Month: February 2014

In addition to the already noted fireworks out of China, where the Yuan saw the biggest daily plunge since 2008 and the ongoing and very rapid newsflow out of the Ukraine, focus this morning was very much of the latest Eurozone CPI data, which despite matching previous low levels, came in above expectations and in turn resulted in an aggressive unwind of short-EUR bets as market participants were forced to re-asses the likelihood of more easing by the ECB. Still, even though the Euribor curve bear steepened and Bunds came under significant selling pressure, the EONIA forward curve remained inverted, signifying that there is still a degree of apprehension over what is unarguably very low inflation data.

Looking elsewhere, even though the PBOC engineered correction resulted in the Chinese CNY posting record loss this week, the Shanghai Comp settled the session in the green, as the initial volatility surrounding the exodus of carry trades gradually abates. In Europe this morning, stocks are seen lower across the board, with healthcare and financials underperforming.

Going forward, market participants will get to digest the release of the latest GDP data from Canada and the US, as well as Chicago PMI and Pending Home Sales data.

Bulletin headline summary from Bloomberg and RanSquawk

• EUR strengthened across the board and the Euribor curve bear steepened following the release of higher than expected Eurozone CPI data.
• Even though the PBOC engineered correction resulted in the Chinese CNY posting record loss this week, the Shanghai Comp settled the session in the green, as the initial volatility surrounding the exodus of carry trades gradually abates.
• Crisis in Ukraine continues to escalate, after Ukraine’s interior minister accused Russian naval forces of occupying Sevastopol airport in the autonomous region of Crimea.
• Treasury 10Y notes headed for best weekly gain in a month as ongoing unrest in Ukraine and poor U.S. economic data drove strong bidding at 2Y/5Y/7Y auctions.
• USTs also benefited from rally in JPY and expectations that today’s month-end index extension (0.13yr est. for Barclays Treasury Index, biggest since Aug. 2011), will drive demand
• The euro-area inflation rate exceeded economists’ forecasts in February, easing pressure on the ECB to take action next week to foster the fragile economic recovery
• Ukraine’s new government on its first day in office invited the IMF to Kiev for talks about a bailout worth as much as $15b while deposed former President Viktor Yanukovych, who claims to be the country’s rightful leader, surfaced in Russia and will hold a news conference today
• Armed troops wearing uniforms without insignia arrived at Crimea’s main airport in Simferopol while servicemen from Russia’s Black Sea Fleet blocked Sevastopol’s Belbek airport, acting Interior Minister Arsen Avakov said on his Facebook account; the fleet said it wasn’t involved in the incident
• China’s yuan tumbled by the most on record on speculation the central bank will widen the currency’s trading band, allowing greater volatility at a time when growth is slowing in the world’s second-largest economy
• Several thousand anti-government demonstrators marched in Caracas yesterday after Maduro tried to defuse two weeks of protests by granting Venezuelans an  unexpected six-day holiday
• The London gold fix may have been manipulated for a decade by the banks setting it, researchers say
• Goldman Sachs, which generated 46% of revenue from sales and trading last year, recorded losses from that business on 27 days in 2013, up from 16 the previous year
• Sovereign yields mostly lower. EU peripheral spreads steady. Nikkei -0.6%; Shanghai Composite gains 0.4%. European stocks and U.S. stock-index futures decline. WTI crude, gold and copper little changed

US event calendar:

• 8:30am: Revised GDP q/q, 4Q, est. 2.5% (prior 3.2%)
  • Personal Consumption, 4Q, est. 2.9% (prior 3.3%)
  • GDP Price Index, 4Q, est. 1.3% (prior 1.3%)
  • Core PCE q/q, 4Q, est. 1.1% (prior 1.1%)
• 9:45am: Chicago Purchasing Managers, Feb., est. 56.4 (prior 59.6)
• 9:55am: UofMich. Confidence, Feb. final, est. 81.2 (prior 81.2)
• 10:00am: Pending Home Sales m/m, Jan., est. 1.8% (prior -8.7%)
• Pending Home Sales y/y, Jan., est. -10.8% (prior -6.1%)
• 11:00am: POMO- Fed to purchase $1b-$1.25b in 2036-2044 sector

Asian Headlines

Despite the fact that the Chinese CNY posted weekly record loss this week, with money market rates also edging higher, the initial volatility which was observed in equity markets has abated amid spec. that the PBOC is engineering a temporary correction. As a result, while the CNY carry trade squeeze continued to support flows into JPY, with consequent move lower by the Nikkei 225 index, the Shanghai Comp was able to settle session in minor positive territory.

Japan’s GPIF’s weighting in Japanese equities at 16.6% at end-Dec, nearing allocation ceiling of 18% and domestic bonds at 53.40%, nearing allocation floor of 52%. Japan’s GPIF public pension fund shows investment gain for record 6th consecutive quarter in Oct-Dec. (RTRS)

Japanese National CPI (Jan) Y/Y 1.4% vs. Exp. 1.3% (Prev. 1.6%)

Japanese Industrial Production (Jan P) M/M 4.0% vs. Exp. 2.8% (Prev. 0.9%) – The headline figure posted its fastest monthly gain since June 2011.

EU & UK Headlines

Eurozone CPI Estimate (Feb) Y/Y 0.8% vs. Exp. 0.7% (Prev. 0.8%) – Which immediately resulted in steepening of the Euribor curve and EUR supportive flows across the board as bets of further easing by the ECB were unwound.

Norway’s oil fund says sharply increased US, German, British government bond holdings in Q4 (the fund held 37.3% of bonds at end 2013 vs. 35.5% at end Q3). The fund also held 61.7% of portfolio in equities at end of 2013 vs.63.6% at end of Q3. 2013 return was second best in its history, highest since 2009. (RTRS)

Der Spiegel writes citing sources that publicly traded banks may not have to immediately disclose capital shortfalls identified by ECB in its Asset Quality Review (AQR).

Barclays preliminary pan-Euro agg month-end extensions: (+0.07y) (12m avg. +0.07y)

Barclays preliminary Sterling month-end extensions:(+0.05y) (12m avg. +0.06y)

US Headlines

Fed’s Fisher said that as soon as feasible, the Fed should stop asset purchases entirely. He also said that he was pleased with the decision to taper. (RTRS)

Barclays preliminary US Tsys month-end extensions:(+0.12y) (12m avg. +0.07y) – Large extension is a result of the refunding auctions earlier this month.

Equities

Financials underperformed in Europe this morning, with Erste Group Bank trading sharply lower after the bank posted less than impressive earnings and also noted that it has EUR 435mln exposure to Ukraine, despite also noting that it is not particularly concerned about it. At the same time, Spanish listed Bankia bank shares also came under selling pressure after the Spanish government started selling some of its stake in nationalised lender.

FX

The release of higher than expected Eurozone CPI data, which in turn buoyed demand for the joint-bloc currency and pushed EUR/USD to its highest level since late December. At the same time, consequent USD weakness supported GBP/USD, which remained in the green despite the aggressive bid by EUR/GBP. Looking elsewhere, even though spot JPY rate recovered following the sell-off overnight amid yet another move higher by USD/CNY rate, implied vols remain better bid as the pain trade continues.

Crisis in Ukraine continues to escalate, after Ukraine’s interior minister accused Russian naval forces of occupying Sevastopol airport in the autonomous region of Crimea. The other main Crimean airport, Simferopol, has also been occupied by armed men. The men are thought to be pro-Russia militia. (BBC)

Commodities

CME lowered initial margins for crude oil future NYMEX initial margins for specs by 8.8% to USD 3,410 per contract from USD 3,740 per contract. (BBG)

More winter storms are predicted for next week, with snow sleet and rain expected through out the US north east. (BBG)

China added 1.084bln tonnes to its oil reserves last year, with NatGas proven reserves increasing by 616.4bln cubic meters. (China News Service)

India gold imports may total 22 tons in February, according to India Gems & Jewellery Trade Federation. (BBG)

Freeport may be forced to declare force majeure at its Grasberg mine in Indonesia after the new concentrate ore rules in effect there. (BBG)

* * *

We conclude with the traditional Jim Reid overnight recap

We’ll review Yellen’s testimony in more detail below, but first we’ll take a quick look at overnight markets where the focus is again on China and the renminbi. As we type this morning, the CNH and CNY have declined by 0.4% and 0.6% respectively against the USD. At one stage the CNY was around 0.85% weaker on the day and pushing up against the top end of the PBOC’s daily trading band. Though the quantum of these falls doesn’t sound large, they are the largest oneday declines since 2008 according to Bloomberg data. Some are wondering whether the PBoC will step in to stabilise the yuan, but reports (Financial Times) have been suggesting that the central bank is indeed trying to shake out speculators who have put on the renminbi carry trade. Indeed, the USDCNH rate (6.13) is approaching the 6.20 mark, which is reportedly a key technical level for many SME and retail investors who have entered into leveraged CNH-appreciation option structures known as Target Redemption Forwards or TRFs (WSJ and Financial Times). All this follows a sharp devaluation in the CNH and CNY over the last fortnight, including a five-day window where it recorded its sharpest decline since the currency’s devaluation in 1994 (Financial Times). The moves come ahead of China’s National People’s Congress starting next week where economic and market reforms will again be discussed by China’s leaders (Reuters).

Asian equity markets are trading with a downbeat tone partly in reaction to the continued renminbi depreciation, with losses on the Hang Seng (-0.3%), Nikkei (-1.0%) and KOSPI (-0.2%). Chinese equities are underperforming headlined by the HSCEI (-0.8%) and Shanghai Composite (-0.95%). There have also been falls in the AUDUSD (-0.1%), copper futures (-0.4%), and in USDJPY (-0.5%) in sympathy with the move in the renminbi. Note that copper futures have declined for eight days straight, with Chinese import iron ore following a similar pattern. Elsewhere in Asia, the latest Japanese CPI numbers for February were broadly in line with market expectation. The headline reading of +1.4% YoY was marginally higher than the 1.3% expected, but slower than the 1.6% YoY recorded in January. Core CPI rose 0.7% YoY which was in line with consensus estimates and the prior month’s result.

Looking at Yellen’s speech in more detail, perhaps the key highlight was Yellen’s commentary relating to the recent run of disappointing US data. On this she mentioned that “part of that softness may reflect adverse weather conditions, but at this point it’s difficult to discern exactly how much. In the weeks and months ahead, my colleagues and I will be attentive to signals that indicate whether the recovery is progressing in line with our earlier expectations”. On rate thresholds, Yellen hinted that the Fed was moving away from quantitative guidance saying the Fed will look beyond the 6.5% unemployment threshold to decide more broadly whether the labor market was healthy enough for tightening. Consistent with other Fed speakers of late, Yellen said it would take a “significant change” in the outlook for the Fed to pull back from its gradual reduction in monthly asset purchases. There were also comments on assets bubbles and financial stability, but on these topics Yellen’s comments were fairly similar to those she made before the House Committee on February 11th. US 10yr yields were rangebound between 2.63% and 2.66% yesterday, closing at a three-week low of 2.63% (or -3bp).

Taking a closer look at yesterday’s market moves, there was firmer sentiment in EM in particular in LATAM where we saw solid gains in equities including in Brazil (+2.1%) and Mexico (+0.8%). The CDX EM credit index (+0.25pt in price) managed to recover most of the Ukraine/Turkey-inspired losses on Wednesday but there was still some nervousness about political and ethnic tensions in Ukraine. Indeed, before Yellen’s testimony markets were weighed by reports that an unnamed, armed group had taken control of the local Crimean parliament in the Ukraine. There are also unconfirmed reports this morning that dozens of armed men in military uniforms have seized an airport in the capital of Ukraine’s Crimea region (AP). The report said the men with “Russian Navy ensigns” first surrounded the Simferopol Airport’s domestic flights terminal. On a more positive note, Ukrainian Prime Minister Arseniy Yatsenyuk’s government on its first day in office invited the IMF to Kiev for talks about securing funds of up to $15 billion. Meanwhile former President Viktor Yanukovych, who claims to be the country’s rightful leader, surfaced in Russia and will hold a news conference today, according to Bloomberg.

In terms of data flow, the main highlight was the better than expected US durable goods report. US January durable goods orders declined 1.0% on the headline (-1.7% consensus) but rose in the core orders category by +1.7% (vs -0.2% expected). Initial jobless claims for the week ending February 22 (one week after the February employment survey period) rose 14k to 348k (335k expected). In terms of earnings, RBS stock fell 7.74% after the company reported FY13 earnings. The UK Telegraph noted that the bank’s cumulative losses since its bailout has now drawn level with the GBP46bn equity pumped into it by the government in 2008. Elsewhere in the European banking sector, Bloomberg is reporting that the Austrian finance ministry is seeking ways to force holders of Hypo Aple-Adria-Bank debt, guaranteed by the province of Carinthia, to accept losses (Bloomberg). The bank is facing mounting losses and two-thirds of Austrians say the government “should walk away” according to a Gallup poll. Bloomberg is describing this as an interesting test case given that the bonds in question are guaranteed obligations of a 100% government owned bank.

Looking at the day ahead, we have a number of data releases including the Euroarea CPI estimate for February which is a key datapoint ahead of the March ECB meeting. The market is expecting a print of around 0.7% YoY, although a couple of the more recent analyst estimates have come in below that, possibly due to yesterday’s below-expectation German CPI reading. In Europe, we also get German retail sales (+1.0% MoM consensus) and Euroarea unemployment. Across the Atlantic, the highlights are the second estimate of US Q4 GDP, the Chicago PMI, UofM confidence and pending home sales. Canada will also report Q4 GDP and there are central bank speakers from the BoE (Carney) and Fed (Fisher). On Saturday, China will release its official February manufacturing PMI (consensus is 50.0 which would be a sixteen month low). Also over the weekend, Berkshire Hathaway will release its Q4 earnings and many are tipping the conglomerate will announce a record FY13 profit. There will also be plenty of focus on CEO Warren Buffet’s annual letter to shareholders which is scheduled to be released at the same time.

via Zero Hedge http://ift.tt/1kuu2oB Tyler Durden

The bizarre events in the Crimea continued overnight, after unidentified masked men but dressed like those who took over the parliament in Simferopol yesterday, took over two airports by blockading one near the Russian naval base in Sevastopol and another in the capital of Simferopol. This prompted the Ukraine’s interior minister Arsen Avakov, to accuse Moscow’s military of blockading the airports, and in a Facebook post, he called the seizure of the Belbek international airport in the Black Sea port of Sevastopol a “military invasion and occupation.” He added: “It is a breach of all international agreements and norms.” As NBC reports, the Interfax news agency quoted Russian military sources as saying the incident at Belbek airport was intended to stop “fighters” flying in. However, Interfax later quoted a Russian official as saying that no units had approached the airport or blockaded it. In a nutshell, Russia continues to push with escalation ever further, and is testing just how far it can and will go without Ukraine responding.

2-3 dozen militiamen at Simferopol #Crimea airport quickly piled into a truck – with no plates – and are leaving. http://ift.tt/NC2sKZ

— Alexander Marquardt (@MarquardtA) February 28, 2014

Kyivpost has a more detailed account:

Two Crimean airports were taken over by Russian military troops, Interior Minister Arsen Avakov said on Facebook this morning. He said the situation in the autonomous republic has now escalated to “a military intervention” and called on the National Security Council to take urgent steps towards its regulation.

 

“My assessment of what’s going on is that it’s a military intervention and occupation in violation of all international agreements and norms,” he said in his statement. “This is a direct provocation of bloodshed on the territory of a sovereign state.”

 

Avakov said that Sevastopol’s military airport Bilbek at night was blocked off by the military units of the Russian navy, which is based in Sevastopol. He said the airport is surrounded by camouflaged military troops with no identification and carrying guns. He said they do not hide their Russian affiliation.

 

Inside the airport there is a group of Ukrainian soldiers and border guards, and Ukrainian police troops have surrounded the outer perimeter of the airport. “There have been no armed clashes so far,” he said.

 

The navy base is Sevastopol is key for the Russian army. Under agreements signed between two countries in 2010, the Russian military can continue to use Sevastopol until 2042, with an option of extending the lease to 2047.

 

Some 70 kilometers away from the coast, in Crimean capital Simferopol, another airport was taken over by a group of about 100 plain-clothed men, who went inside the airport and onto the runway.

 

“The interior troops and police pushed these people first into the airport building, and then out of the territory. No weapons were used,” Avakov said.

 

He said that after the armed men left, a new group of camouflaged men arrived around 1:30 in the morning. They carried automatic weapons and had no markings. Avakov said they entered the building and stayed int he restaurant.

 

“They are not hiding their affiliation with the army of the Russian Federation,” Avakov said. “Told by the Ukrainian Interior Ministry workers that they are military men and have no right to be there, they answer curtly that they have no instructions to negotiate with you.”

 

Avakov said that so far there have been no clashes, but tension is growing as Ukrainian police troops continue to arrive. “The law enforcement organs cannot oppose the army,” Avakov concluded.

In the meantine, Ukraine is starting to realize that it may have bitten more than it can chew, and as Interfax reported:

• UKRAINE WEIGHS STATE OF EMERGENCY IN CRIMEA: INTERFAX
• RUSSIA BLACK SEA FLEET, HELICOPTERS BREAK UKRAINE ACCORDS: IFX

And the immediate re-escalation:

• RUSSIAN BLACK SEA FLEET SETS UP BALACLAVA BLOCKADE: INTERFAX

Visually:

Coastguard and frigate at entrance to Balaclava bay http://ift.tt/1dIjZrg

— Christian Fraser (@ForeignCorresp) February 28, 2014

Yet none of this compares to today’s main event when a t 5pm local time, in the Rostov-on-Don Technical University, deposed Ukraine president Yanukovich who is currently in Russia, is expected to hold a press conference. Missing since the beginning of the week, the ousted ukrainian president had fled the country to Russia in the latest days, either by car through the Donetsk region, either escorted by military planes, according to different reports.

We doubt anything he says will difuse the situation.

via Zero Hedge http://ift.tt/1dIkKR4 Tyler Durden

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Sugar is like a heroin addiction. The effects are bingeing, withdrawal and craving or cross-sensitization. But, you don’t just have to literally eat it to get the effect of the kick that it provides. Sugar is hot property right now and the prices are rising and that’s because there is going to be a fall in production for the first time in five years this year and it’s all down to the weather. Oh! I can hear the scare-mongers voicing off about the planet, doom, gloom and global-warming, citing the Brits that are water-logged up to their armpits. Sugar hasn’t increased as much for the past five months and yesterday raw sugar rose by 4.1%, reaching 17.41 cents per pound.

Sugar has gone up and down over the years as with any commodity, but in October 1974 it reached the all-time high of 64 cents per pound. The opposite end of the spectrum was when it fell to just 2 cents per pound in the 1960s. Today, it’s Brazil that is the largest world producer and it’s sugar-based ethanol that has managed to maintain prices of sugar over the past 8 years. The world’s (sugar) eggs are all in one basket these days as Brazil accounts for 80% of world production. World production stands at approximately 23.8 million hectares of sugarcane and a harvest of 1.69 billion tons. After Brazil the top producers are India, China, Thailand and Pakistan.

But, the dire weather conditions in Brazil over the past few months have meant that the country is now being rationed on water supplies in 11 states. Crops have been wiped out and there are 6 million people that are suffering directly from the consequences of the adverse seasonal conditions.

The International Sugar Organization is now warning that sugar will see its output fall this year for the first time in half a decade. Supply will be disrupted and that means that prices will rise. According to data from theCommodities Futures Trading Commission investors cut net short positions by 22% last week. Prices may come back to around 19 cents per pound this year at the end of the year when supply and demand have come back into equilibrium. Until then, it is the rise in prices that will be foreseen due to a lack of output.

Some might see the saving grace of the sugar losses with regard to the output falling. Sugar cane has the highest toll on biodiversity according to some experts, destroying the soil, the water and creating air pollution. The habitat is destroyed to make way for the planting of sugar cane and there is extensive irrigation and use of chemical pesticides, routinely discharged into the watertable. Or perhaps it will just lead to greater destruction as the farmers scramble to produce more to fill the shortfall in production. The world has gone mad on sugar and there is a growing appetite for it.

• At the end of 2013 Chinese imports of sugar soared by 20%. India consumes the most sugar in the world and is closely followed by China, importing 709, 873 metric tons. 
• China has increased by 109% its imports in comparison with 2012. 
• There are 40 million sugar farmers in China at the moment and the government is largely responsible for importing so much to support them. 
• High prices on the domestic sugar market have meant that importers have increased the quantities they are buying from the global market.

The International Sugar Organization shows that the price of sugar yesterday stood at 17.62 cts/lb for the daily price, 16.36 cts/lb for the last 15-day average and a white-sugar price index (average of the close of the quotes for the first two future positions of White Sugar Contract in the UK) of $479.65 per ton or 21.76 cts/lb.

Originally posted: Sugar: Not So Sweet

 

via Zero Hedge http://ift.tt/1ktZVxs Pivotfarm

The legends are abandoning the markets.

 

Stanley Druckenmiller founded his hedge fund Duquesne Capital in 1981. From 1986 onward he maintained average annual returns of 30%. He also managed George Soros’ Quantum Fund from 1988-2000. During that latter period he famously facilitated Soros’ “breaking of the Bank of England” trade: the legendary trade which netted over $1 billion in a single day.

 

Druckenmiller closed Duquesne Capital in 2010, stating that he was no longer able to meet his investment “standard[s]” in the post-2008 climate (he made money in 2008 before the Fed began to alter the risk landscape).

 

Druckenmiller’s key strength has always been macro-economic forecasting. That he would feel the capital markets were not offering him the opportunities he needed says a lot.

 

Seth Klarman is another investment legend who is returning capital to clients. Widely considered to be the Warren Buffett of his generation, Klarman recently cited a lack of “investment opportunities” as the cause for his decision to downsize his legendary Baupost Group hedge funds.

 

Other legends or market outperformers who have returned capital to investors or closed their funds to outside investors are Carl Icahn and Michael Karsch. Indeed, even value legend Warren Buffett is sitting on the single largest amount of cash in the history of his 50+ year career as an investor, stating that stocks are “fully valued” at current levels (Buffett largely does not believe in shorting the market, so his decision to be in cash is a strong indicator of opportunities).

 

These men are masters of the capital markets. They are voting with their feet and pulling their capital out of them. Given that their personal compensation is closely linked to assets under management and profit sharing, this decision is akin to the choice to forego additional wealth that could be made quite easily (none of these individuals would have trouble raising several billion more in capital) rather than trying to find opportunities in a challenging market.

 

If they’re bailing on the market… what are the odds trouble is approaching?

 

For a FREE Special Report outlining how to set up your portfolio from the next bear market collapse, swing by: http://ift.tt/170oFLH

 

Best Regards

Phoenix Capital Research 

 

 

 

via Zero Hedge http://ift.tt/1eDHyRJ Phoenix Capital Research

And just like that the Chinese yuan devaluation has shifted away from the merely “orderly.”

In the past few hours of trading, China, which as we reported two days ago has started intervening aggressively in the Yuan market, has seen its currency crash by nearly 0.9%, which may not seem like much, but is in fact the largest drop since December of 2008, and at last check was trading at around 6.18, even as the PBOC fixed the CNY reference rate 0.02% higher from the last official close to 6.1214, erasing pivot support point at 6.1346 and 6.1408.  Naturally this means that the obverse, the CNYUSD, has crashed to as low as 0.1620. Should this move sustain without reverting, this will be the biggest weekly loss ever! The dramatic move is shown on the chart below.

 

There isn’t much commentary on this most recent dramatic move aside from this commenbt by Zhou Hao, a Shanghai-based economist at ANZ, who said “CNY movements indicate that the authorities are determined to deter capital inflows and there were likely stop-losses triggered when the CNY broke key psychological levels.”

What is more notable is that the move, while certainly intending to shake out the carry traders bent on riding the USDCNY ever lower, is starting to appear borderline erratic. As a reminder, and as we posted yesterday before the FT picked up the story earlier today, there is a lot of pain potentially in store for those trading the Yuan, because while the move may not seem massive, the reality is that the carry trade positions have massive, massive leverage associated with them, with the pain level starting at $500 billion in losses once the Yuan enters the 6.15-6.20 gap, and rises exponentially from there.

This is what we warned yesterday:

The total size of the carry trade is hard to estimate although even just looking at some of the onshore CNY positions accumulated, DB Asia FX strategist Perry Kojodjojo estimates that corporate USD/CNY short positions are around $500bn. The size of the carry trade and the fact that China saw significant capital outflows during the last period of substantial Renminbi depreciation in the summer of 2012 has led to concerns over what this might mean for both the Chinese economy and financial markets as well as broader global financial implications.

Morgan Stanley believes that one such carry-trade structured product that will be the “pressure point” for this – should the Yuan continue to depreciate – is the Target Redemption Forward (TRF) which has a payoff that looks as follows…

While this is just an example of a product payoff matrix to the holder, the broader point is that the USD/CNH market has a particular level (or range of potential levels) at which three factors can create non-linear price action. These are:

1. Losses on TRF products will (on average) crystallize if USD/CNH goes above a certain level. This has implications for holders of TRF products, who are mostly corporates;

2. The hedging needs of writers of TRF products (banks) mean that there is a point of maximum vega for banks in USD/CNH. Below this level banks need to sell USD/CNH vol; above this level banks need to buy USD/CNH vol;

3. The delta-hedging needs of banks are complex. As we approach the average strike (the 6.15 in the theoretical point of Exhibit 1), banks need to buy spot USD/CNH. Above this point but below the European Knock-in (EKI) (i.e., between 6.15 and 6.20 in Exhibit 1), banks need to sell spot. Then above the EKI, banks don’t need to do anything in spot.

From internal Morgan Stanley data, we estimate that the point of maximum vega is somewhere in the range of 6.15-6.20, and that the 6.15-6.20 in Exhibit 1 is reasonably indicative of the average strikes and EKIs in the market.

In other words, so long as the TRF products remain in place (i.e., are not closed out) and we remain below the maximum vega point (somewhere between 6.15 and 6.20), there is natural selling pressure by banks in USD/CNH vol. When we get above that level, there is natural vol buying pressure.

 

 

Of course, in the scenario that USD/CNH keeps trading higher and goes above the average EKI level, the removal of spot selling flow by banks and the need to buy vol means the topside move may accelerate.

Simply put, if the CNY keeps going (whether by PBOC hand or a break of the virtuous cycle above), then things get ugly fast…

How Much Is at Stake?
In their previous note, MS estimated that US$350 billion of TRF have been sold since the beginning of 2013. When we dig deeper, we think it is reasonable to assume that most of what was sold in 2013 has been knocked out (at the lower knock-outs), given the price action seen in 2013.

Given that, and given what business we’ve done in 2014 calendar year to date, we think a reasonable estimate is that US$150 billion of product remains.

Taking that as a base case, we can then estimate the size of potential losses to holders of these products if USD/CNH keeps trading higher.

In round numbers, we estimate that for every 0.1 move in USD/CNH above the average EKI (which we have assumed here is 6.20), corporates will lose US$200 million a month. The real pain comes if USD/CNH stays above this level, as these losses will accrue every month until the contract expires. Given contracts are 24 months in tenor, this implies around US$4.8 billion in total losses for every 0.1 above the average EKI.

Deutsche Bank concludes…

Looking forward it’s possible that the PBOC is not attempting to actively engineer a sustained depreciation of the Renminbi but rather is attempting to increase the level of two-way volatility in the market to discourage the carry trade and also excessive capital inflows. In terms of the broad risk going forward the sheer scale of the challenge the PBOC has set out to tackle likely means they will have to move with restraint. This is certainly a story to watch…

As Morgan Stanley warns however, this has much broader implications for China…

The potential for US$4.8 billion in losses for every 0.1 above the average EKI could have significant implications for corporate China in its own right, as could the need to post collateral on positions even if the EKI level is not breached.

 

However, the real concern for corporate China is linked to broader credit issues. On that, it’s worth reiterating that the corporate sector in China is the most leveraged in the world. Further loss due to structured products would add further stress to corporates and potentially some of those might get funding from the shadow banking sector. Investment loss would weaken their balance sheets further and increase repayment risk of their debt.

 

In this regard, it would potentially cause investors to become more concerned about trust products if any of these corporates get involved in borrowing through trust products. In this regard, this would raise concerns among investors, given that there is already significant risk of credit defaults to happen in 2014.

Remember, as we noted previously, these potential losses are pure levered derivative losses… not some “well we are losing so let’s greatly rotate this bet to US equities” which means it has a real tightening impact on both collateral and liquidity around the world… yet again, as we noted previously, it appears the PBOC is trying to break the world’s most profitable and easy carry trade – which has created a massive real estate bubble in their nation (and that will have consequences).

+++++++++++++++

The bottom line is the question of whether the PBOC’s engineering this CNY weakness is merely a strategy to increase volatility and thus deter carry-trade malevolence (in line with reform policies to tamp down bubbles) OR is it a more aggressive entry into the currency wars as China focuses on its trade (exports) and keeping the dream alive? (Or, one more thing, the former morphs into the latter as a vicious unwind ensues OR the market tests the PBOC’s willingness to break their momentum spirit).

It appears, as Bloomberg notes, the PBOC is winning: “Yuan has gone from being most attractive carry trade bet in EM to worst in 2 mos as central bank efforts to weaken currency cause volatility to surge. Yuan’s Sharpe ratio turned negative this yr as 3-mo. implied volatility in currency rose in Feb. by most since May, when Fed signaled plans to cut stimulus.”

So far the PBOC’s “shock and awe” has impressed currency traders. Hopefully, the PBOC knows what it is doing because if indeed it causes the carry trade to unwind, the unwind could send the currency plunging well beyond the central bank’s intended limits. What happens then nobody knows.

Curious for more? Read our first post in this series: Welcome To The Currency Wars, China (Yuan Devalues Most In 20 Years)

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

Some very disturbing thoughts are laid out in this blog post written by Dai Xu. He is a Chinese author, social commentator, and the president of Marine Institute For Security And Cooperation, he also a professor at the National Defense University. First posted in the US China Perception Monitor.

China Not Afraid of Conflict

The year 2013 was a year without fighting, but there was a strong potential for conflict. This year, the impact of local wars on the world situation is much more serious than in previous years.

This year, the U.S. behaved very arrogantly, and Obama’s intentions were unclear; the Middle East retreated, East Asia rallied.

In the 20^th century, as a challenger of empires built on hegemonies, America’s national strategy was to break up and surround Eurasia and its three big political powers: the Middle Eastern Islamic world, Russia, and China. America also wanted to make further steps toward the fragmentation of these empires and complete their establishment of a global empire.

Throughout the presidencies of George H.W. Bush, Clinton, and George W. Bush, the last 20 years of military campaigns, and especially America’s current three front war, the U.S. has made several important advances: anti-U.S. powers are about to disappear in the Middle East, the Russian strategic space has already been reduced to Georgia and the Ukraine, and their strategic “C-shaped” encirclement of China is basically completed.

When Obama took office, he faced several strategic options. The first was to resolve the Middle East’s final two encirclements, and isolate the two anti-U.S. nations, namely Syria and Iran, in order to complete the “Greater Middle East Reform Initiative.” The second was to admit Georgia and the Ukraine into NATO and continue to put pressure on Russia. The third was to tighten up the strategic encirclement of China and wait for an opportunity to mobilize their secret ideological allies inside China, in an attempt to complete the final assault from both inside and outside.

Russia’s war against Georgia and its decision to cut off gas to the Ukraine have made the U.S. realize that the polar bear means what it says and it is difficult to break through the frontline in Central Asia . After deliberation, Obama and his team of official advisors chose to reset Russian-U.S. relations. As a result, Hillary Clinton recommended “smart power,” and America decided that it would make advances on the other two strategic fronts. (As a result, the strategic justification for keeping troops in Afghanistan was not sufficient, which caused Obama to declare that he would withdraw U.S. troops in 2014.)

During Obama’s first term in office, his most important strategic move was to publically declare a shift toward the East. The U.S. State Department pushed for the exclusion of China in Trans-Pacific Partnership, in order to diplomatically and economically isolate China. The Pentagon declared they would implement an air-sea war strategy. They initiated projects that by 2020, will result in over 60% of U.S. air and sea assets being located in the Asia-Pacific region. Their political, economic, and military fists swing repeatedly against China, a nation that has committed itself to peaceful development

Lines are being drawn, with various other countries choosing sides. For example, the Philippines and Japan are taking aggressive stances in order to cause trouble, with Japan being the most provocative. In spite of efforts to instill a Chinese-Japanese diplomatic consensus, Shinzo Abe, the Japanese Prime Minister, has adopted a stubborn stance of not afraid of being accused as “a re-militarized nation” and is preparing for confrontation with China. The Philippines wants the U.S. to return to the Subic Bay. India and Vietnam are flirting with each other to cook up anti-China schemes.

The U.S. initially used the plot to make noise in the East, but actually impacted the West. Having deployed smaller nations in the Asia-Pacific region to distract China, Washington has reached out to Tunisia and Egypt and knocked out Libya. Taking advantage of the Jasmine Revolution, the U.S. wanted to “set fire” to Syria and Iran. Americans issued numerous ultimatums to Syria. Paris and London eagerly joined the chorus. At the crucial moment, China and Russia put out a full-force effort to mediate the crisis, and Syria has, for the time being, avoided calamity. This certainly is not America accepting Russia’s offer; instead, it is due to America’s inability  to find a suitable agent in the anti-Syrian government mob. At the same time, explosions and rampages occured in Iraq and Libya, both of which were baptized with American democracy. Moreover, the military has jailed the popularly elected president in Egypt. The American government being embarrassed and upset by Edward Snowden was another factor that has caused heartburn to members of the Obama  team. Snowden’s explosive revelations have exposed America’s dark secrets of global eavesdropping and forced Washington off their high ground, having always made moralistic accusations against others.  Evidently, if the U.S. decided to take military action against Damascus alone, it would not win praise from the media, popular support at home, or allies’ help from abroad. American threats against Syria were designed to divert attention away from its own dilemma. Moscow’s plan of destroying Syrian chemical weapons was too good of a face-saving way out for the U.S. to reject it. China is huge with nuclear weapons and it cannot be defeated by conventional forces. Syria is too messy for an easy solution. Iranians are wise and are willing to make a deal. As a result, Obama decides to play the role of a nice guy, taking the olive branch extended by Tehran, despite angry denunciation from Israel and Saudi Arabia—two of its diehard allies in the Middle East. The region that has been buried in war talks suddenly becomes very quiet. This demonstrates again that the world will be able to embrace peace if the U.S. does not make trouble. In the first year of his second term, Obama has been unable to act decisively to accomplish his goals, but this doesn’t mean that the Nobel Peace Prize winner has been able to sit still and appreciate his medal. In modern times, driven by the ambition to expand its empire, one of the top priorities for American Presidents is to engage in military conquests. Not totally satisfied with toppling Gaddafi during his first term, Obama is planning something even bigger. After pulling back in Central Asia, the U.S. may do the same in the Middle East. It is training its gun at China. The year 2014 is the 100th anniversary of World War I. American strategists discovered a long time ago (and actually facilitated the outcome) that “Modern circumstances share many interesting qualities with pre-1914 circumstances” and both Chinese and American governments will be unwilling to show weakness in front of their former opponents and current rivals. American strategists believe that China could come to replicate some of the conditions that made Europe so volatile a hundred years ago, and use this idea as a motivation to not voice a position on the Senkaku Islands dispute.

The year 2014 is the centennial of the outbreak of World War I. Some American strategists have discovered that the situation in Asia is similar to the situation in Europe before the outbreak of the war. Neither the government of China nor the government of Japan has any intention to engage in any compromise. Therefore, American strategists come up with the idea to replicate the script of World War I in which all European nations were crippled. This is the fundamental motive of not taking a position on the dispute over the Diaoyu Islands between Beijing and Tokyo.

2014 is also the 120^th anniversary of the first Sino-Japanese War, which has remained prominent in the minds of both the Chinese and the Japanese. After a comprehensive study of America’s pivot in Asia, Japan chose September 11, 2012 to announce its “purchase” of the Diaoyu Islands. This is a huge national decision. From this point on, the rivalry between China and Japan has changed from territorial and resource rivalry to strategic competition. The strategic layout in East Asia has truly become a chess gameinvolving three nations. The U.S. hopes to see Sino-Japan confrontation, which will result in power reduction of China and Japan, as was the case of the U.K. and Germany. Japan desires to provoke a war between the U.S. and China, which will lead to its rearming and rise as a new power in the West Pacific. Many Japanese naval and air force officers have made this preference very public.

At the present time Japan does not have the strength to declare war on China. However, if the U.S. and China get into a war, China will suffer and Japan can seize the opportunity to gain power and eventually finish China off—repeating what it did during the first Sino-Japanese War and disrupt China’s attempt at modernization.

The ulterior motives of both America and Japan are on full display after China adopted its air defense identification zone. Japan is consistently arrogant, but the U.S. is a double dealer. It sent up a B-52 into the ADIZ to calm down Japan but also sold out Tokyo by instructing commercial airlines to file their flight path with China. Americans provoke while also simultaneously attempting to curry favor from China.

December 1, 2013 is the 70^th anniversary of the Cairo Declaration that established the international political order in the wake of World War II. There was national silence in Japan on this occasion. It has deliberately chosen to forget the core contents of its surrender. Taking into consideration the annual historical controversy, we see a Japan that clearly attempts to overthrow the outcome of World War II. This is similar to what Germany tried to do after its defeat in World War I.  The United States, Australia, and the Philippines “understand” Japan’s efforts at re-arming itself. Even Great Britain is in support of the Japanese position on the ADIZ. This reminds us of the Anglo-Franco Appeasement in the 1930’s. The fact that Russia refuses to take a position on Sino-Japan territorial dispute shows how successful Tokyo’s diplomacy has been. 2013 saw major leadership changes in China, America, Japan, Russia, and North and South Korea. New changes have also led to new policies.

Despite the bottomless financial crisis, America continues to conduct experiments on developing aircrafts armed with electromagnetic launching capabilities. Following the entrance of F-22 “V-22 “Osprey, the “Global Eagle” is beginning to enter Japan. The frequency of American military exercises in the Pacific Ocean has increased. In this noisy atmosphere, Japan has begun to export arms, which is the first step in converting its strong industries into facilities that can mass manufacture military equipment. 2013 also saw the commissioning of what will be Japan’s third aircraft carrier, “Izumo.” Izumo was the name of an armored cruiser built by Japan using Chinese reparation and was the flagship when Japan invaded China. Using this name for the new aircraft carrier is certainly provocative in nature.

China has formed the F-15 wing and its first aircraft carrier “Liaoning” has undertaken a battle group tour in the South China Sea.  President Xi inspects troops often and asks the PLA to be ready to fight and able to win. At the same time, F-20 has entered the test flight phase and even F-31 made an appearance. China’s three fleets have sailed to the first island chain and conducted joint exercises with the Russian Navy.

North Korea does not want to play the second fiddle. It conducted the third nuclear test in 2013 and attempted to send a satellite into orbit. An arms race is unfolding in the Asia Pacific region. Since the end of World War II, fighter jets from China, the U.S., Japan, and Russia have descended upon the Western Pacific en mass. The world is holding its breath as statesmen from Asia-Pacific nations are assessing each other’s situation and trying to determine an action plan.

2013 was the prelude that will determine the fate of East Asia and the political and military focus of the world in the near future. Due to America’s global strategy and the implementation of Japan’s strategies, there will be further deterioration of military status in East Asia, if not the entire Asia-Pacific region. Other parts of the world appear to be relatively quiet because the United States is too busy to get involved. Russia is taking advantage of this situation to ram through integration of the region that used to be the former Soviet Union.

As a new round of military, political, and economic reshuffle unfolds the Asia-Pacific region, which experienced the most bloody and the largest casualties in recent history, it will once again be the main battleground.

What is the mode of war that can “destroy” China?

Since the end of WWII, every American strategy shift is triggered by a new technology that gives rise to a military revolution. For the Cold War, it was nuclear weapons; for the Gulf War,  it was information; this time, America’s pivot to Asia is led by the Internet technology that has produced a mixture of cyberspace electronic warfare and ideological information warfare. The first kind of warfare is limited to conventional military areas, but the second kind of warfare has invisibly formed a different kind of fighting that defies all military concepts. In 2013, manipulated by a mysterious force outside China, a few Chinese language websites controlled by foreign capitals have manufactured a few anti-military and anti-patriotic incidents. The anti-Communist, anti-Chinese government, and anti-China forces have joined hands in stirring up these incidents. In response, the broad masses of patriotic netizens have launched a counter offensive. With collaboration from relevant agencies of the Chinese government, a victory was achieved in this pitched cyberspace battle similar to the battles fought during the Korean War.

Although one does not see smoke in cultural fighting, ideological struggles, or cyber warfare, they are equally destructive and shocked and enlightened Chinese military thinkers. The Soviet Union used to possess thousands of nuclear warheads and 4 million troops, but they were all fragmented by the invisible and ubiquitous informational and ideological warfare. It makes one shudder to think that countries like Tunisia, Libya, and Egypt could be overthrown overnight by Twitter in the age of social media. Deep rivers run quieter. The new features of this kind of warfare have revealed themselves after China’s effort to clamp down on Internet rumors have caused harsh criticisms from non-civil forces outside China. John Huntsman’s public speech calling hundreds of millions of Chinese cell phone internet users to begin regime change, has proven that China’s military researchers should pay more attention to the fifth column inside China. Military affairs, politics, economics, culture, ships, keyboards, history, and the present, have combined to form a new battleground where battles are going to be epic. Television and informational and psychological warfare in the age of dollars were the mode of warfare that could defeat the Soviet Union. The Internet and informational and ideological warfare will the mode of warfare that will defeat China. The eyes of the Chinese military cannot train on the visible enemy and their metal weapons. The era of the Internet demands all new knowledge on wars and anti-wars.

The Sino-Japanese War in 1894, World War I, World War II, the collapse of Eastern Europe, the chaos of the Middle East—all of these historical tragedies are in front of China and serve as the background behind the China dream. The world is brutal, military affairs are changing fast, and the strategies are interactive. Will the ghostlike war in East Asia take place? When will it take place? It is determined by both the actors and the reactors. The answers lie in historical common sense and wise judgment.

In 2013, China embarks on a new road after the conclusion of the Third Plenum of the 18^th National Congress of the Chinese Communist Party. On December 26, China solemnly commemorated the 120th anniversary of the birth of Mao Zedong. On this same day, Japanese Prime Minister Shinzo Abe provoked China by visiting the Yaksukuni Shrine in Tokyo. In response, the Chinese Foreign Ministry spokesman quoted Mao Zedong’s “On Protracted War,” and implied that the final victory will belong to China. The new China is born in blood and fire, and is not only unafraid of war, but also courageous in welcoming reasonable and lawful conflict, because defending the country from aggression serves to further boost the development of the state’s power. The Chinese nation loves peace, but there is little doubt that glory drenched in blood will pave China’s road to revitalization. This is the glory that generations to come will treasure.  Sound the alarms for war preparation, remold our firm convictions, wake up the fearless people, and revive our strategic industries—our country is moving forward and our future is bright!

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