Dear All,
My China and Fed analysis… This is the un-edited, not spell checked version – Tradingfloor.com will of course have more official version later…
https://www.tradingfloor.com/
Investment conclusion:
· Value at risk, VaR, explosion will drive a risk-off scenario. Less transparency, lower growth, risk of deflation and lack of understanding add up to less positioning and risk of breaking support levels in equity (DAX futures support 10.668 my entry SELL level…)
· US Dollar should weaken I see 1.14/1.1500 before retest 1.1000 but then higher into year-end (1.1900 target) (chart below) .The action taken by China is setting in motion events which will change the consensus away from recycling of excess capital from Asia to the US bond market and probably a sizeable reduction in China 3.6 trillion US$ foreign exchange reserves. In simple terms US will get less help to finance its deficits from Asia, and the price paid for this is a continued rise in the cost of capital, which can already be seen in bond yield spreads. Add to this that the US$ strength is inverse correlated to the rate cycle (higher cost of capital makes US$ weaker – as price of money goes up, price of currency needs to adjust down for a reserve currency.
· Commodities or real tangible asset will become more attractive. China opening up, SNB not supporting floor, FED and BOE leaving behind QE, and less recycling will see US$ peak, and in the process coming from zero growth, zero interest rates and zero hope will leave all "paper" asset with an expected return of …zero.. Hence more attractive valuations for something like gold and silver, which remains my favorite long. Chinese investors is already moving into gold as seen from chart below, as they leave behind real estate, stock market and state banks deposits for the only currency NOT controlled by a central bank gold
China: 'Coming events cast their shadows before them' (山雨欲来风满楼) – Chinese proverb
The state of confusion on China is astonishing. Rarely have I seen so many smart people being so confused at the same time. China remains an enigma for especially Anglo-Saxon analyst and strategist, being brought up with central banks and policy makers who at all costs wants to extend-and-pretend. I guess my conclusion is that China stopped pretending through the devaluation this week.
I am upset with myself as my recent trip to China (early July) brought home three major points which should have given me the insight to this devaluations: First, and most surprising the actual liberalization going on in China was faster than even policy makers and regulators would have thought. Secondly, the internalization of the CNY was a big talking point and something I constantly had to discuss and in that context the third observation: All the major FX players in China was short the CNY. Yes, I'm too stupid, but the bigger point being China's devaluation did not happen in total surprise or out of context!
This is major step, a brave one, but one which perfectly fits the plan to support the Chinese economy while the "bridge" to the Silk Road project which should come fully online in 2016 and 2017. The catalyst remains the internalization of the CNY. This means being included in IMF, Special Drawing Rights, which again comes with demand of more market based pricing of the currency.
That China times it perfectly ahead of the FED hike potential hike in September, and note that Vice-governor Dudley this morning said: "…May not be inappropriate for Yuan to adjust to the economy" is clear indication it will not stop FED… (more on this later…)….and ahead of the September meet where Obama hosts President Xi for a state visit. Yes, China has a plan. You may disagree, but they have a plan! Where is the plan for Greece, Europe, Latin America or even the US? "Show me the money"
Now before being taken for a Sino fan, let me stress that having a plan does not mean necessarily delivering, hence if…. This devaluation is followed by further integration and better access to China's financial market it will be net positive over time – How can moving from closed capital account structure to open economy be net negative?
The devaluation will also have a net positive impact on the growth in China, but to honest I think growth will have more stimulus from the cocktail of lower rates (RRR cuts started in February) and lower commodity and energy prices. Actually, electricity consumption is slightly rising indicating the worst is over, or that lower input cost is working:
China Electricity Consumption (YoY) – Leading by 3 month vs. MNI China PMI (lagging)
China bubble or not?
Many I have talked to over the last 24 hours sees China as "imploding"… hmm.. maybe a few data points is in order…..I know, I know…facts is boring… but..
China total debt to gdp is 282% according to McKinsey&Company report: Debt and (not much) deleveraging from February 2015 which is high, but relatively the same levels as other major nations:
Oh I forgot to give you Japan's and Spain's data: Japan debt to gdp: 517% of GDP and Spain's: 401%.......
This is the point to me. There is too much focus on the 3% move in CNY relative to the bigger macro implications. China's nominal GDP growth easily outgrows the price of debt, the gross domestic saving of 49.9% of GDP provides a deep and stable funding for China's authorities. McKinsey of course is right in pointing out that the "velocity of growth in debt is concerning"……but here we also have to address the fact that China is coming of age…. They are in different path of their socio-economic cycle to developed markets which means investment before return and the good news is that during 2008-2010 China just spend more money, now they are opening the markets.
Finally, the move so far, at least needs to be put in perspective: The CNY is 14% stronger than in 2014 same time of year, the US (and hence US$) has risen against all currencies, the export volume is down and most importantly China's two main competitors: Korea and Japan have devalued 15% and 40% over last two years…….
Bloomberg estimates a 10% devaluation will mean 10% growth in export – 10-15% sliding devaluation is very like in my opinion…. And the negative is risk of capital flight – again Bloomberg – estimate that for every 1% move in CNY there is 40 bln. US$ leaving, that is 400 bln. for 10%..... risk but one China can afford with 3.4 trillion US$ of reserves.
But… these are just words – the real test is how the market reacts over the next two-three weeks and to monitor this my dear colleague Mads Koefoed has created an INDEX/Instrument monitor which uses Monday close as index-100 – (before first devaluation) – so far the score is this:
Or sorted by performance since devaluation:
Indeed.. I think that the Chinese proverb is right: 'Coming events cast their shadows before them' or is another Chinese proverb more appropriate: "A wise man should not stand next to a dangerous wall"… only time will tell..
Finally,
A Bloomberg chart done on the back of Vice-governor Fischer speech on Monday caught my attention. In world where everything is prices to "in-perfection" economically, it's interesting to see how job growth leads and correlates highly (>70%) with inflation and far more so than GDP growth – are we about to get inflation surprise or at least a re-pricing of future inflation?
Fed will hike in September…….remains my FED call – and that FED hike starts a new market cycle with lower US$, higher rates, and rising commodities but FED remains the catalyst.
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
Phone: +45 39 77 40 00 | Direct: +45 39 77 62 23 | Mobile: +45 51 54 50 00
Research: http://www.tradingfloor.com/traders/steen-jakobsen
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