Month: January 2014

And so following yet another Fed taper, coupled with another disappointing manufacturing data point out of China, emerging markets did their thing first thing this morning and all the most unstable EM currency pairs – the TRY, the RUB, the ZAR and the HUF – all plunged promptly in the process pushing down the USDJPY which as become a natural carry offset to EM troubles, only to rebound promptly. Specifically, USDTRY blew out 400 pips to 2.3010 highs after which it bounced, and has now stabilized around 2.27, well above the Turkish central bank intervention level, USDZAR is back down to 11.2120 after hitting five-year highs of 11.3850, the Ruble also plunged after which it jumped on speculation of Russian central bank intervention, while futures are tracking even the tiniest moves by USDJPY and pushing the Emini which is trading in a liquidity vaccum by a quarter point for ever 2 or pips. And with all news overnight shifting from bad to worse (keep an eye on declining German inflation now) it goes without saying, that EM central banks around the world now are desperately trying to keep their currencies under control: which is why the market’s jitteryness is only set to increase from here on out.

Looking at the day ahead, the focus will be on whether there is any more follow through to what we saw yesterday in EM. That aside we have a number of important data releases today starting with the German inflation and unemployment report for January as well as Spanish Q4 GDP. The ECB will publish its Bank Lending Survey. In the US, the advanced estimate of Q4 GDP will be the main focus where the estimate is for an annual QoQ print of 3.2%. Today is one of the busiest days on the corporate reporting calendar with 10% of the S&P500 provide earnings updates, including Exxon Mobil and Google which are the second and third largest companies by market cap.

Market recap from RanSquawk:

Concerns over EM remained at the forefront this morning, with TRY, ZAR bid vs. USD and EUR/HUF at its 2y high, as market participants digested the release of less than impressive macroeconomic data from China, as well as yesterday’s decision by the FOMC to taper QE by USD 10bln. As a result, firmer USD, together with softer inflation data from German states meant that EUR/USD remained under pressure since the EU open. At the same time, worse than expected money supply and mortgage approvals data from the UK, together with touted month-end buying of EUR/GBP weighed on GBP/USD, which trades in close proximity to the 50DMA line.  The risk averse sentiment, as well as month-end buying supported Bunds, while USTs continue to underperform as market participants adjust their Fed Fund expectations following yesterday FOMC decision. Going forward, focus turn to the advanced GDP report from the US, 5y and 7y auctions by the US Treasury and earnings by Exxon, Google and 3M.

Overnight headline bulletin from Ran abnd Bloomberg:

• Initial weakness in EM currencies was reversed after Russian central bank verbally intervened to support RUB, which filtered through into other EMFX.
• Bunds outperformed USTs throughout the session, supported by soft inflation data from Germany, general risk averse tone amid concerns over EM and also touted month-end buying.
• The Nikkei 225 index fell over 2% as risk averse sentiment following the FOMC supported the bid tone in JGBs, weaker than expected macroeconomic data from China also weighed on sentiment.
• Treasuries decline, paring advance that yesterday drove 10Y yield to lowest close since Nov.; week’s auctions conclude today with $35b 5Y (WI 1.565% vs 1.60% stopout in Dec.) and $29b 7Y (WI 2.19% vs. 2.385% last month).
• A Chinese Purchasing Managers Index fell to 49.5 from 50.5 in Dec., HSBC Holdings Plc and Markit Economics said in a statement today, the first contraction in six months and below the median 49.6 estimate in a Bloomberg News survey
• German unemployment fell by 28k to 2.93m, more than forecast;  jobless rate unexpectedly fell to 6.8 percent, unchanged from a revised December figure and matching the lowest rate in at least two decades
• New Zealand’s central bank said it intends to start raising borrowing costs “soon” as the economy strengthens. The currency fell as markets had priced in about a 50% chance of a rate increase today
• Even as he calls income inequality the “defining challenge of our time,” Obama is pursuing new trade agreements that some of his political allies say will only make the problem worse
• Ukraine’s president quashed a demand to unconditionally pardon protesters calling for his resignation, prolonging the country’s political crisis after Russia threatened to withhold aid
• Sovereign yields mostly lower; exceptions include Ireland, Greece, Spain and the U.S.; EU peripheral spreads widen. Asian equity markets slide, European  markets fall, U.S. stock-index futures slightly higher. WTI crude higher, gold and copper lower

Asian Headlines

The Nikkei 225 index fell over 2% as risk averse sentiment following the FOMC supported the bid tone in JGBs, in turn encouraging bull flattening of the JPY swaps curve. Yet another less than impressive macroeconomic data release from China – Chinese HSBC Manufacturing PMI (Jan) M/M 49.5 vs. Exp. 49.6 (Prev. 50.5) – further weighed on sentiment.

Analysts at HSBC said that a soft start to china’s manufacturing sectors in 2014 was partly due to weaker new export orders and slower domestic business activities during January. While analysts at Credit Suisse have cut their Chinese Q1 GDP growth target to 7.3% from 7.7%. (RTRS/Credit Suisse)

EU & UK Headlines

Bunds outperformed USTs throughout the session, supported by soft inflation data from Germany, general risk averse tone amid concerns over EM and also touted month-end buying.
German CPI Saxony (Jan) M/M -0.5% (Prev. 0.4%)
German CPI Bavaria (Jan) M/M -0.7% (Prev. 0.5%)
German CPI North Rhine Westphalia (Jan) M/M -0.6% (Prev. 0.5%)
German CPI Baden Wuerttemberg (Jan) M/M -0.6% vs Prev. 0.3%
German Unemployment Change (000’s) (Jan) M/M -28K vs. Exp. -5K (Prev. -15K, Rev. -19k)
German Unemployment Rate (Jan) M/M 6.8% vs Exp. 6.9% (Prev. 6.9%, Rev. 6.8%)
Eurozone Consumer Confidence (Jan F) M/M -11.7 vs Exp. -11.7 (Prev. -11.7)
Eurozone Business Climate Indicator (Jan) M/M 0.19 vs Exp. 0.35 (Prev. 0.27, Rev. 0.20)
Italian bond auction results: Sells EUR 7bln vs. Exp. EUR 7bln 2019 and 2024 BTP and Sell EUR 1.46bln vs. Exp EUR 1.5bln in 2018 FRN.
– Sells EUR 4bln 2.5% 2019, b/c 1.49 (prev. 1.28), avg. yield 2.43% (prev. 2.71%)
– Sells EUR 3bln 4.5% 2024, b/c 1.32 (prev. 1.34), avg. yield 3.81% (prev. 4.11%)
– Sells EUR 1.46bln 2018 FRN, b/c 2.84, avg. yield 1.79% (Prev. 2.11%)
UK Mortgage Approvals (Dec) M/M 71.6K vs. Exp. 72.9K (Prev. 70.8K)
UK M4 Money Supply (Dec) M/M -1.4% vs Prev. 0.0% (Rev. 0.1%) – biggest decline for 17 years and second biggest in the last 30 years.
Barclays preliminary pan-Euro agg month-end extensions: +0.13y (12m avg. +0.07y)
Barclays preliminary Sterling month-end extensions:+0.19y (12m avg. +0.06y)

US Headlines

Fed watcher Hilsenrath said the Fed sets the bar for change in taper plan continuing to reduce bond buying by USD 10bln a month. He added that the Fed does not see recent emerging market turmoil as impediment to tapering. (WSJ)

JP Morgan forecast 10yr US yields at 3.6% by the end of 2014, with the S&P 500 climbing to 2,000. (JP Morgan)
Barclays preliminary US Tsys month-end extensions:+0.06y (12m avg. +0.07y)

Equities

Heading into the North American open, stocks in Europe are seen somewhat mixed, with FTSE-MIB and IBEX-35 index outperforming on the back of stocks specific news flow. Overall, risk averse sentiment following yesterday’s FOMC decision and concerns over further capital flight from EM weighed on investor appetite for stocks. Of note, German listed fertilizer manufacturer K+S shares fell 2.7% after Potash Corp, the world’s largest potash producer, gave downbeat guidance for the next quarter.

HSBC shares were temporarily halted, with the spike higher of almost 10% being attributed to a fat finger trade, before resuming trade.

FX

EUR came under broad based selling pressure amid a firmer USD and also softer than expected German states CPI, which raised prospect of further policy easing by the ECB. In turn this resulted in bull flattening of the Euribor curve, with EONIA 1y1y rate also underpressure. Elsewhere, lower than expected M4 money supply, which also marked its the biggest decline for 17 years and second biggest in the last 30 years, together with touted month-end buying of EUR/GBP by EU sovereign name weighed on GBP/USD.

In EM space, EMFX reversed initial weakness after Russian central bank verbally intervened to support RUB. However earlier in the session, EUR/HUF traded at its highest level in over 2y, while USD/TRY traded pre interest rate hike levels. RBNZ kept the Official Cash Rate (OCR) unchanged at 2.50% as expected, however NZD/USD fell as there were outside bets of a rate hike (3/15 analysts) (BBG)

Commodities

ABN AMRO Brent crude forecast raised by 5.3% to USD 100/bbl and Brent-WTI spread forecast to narrow to USD 5/bbl this year. (BBG)

China gold demand seen resilient in 2014 and imports seen above 1,300 tons in 2013, according to CNC’s Na Liu. (BBG)

Japanese copper and brass output will cross 800,000 tonnes in 2014, according to the JCBA. (MetalBulletin)

 

* * *

We conclude as always with Jim Reid’s overnight recap

Emerging market jitters returned in force yesterday, with a $10bn Fed taper and a disappointing Chinese HSBC PMI merely adding to the gloom. Overnight the final Chinese HSBC manufacturing PMI for January printed at 49.5, confirming the first sub-50.0 reading in seven months. Recall that the preliminary reading was 49.6 and much of the sequential drop was blamed on a government clampdown on polluting industries during the winter months and an emphasis on anti-corruption efforts in the lead up to the Lunar New Year. Already a couple of banks have downgraded their Q1 Chinese GDP estimates in response to the PMI and it seems that the market sentiment on Chinese growth has yet to find a bottom despite some recent better news on the country’s shadow banking system. The official Chinese PMI reading is due early on Saturday morning (London Time) and the expectation there is for the index to fall to 50.5 from 51.0 in December, which would also be the lowest print in seven months.

Following yesterday’s EM performance, Asian assets are once again being sold off overnight across credit, FX and equities. Losses in equities are being led by the Nikkei (-2.8%) which broke through the 15,000 level. Japanese exporters are underperforming on the back of USDJPY losing another 0.1% overnight following a 0.6% drop on Wednesday. Asian equities touched a session low shortly after the release of the Chinese PMI but the reaction to the data itself was only mildly negative. In credit, the high beta sovereigns including Indonesia have seen their CDS widen by 16bp and Asian IG spreads are about 5-6bp wider on the day. Asian EMFX bellwethers such as the Indonesian rupiah (-0.4%), Korean won (-1%) and Malaysian ringgit (-0.3%) are all struggling against the dollar – though these moves pale in comparison the ones we’ve witnessed in other EM jurisdictions such as in LATAM in recent days. AUDUSD fell about a quarter of a percent post-PMI but has pared back most of those losses. Much of Asia shuts down for the week today for Lunar New Year celebrations and will only begin to gradually from Tuesday next week.

Bernanke’s final FOMC ended on a rather quiet note and there were no real surprises in terms of policy or the Fed’s post-FOMC statement. The reaction to policy statement was fairly subdued with 10yr UST yields ticking down slightly (-7bp on the day at 2.67%) while US credit & equities continued to pull back. In terms of the FOMC itself, DB’s Peter Hooper summed it up succinctly by saying that the FOMC sounded slightly more upbeat about recent economic news, tapered another $10 bn on schedule, left thresholds untouched, and there were no dissents. They acknowledged the stronger pace of growth in H2 last year (specifically in household and business spending), but also observed the mixed picture in labor markets (an allusion to the weak payroll number in December). The FOMC statement did not specifically mention the recent volatility in EM.

The risk reversal that began early in the European session took many by surprise, and investors began questioning whether the hikes from the CBRT and SARB would improve or worsen the growth/inflation dynamic. The ruble (-0.7%), which has now depreciated for 13 straight days, weakened to a five year low thanks in part to Russian Finance Minister Siluanov’s comment that “Russia should not follow the suit of some emerging markets in an attempt to slow rapid depreciation of their currencies”. Following a 6% intraday peak to trough depreciation in the TRY, Turkey’s PM Erdogan said he would give some time for recent rate hikes to succeed before potentially trying alternative measures that he said are ready to be deployed. Erdogan said the government may announce its “Plan B” in a few weeks but didn’t offer much detail on what it entailed. DM credit traded in a massive range yesterday, with the European iTraxx printing as low as 76bp in the morning, and as wide as 85bp in the afternoon for an intraday range of 9bp. The S&P500 (-1.0%) traded down to its 100 day moving average for the fourth time since June 2013.

There was some positive news flow amongst the doom and gloom. A comfortable earnings and revenue beat from Dow Chemical saw the stock rise 3.8% and the chemical sector proved to be one of the only sectors which traded firmer yesterday. The company reported robust demand for its agricultural products and its plastics division appeared to benefit from the abundant supply of gas in North America. The only other sector to trade in positive territory was gold mining (+0.85%), thanks to a 0.84% increase in the gold price as markets sought safe havens. Facebook’s earnings-beat saw the stock trade up almost 12% in extended hours trading. The jump in advertising revenues was quite large (+63%) and the company seemed to convince many that its transition to mobile was progressing well with the majority of advertising revenue in the quarter coming from mobile.

With Bernanke’s final day at the Fed tomorrow, and a number of media outlets publishing a review of Bernanke’s time at the helm, there was an interesting poll published by Gallup that suggested that public opinion was divided on Bernanke’s time as Fed Chairman. The poll, which was conducted on January 25th to 26th, showed that the percentage of respondents approving of Bernanke’s chairmanship was 40%, which is 25 percentage points lower than Alan Greenspan’s approval rating in a similar Gallup poll conducted in Jan2006 in the final days of Greenspan’s tenure. The poll also showed that Bernanke’s disapproval rating of 35% is 14 percentage points higher than that of Greenspan’s 21%. Perhaps it’s unsurprising, but the majority of Republicans respondents disapproved of Bernanke’s Chairmanship (53%) while only 19% of Democrats felt the same way. In terms of income, those with an annual household income of $90,000 or higher showed the greatest approval rating for Bernanke (54%) versus only 34% of households with income less than $24,000.

It’s also worth highlighting that the percentage of respondents with “no opinion” of Bernanke’s tenure was as high as one-in-four (25%) which is 11 percentage points higher than those with no opinion in Greenspan’s poll (14%) – this is despite Bernanke’s Chairmanship spanning the turbulent years of the global financial crisis, the introduction of ZIRP and the subsequent years of QE.

Looking at the day ahead, the focus will be on whether there is any more follow through to what we saw yesterday in EM. That aside we have a number of important data releases today starting with the German inflation and unemployment report for January as well as Spanish Q4 GDP. The ECB will publish its Bank Lending Survey. In the US, the advanced estimate of Q4 GDP will be the main focus where the estimate is for an annual QoQ print of 3.2% (DB is top of the market at 4.0%). Today is one of the busiest days on the corporate reporting calendar with 10% of the S&P500 provide earnings updates, including Exxon Mobil and Google which are the second and third largest companies by market cap.

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The Queen’s finances are at a “historic low” with just £1 million ($1.9 million) left in reserve, British MPs have been told.
Her courtiers have been advised to take money-saving tips from the Treasury.

Read more: http://ift.tt/1b94IyO…

 

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Recovery indeed…

via Zero Hedge http://ift.tt/1iNyGQH williambanzai7

Submitted by Zachary Zeck via The Diplomat,

The prominent realist international relations scholar John Mearsheimer says there is a greater possibility of the U.S. and China going to war in the future than there was of a Soviet-NATO general war during the Cold War.

Mearsheimer made the comments at a lunch hosted by the Center for the National Interest in Washington, DC on Monday. The lunch was held to discuss Mearsheimer’s recent article in The National Interest on U.S. foreign policy towards the Middle East. However, much of the conversation during the Q&A session focused on U.S. policy towards Asia amid China’s rise, a topic that Mearsheimer addresses in greater length in the updated edition of his classic treatise, The Tragedy of Great Power Politics, which is due out this April.

In contrast to the Middle East, which he characterizes as posing little threat to the United States, Mearsheimer said that the U.S. will face a tremendous challenge in Asia should China continue to rise economically. The University of Chicago professor said that in such a scenario it is inevitable that the U.S. and China will engage in an intense strategic competition, much like the Soviet-American rivalry during the Cold War.

While stressing that he didn’t believe a shooting war between the U.S. and China is inevitable, Mearsheimer said that he believes a U.S.-China Cold War will be much less stable than the previous American-Soviet one. His reasoning was based on geography and its interaction with nuclear weapons.

Specifically, the center of gravity of the U.S.-Soviet competition was the central European landmass. This created a rather stable situation as, according to Mearsheimer, anyone that war gamed a NATO-Warsaw conflict over Central Europe understood that it would quickly turn nuclear. This gave both sides a powerful incentive to avoid a general conflict in Central Europe as a nuclear war would make it very likely that both the U.S. and Soviet Union would be “vaporized.”

The U.S.-China strategic rivalry lacks this singular center of gravity. Instead, Mearsheimer identified four potential hotspots over which he believes the U.S. and China might find themselves at war: the Korean Peninsula, the Taiwan Strait and the South and East China Seas. Besides featuring more hotspots than the U.S.-Soviet conflict, Mearsheimer implied that he felt that decision-makers in Beijing and Washington might be more confident that they could engage in a shooting war over one of these areas without it escalating to the nuclear threshold.

For instance, he singled out the Sino-Japanese dispute over the Senkaku/Diaoyu Islands, of which he said there was a very real possibility that Japan and China could find themselves in a shooting war sometime in the next five years. Should a shooting war break out between China and Japan in the East China Sea, Mearsheimer said he believes the U.S. will have two options: first, to act  as an umpire in trying to separate the two sides and return to the status quo ante; second, to enter the conflict on the side of Japan.

Mearsheimer said that he thinks it’s more likely the U.S. would opt for the second option because a failure to do so would weaken U.S. credibility in the eyes of its Asian allies. In particular, he believes that America trying to act as a mediator would badly undermine Japanese and South Korean policymakers’ faith in America’s extended deterrence. Since the U.S. does not want Japan or South Korea to build their own nuclear weapons, Washington would be hesitant to not come out decisively on the side of the Japanese in any war between Tokyo and Beijing.

Mearsheimer did add that the U.S. is in the early stages of dealing with a rising China, and the full threat would not materialize for at least another ten years. He also stressed that his arguments assumed that China will be able to maintain rapid economic growth. Were China’s growth rates to streamline or even turn negative, then the U.S. would remain the preponderant power in the world and actually see its relative power grow through 2050.

In characteristically blunt fashion, Mearsheimer said that he hopes that China’s economy falters or collapses, as this would eliminate a potentially immense security threat for the United States and its allies. Indeed, Mearsheimer said he was flabbergasted by Americans and people in allied states who profess wanting to see China continue to grow economically. He reminded the audience that at the peak of its power the Soviet Union possessed a much smaller GDP than the United States. Given that China has a population size over four times larger than America’s, should it reach a GDP per capita that is comparable to Taiwan or Hong Kong today, it will be a greater potential threat to the United States than anything America has previously dealt with.

via Zero Hedge http://ift.tt/1iNyJfB Tyler Durden

Investors in China have been running scared of a default on a high risk trust product; but, as Bloomberg's Tom Orlik notes, they should embrace it. The implicit guarantee that no investments will go sour is one of the key problems with China’s financial system as Orlik adds it encourages reckless lending often to borrowers whose only merit lies in backing from a deep-pocketed government. Crucially, as JPMorgan warns in a recent note, "avoiding defaults is not the right answer, as it will only delay or even amplify the problem in the future."

A default that encourages lenders to price in risk would be a positive development and the CEG#1 was an ideal product to 'fail' with its 11% yield and clear idiosyncratic company problems. However, regulators won't have to wait long for a second chance as JPM warns "There will be a default in China’s shadow banking industry this year as economic growth momentum slows."

 

Via Bloomberg's Tom Orlik,

Investors Should Embrace Defaults in China’s Fragile Financial System

 

…

 

In the years before the 2008 financial crisis, nominal growth outstripped the lending rate. Outstanding credit relative to GDP was low, keeping a lid on the burden of repayment. Against that backdrop, most borrowers were able to cover their costs and the chances of a default were low.

 

 

The situation today is different. Nominal growth has more than halved to 9 percent in 2013 from close to 23 percent in 2007.

 

Borrowers from trusts and other parts of the shadow financial system face interest rates in excess of 20 percent. An explosion in lending has increased the burden of repayment to more than 30 percent at the end of 2013 from about 19 percent of GDP at the end of 2008.

 

Lower growth, higher borrowing costs and mounting repayment costs mean defaults by borrowers and even bankruptcy at some small lenders are likely. After initial turmoil, that could actually be beneficial.

 

…

And JPMorgan adds:

• China may narrowly escaped the first default in its shadow banking industry
• Absence of default has become a major market distortion
• The challenge is to contain the contagion risk if a default happens

 

…local media reported that the China Credit Trust has reached a last-minute agreement with investors, with all principal and most accrued interest to be repaid. That means China will again narrowly escaped the first default in its shadow banking. However, the worries remain.

 

The absence of default has become a major distortion in China’s shadow banking, and we believe that default will happen in 2014 amid economic slowing. The concern is that, if a default occurs, whether investors will walk away and put the whole shadow banking market into a liquidity-driven credit crisis.

But contagion is possible…

The concern about the contagion risk is not groundless. In the past several years, non-bank financing (or the so-called shadow banking) has grown rapidly.

 

We estimate that the gross amount (i.e. with possible overlapping among sub-components) of non-bank financing in China reached RMB 36 trillion by the end of 2012 (or nearly 70% of GDP), compared to RMB 18.3 trillion in 2010 (or 46% of GDP).

 

Non-bank financing continued to grow fast in 2013. An update of our estimate suggests that nonbank financing has further increased to RMB 46.7 trillion by September 2013 (or 84% of GDP). The increase was most dramatic for trust assets (an increase of RMB 2.66 trillion in the first nine months of 2013), wealth management products (an increase of RMB 2.82 trillion), entrust loans (an increase of RMB 1.8 trillion) and bank-security channel business (i.e. banks use security firms as a channel to extend loans, which more than doubled in the first three quarters in 2013 and reached RMB 2.79 trillion).

 

 

The rapid growth in non-bank financing activities, especially for trust loans, WMPs and banksecurity channel business, has been driven by the perception of implicit guarantee from product issuers and distributors. The absence of default confirmed such perception.

 

…

 

In addition, there is substantial overlap between interbank assets and other components, for instance WMPs investing on interbank assets or claims on trust assets being traded in interbank markets. Nonetheless, banks are closely connected to shadow banking activities, hence possible turbulence in shadow banking will also affect the banking system.

We believe that default will happen in 2014 as the growth momentum slows down, and it will help restore market discipline and mitigate the moral hazard problem in the long run. However, the challenge is how to contain the near-term negative impact, as there could be three possible outcomes (in the order of increasing severity) if a default occurs.

The first possibility is that it is perceived as an idiosyncratic event, i.e. no spillover at all. This is the least likely outcome.

 

The second possibility is that the contagion risk is contained within a manageable level, i.e. only to similar products or sectors. For instance, if "Credit equals Gold No 1" defaults, investors will move away from collectively trust products that are only sold to wealthy individuals (but not affecting WMPs that are sold to retails investors); investors will worry about the credit quality of similar loans (non-SOE borrowers in mining industry), but not spillover to other products (e.g. local government debt, real estate companies and SOEs); investors question about the safety of trust companies but not banks. We can call it "limited spillover".

 

The third possibility is a “systemic spillover”. In a mild scenario, it will affect the vulnerable components such as trust loans (48% of trust AUM), WMP investment on non-standard credit products (estimated to be 35-50% of total WMPs) and bank-security channel business. In a worse scenario, it will affect the whole trust industry, WMPs and channel business (with a total gross size of RMB 23 trillion). Rollover of trust products (we estimate 30-35% trust products will mature in 2014) and WMP (64% WMPs has maturity less than 3 months) becomes extremely difficult. The liquidity stress could evolve into a full-blown credit crisis.

What can the government do? In our view, avoiding defaults is not the right answer, as it will only delay or even amplify the problem in the future. Meantime, there are measures the governme
nt can take to contain the contagion risk.

First, let defaults happen but establish a transparent legal process (rather than under-table arrangements) to resolve the dispute between different parties.

 

Second, regulators should tighten supervisory and regulatory framework to contain regulatory arbitrage activities, and clarify the responsibilities in various shadow banking products. The uncertainty in regulatory and legal responsibility behind each product is an important caveat in the market, and could amplify the contagion risk.

 

Third, impose hard budget constraints on local governments and SOEs, so as to avoid crowding out of credit to other business borrowers and establish risk-based pricing practices.

 

Finally, avoid defaults that could be easily linked to systemic concerns, such as the default of banks (rather than non-bank financial institutions as the perception of government protection on banks is stronger) or local government financial vehicles or SOEs. Similarly, the default of a WMP could have a bigger impact than a trust product, as the latter does not have maturity mismatch problem and are sold to wealthy individuals rather than retail investors. In that sense, China may miss an "ideal” first default if “Credit Equals Gold No 1” gets bailed out.

Investors in China have been running scared of a default on a high risk trust product; but, as Bloomberg's Tom Orlik notes, they should embrace it.

And they are going to get a chance again soon as there are considerably more of these maturing in the next quarter…

 

Perhaps that is why 3mo SHIBOR has been rising 9 days in a row…

via Zero Hedge http://ift.tt/1icx9kB Tyler Durden

Investors in China have been running scared of a default on a high risk trust product; but, as Bloomberg's Tom Orlik notes, they should embrace it. The implicit guarantee that no investments will go sour is one of the key problems with China’s financial system as Orlik adds it encourages reckless lending often to borrowers whose only merit lies in backing from a deep-pocketed government. Crucially, as JPMorgan warns in a recent note, "avoiding defaults is not the right answer, as it will only delay or even amplify the problem in the future."

A default that encourages lenders to price in risk would be a positive development and the CEG#1 was an ideal product to 'fail' with its 11% yield and clear idiosyncratic company problems. However, regulators won't have to wait long for a second chance as JPM warns "There will be a default in China’s shadow banking industry this year as economic growth momentum slows."

 

Via Bloomberg's Tom Orlik,

Investors Should Embrace Defaults in China’s Fragile Financial System

 

…

 

In the years before the 2008 financial crisis, nominal growth outstripped the lending rate. Outstanding credit relative to GDP was low, keeping a lid on the burden of repayment. Against that backdrop, most borrowers were able to cover their costs and the chances of a default were low.

 

 

The situation today is different. Nominal growth has more than halved to 9 percent in 2013 from close to 23 percent in 2007.

 

Borrowers from trusts and other parts of the shadow financial system face interest rates in excess of 20 percent. An explosion in lending has increased the burden of repayment to more than 30 percent at the end of 2013 from about 19 percent of GDP at the end of 2008.

 

Lower growth, higher borrowing costs and mounting repayment costs mean defaults by borrowers and even bankruptcy at some small lenders are likely. After initial turmoil, that could actually be beneficial.

 

…

And JPMorgan adds:

• China may narrowly escaped the first default in its shadow banking industry
• Absence of default has become a major market distortion
• The challenge is to contain the contagion risk if a default happens

 

…local media reported that the China Credit Trust has reached a last-minute agreement with investors, with all principal and most accrued interest to be repaid. That means China will again narrowly escaped the first default in its shadow banking. However, the worries remain.

 

The absence of default has become a major distortion in China’s shadow banking, and we believe that default will happen in 2014 amid economic slowing. The concern is that, if a default occurs, whether investors will walk away and put the whole shadow banking market into a liquidity-driven credit crisis.

But contagion is possible…

The concern about the contagion risk is not groundless. In the past several years, non-bank financing (or the so-called shadow banking) has grown rapidly.

 

We estimate that the gross amount (i.e. with possible overlapping among sub-components) of non-bank financing in China reached RMB 36 trillion by the end of 2012 (or nearly 70% of GDP), compared to RMB 18.3 trillion in 2010 (or 46% of GDP).

 

Non-bank financing continued to grow fast in 2013. An update of our estimate suggests that nonbank financing has further increased to RMB 46.7 trillion by September 2013 (or 84% of GDP). The increase was most dramatic for trust assets (an increase of RMB 2.66 trillion in the first nine months of 2013), wealth management products (an increase of RMB 2.82 trillion), entrust loans (an increase of RMB 1.8 trillion) and bank-security channel business (i.e. banks use security firms as a channel to extend loans, which more than doubled in the first three quarters in 2013 and reached RMB 2.79 trillion).

 

 

The rapid growth in non-bank financing activities, especially for trust loans, WMPs and banksecurity channel business, has been driven by the perception of implicit guarantee from product issuers and distributors. The absence of default confirmed such perception.

 

…

 

In addition, there is substantial overlap between interbank assets and other components, for instance WMPs investing on interbank assets or claims on trust assets being traded in interbank markets. Nonetheless, banks are closely connected to shadow banking activities, hence possible turbulence in shadow banking will also affect the banking system.

We believe that default will happen in 2014 as the growth momentum slows down, and it will help restore market discipline and mitigate the moral hazard problem in the long run. However, the challenge is how to contain the near-term negative impact, as there could be three possible outcomes (in the order of increasing severity) if a default occurs.

The first possibility is that it is perceived as an idiosyncratic event, i.e. no spillover at all. This is the least likely outcome.

 

The second possibility is that the contagion risk is contained within a manageable level, i.e. only to similar products or sectors. For instance, if "Credit equals Gold No 1" defaults, investors will move away from collectively trust products that are only sold to wealthy individuals (but not affecting WMPs that are sold to retails investors); investors will worry about the credit quality of similar loans (non-SOE borrowers in mining industry), but not spillover to other products (e.g. local government debt, real estate companies and SOEs); investors question about the safety of trust companies but not banks. We can call it "limited spillover".

 

The third possibility is a “systemic spillover”. In a mild scenario, it will affect the vulnerable components such as trust loans (48% of trust AUM), WMP investment on non-standard credit products (estimated to be 35-50% of total WMPs) and bank-security channel business. In a worse scenario, it will affect the whole trust industry, WMPs and channel business (with a total gross size of RMB 23 trillion). Rollover of trust products (we estimate 30-35% trust products will mature in 2014) and WMP (64% WMPs has maturity less than 3 months) becomes extremely difficult. The liquidity stress could evolve into a full-blown credit crisis.

What can the government do? In our view, avoiding defaults is not the right answer, as it will only delay or even amplify the problem in the future. Meantime, there are measures the government can take to contain the contagion risk.

First, let defaults happen but establish a transparent legal process (rather than under-table arrangements) to resolve the dispute between different parties.

 

Second, regulators should tighten supervisory and regulatory framework to contain regulatory arbitrage activities, and clarify the responsibilities in various shadow banking products. The uncertainty in regulatory and legal responsibility behind each product is an important caveat in the market, and could amplify the contagion risk.

 

Third, impose hard budget constraints on local governments and SOEs, so as to avoid crowding out of credit to other business borrowers and establish risk-based pricing practices.

 

Finally, avoid defaults that could be easily linked to systemic concerns, such as the default of banks (rather than non-bank financial institutions as the perception of government protection on banks is stronger) or local government financial vehicles or SOEs. Similarly, the default of a WMP could have a bigger impact than a trust product, as the latter does not have maturity mismatch problem and are sold to wealthy individuals rather than retail investors. In that sense, China may miss an "ideal” first default if “Credit Equals Gold No 1” gets bailed out.

Investors in China have been running scared of a default on a high risk trust product; but, as Bloomberg's Tom Orlik notes, they should embrace it.

And they are going to get a chance again soon as there are considerably more of these maturing in the next quarter…

 

Perhaps that is why 3mo SHIBOR has been rising 9 days in a row…

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“The last duty of a central banker is to tell the public the truth” – US Federal Reserve Vice Chairman Alan Blinder, 1994

 

By now, everyone knows that bankers lie…all the time. They tell one group of clients to sell an asset while secretly telling another group of clients to buy the same asset. They tell other clients to buy assets and then short that very asset behind their clients’ backs. They tell the world they don’t engage in any type of gold swaps nor do they rehypothecate gold, but yet when Germany asks for its 300 tonnes back from the US Central Bank, they respond by telling Germany that they have it all but only return 5 tonnes in the whole of 2013. Five tonnes represents 0.06% of the alleged gold the US Central Bank claims is in deep storage somewhere in the United States.

 

Yesterday the US Central Bank said that they are cutting their purchases of US Treasuries yet again from $75B a month to $65B a month. But as I stated yesterday in our weekly newsletter sent to thousands before the FOMC announcement, “I do not care if the US Central Bank’s FOMC lies later today when they announce policy and if they state they are going to taper QE more just to knock down gold and silver prices again in the short-term, because the REALITY is not only can they not maintain such a policy other than for the very short-term, but that they will eventually need to INCREASE QE just to prevent disaster and all the huge bubbles they have created all over the world from popping.”

 

In today’s world, it simply doesn’t matter what any of the bankers say because the only thing we know to be true is that their words are never to be trusted. The only thing that matters is what bankers are actually doing behind closed doors after spouting propaganda lies to the public. Below, we use a mission to Mars to clearly illustrate the insanity of Central Bank-speak.

 

 

 

Other recent SmartKnowledgeU videos for your viewing pleasure:

War is a Bankster Racket

Does Your Gang Affiliation Prevent You From Thinking Clearly?

 

 

About the author: JS Kim is the Managing Director of SmartKnowledgeU, a fiercely independent research & consulting firm that focuses on precious metals. Subscribe to our YouTube channel here and our Twitter feed here.

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An oldie but a goodie… On the final FOMC meeting of Ben Bernanke’s illustrious career as Fed Chair, we thought it appropriate to dust off the following musical reminder of just who the Fed are…

“… you see the Federal reserve is not a government thang; it’s a bunch of private bankers we obey…and they don’t answer to the people coz they pull the strings; and that’s precisely why we have to say… hey hey, hey hey… F##k The Fed..“

 

 

 

(h/t Mike Krieger’s Liberty Blitzkrieg blog)

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Following last week’s Flash PMI print of 49.6, the Final print for January China Manufacturing dropped further to 49.5 confirming the contraction is deepening. Japanese stocks were down the most since August in the early going as Nikkei futures extended the losses from the US day-session (and rather notably decoupled from USDJPY and breaking below 15,000). The Nikkei is heading for the worst month since May 2012 (-8.66% so far). S&P futures tracked USDJPY as 102.00 was defended aggressively. Chinese stocks are also tumbling (though not as hard as Japan and US) and the PBOC will not be adding liquidity today. Furthermore the blame is being shifted as Deputy FinMin Zhu warns that the “Chinese economy faces risks from overseas uncertainty.” EM FX is drifting lower still.

 

The Final HSBC Manufacturing PMI print dropped from 49.6 Flash to 49.5 – its biggest drop since June and lowest since July 2013…

 

The Lowlights…

“Employment levels at Chinese manufacturers had quickest reduction of payroll numbers since March 2009”

 

“New export orders declined for the second month running in January, firms mentioned weaker demand in a number of key export markets.”

 

Bad for Australia: “the rate of input price deflation was marked overall, amid reports of lower raw material costs.”

 

“Reduced cost burdens were passed on to clients and marked the second consecutive month of discounting”

 

 

Japanese bank stocks are down 9% in the last 5 days and Real Estate stocks -12.5% in the last 2 weeks. But most concerning to Abe (and the rest of the carry-trade addicted mob) is the disconnect between JPY and NKY…

 

EM FX continues its slide…

 

In other news, the Baltic Dry Index has now plunged 51% from its late December highs and has collapsed to 5-month lows...

 

Charts: Bloomberg

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