficits and debt load will be sustainable without drastic changes.  This is an update from my piece titled ‘Positioning Yourself for Japan’s Potential Demise…’.  The charts below illustrate some areas of concers for the Land of the Rising Sun:

Fiscal Deficit

Source: Bloomberg


Debt to GDP

Source: Bloomberg

 GDP Growth

Source: Bloomberg

Debt Coming Due % of GDP

Source: Bloomberg


China’s Surprises on Timing, But Not Action

February 12th, 2010 Michael McDonough Comments off

Judging by the market’s reaction, investors were blinded sided today when Chinese officials increase their reserve requirement ratio for the second time during its renewed tightening cycle.  But, really the only surprise was that the hike occurred just prior to the Chinese New Year, which is a week long holiday.  I have been stating for weeks, and I believe the market has widely anticipated that that another RRR hike was imminent, so today’s strong sell-off on the news comes as a bit of a surprise to me, and highlights the fragility to markets and their sensitivity to negative news, even if anticipated.  I should note this action came right after Chinese data pointed to lower than expected consumer inflation.

To help put things into perspective magnitude of this RRR will be far smaller than the country’s open market operations in removing liquidity from the market–so far this year open market operation have likely removed over 4x the liquidity than this move will total.  The market can anticipate additional RRR hikes over the months ahead.  The RRR presently stands at 16.5%, versus a historical high of 17.5%.  I also anticipate the central bank will continue to remove additional liquidity through open market operations via additional issuance and higher yields on its 1Y paper.  Keep in mind so long as China’s reference rate remains at 2.25%, 1Y yields can not move above this level; regular auctions are held on Tuesday and Thursday.

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Lending Spikes in China, Confidence Falls, & Consumer Prices Remain Tame for Now…

February 10th, 2010 Michael McDonough Comments off

According to the China Securities Journal, Chinese banks lent almost CNY1.4 trn in new loans during January–third-largest monthly total on record. This was less than the CNY1.6 trn some outlets has been speculating on, but far more than what I expect the government would have liked. But, considering that it was reported that CNY1.1 trn had been lent by the middle of the month, it would appear government controls began to suppress lending in the latter part of the month.

Consumer inflation unexpectedly slowed in China to 1.5% in January from 1.9% in December. The consensus forecast was for a 2.0% increment. Food inflation, which is a key component to consumer prices in China rose 3.7%, compared to 5.3% in December. I expect consumer prices will continue to accelerate in February, likely moving above 2.0%. Despite the slowdown in consumer prices, wholesale prices jumped 4.3% from 1.2% in December.

Consumer confidence in China fell to a five month low on the back of the government’s tightening and poor stock market performance.  The indicator from to 97.2 in January from 99.1 in December.  The index bottomed in November of 2008 at 88.6.  Any reading below 100 implies pessimists out number optimists.

On a personal note, I recently joined Twitter, so please feel free to add me to your list. Twitter: FiatEconomics


Rate Hikes Likely On Hold in China, At Least for Now…

February 7th, 2010 Michael McDonough Comments off

According to the China Securities Journal Yao Jingyuan, chief economist of China’s National Bureau of Statistics, said “Money supply is too big and that’s leading to excess liquidity.” He went on to say, “I would prefer reserve hikes to rate hikes because rate hikes could cause hot money to flow back.” Jingyuan’s comments are further evidence that Chinese officials will hold-off on rate hikes for as long as possible to avoid hot-money inflows, and will likely continue hiking reserve requirement ratios while using open market operations to remove excess liquidity. Also keep in mind that Chinese New Year will begin on February 14th.

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Concerns in Chinese Real Estate Sector Grow as Transaction Volumes Plummet

February 2nd, 2010 Michael McDonough Comments off

Concerns over the future impact Chinese policies could have on the real estate sector have nearly halted transactions in the sector as buyers expect prices will begin to fall. According to the China Securities Journal, the volume of second-hand property transactions fell nearly 70% m/m in January, with new sale transactions falling by more than 45%. This news likely will not bode well for the Chinese real estate sector, especially companies like EHouse (EJ) who rely on volumes.

Further aggravating China’s real estate sector were comments by Beijing’s vice-mayor picked up by China Daily who said “I want to make it clear – Beijing is determined to curb the price hike.” He added, “I believe Beijing’s property price will not experience wide fluctuation this year.”

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More on China

January 26th, 2010 Michael McDonough Comments off

Following up on my comment from early this morning, Uncertainty of Chinese Tightening Continues to Weigh on Asian Markets, I wanted to mention that, surprisingly, the Chinese central bank, during its regularly scheduled Tuesday auction, did not increase the yield on its one-year paper, keeping it constant at 1.9264%. It is widely expected that once this yield reaches 2.25% — the current deposit rate — a Chinese rate hike is inevitable.

This pause may imply that government officials believe a hike in the reserve requirement ratio and other policies have been effective, and investors may be able to take a short breath prior to an eventual Chinese rate hike. The next regularly scheduled auction will be on Thursday.

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