The "problem" with the China selling reserves argument:
It would have been going for a long considering that they moved from 4.0% surplus in 2014 to negative 1.0% now…..but of course some of it can be "extended" by RRR cut which equates to a need to sterilize 61 bln. US$ per 25 basis cut in RRR. (RRR overview below)
China Capital and Financial account surplus of GDP
China current account is improving slightly….
China Current account % of GDP
M2 the net beneficiary of historic surplus on Current account ..
M2 China absolute and 12 month change….
China just posted the lowest GDP in 24 years – but to estimate impact of RRR cut in US$ and of course, the connection to selling zero coupon bonds globally, mainly US…
RRR is now 18.50% - the 20 yr average 12.00, but assuming significant more stimulus is needed to reignite China growth into Silk Road, we can conservative estimate RRR needs to go down. The BIS requirement is 4.5% - and the US operates with 6-8% since July 2013. In other words banking sector is allowed to leverage 22x outside US and 12.5% in the US – let's assume China goes to 12.00% 20-Y average.
Calculations then become:
(61 bln. US$ * ((20-12))*4 = 1.952 bln. USD. (61 bln. US$ per 25 basis times 8% net change)
China FX reserves inclu. "loss of RRR cuts"
Finally,
The "custody account" at Federal Reserve, i.e: other central banks holding remains as an aggregate largely unchanged since 2013, but Japan is now biggest "shareholder" of US Treasuries replacing China:
Combine this China "negative flow" with US monetary data:
Clearly, the secular wind of US bond market has changed – at face value China could become be the real catalyst for a low point in US rates, even before FED get on with their expected "margin call" / Normalisation rate hike later in 2015.
I have noticed in my way too long financial career that's if never in Washington (Fed) where changes is started – often it's Asia – during my early days in the market it was Japan (1987 crash started in Tokyo) and now it China.
China "saved" the world through biggest monetary stimulus in 2008/09 – bought time, now they are about to start the Silk Road, but to "free up capital" for this they need to sell down their close to zero earning stocks on t-bonds…….
My take however remains: Rates will creep higher for all of the above reasons, but… it will lead to Europe recession and a US flirt with recession, which will give one more go at 1.5% in 10 YR US, as Fed restarts the engines too late in 2016.
In short: I see 3.25% 10 YR before year-end, then sub 1.5% on recession Light in the US. I see Gold in 1425/50 as rotation out of fixed income will benefit commodities at zero bound. Tangibles vs. Intangibles, Inflation hedge vs. deflation.
I am still working hard on Steen's Chronicle: Road Map to 2016 and beyond, but wanted to share my China thought with you as it has material impact on present rate view.
Safe travels,
Steen Jakobsen
Med venlig hilsen | Best regards
Steen Jakobsen | Chief Investment Officer
Saxo Bank A/S | Philip Heymans Allé 15 | DK-2900 Hellerup
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