Month: March 2014

One of the critical steps in President Obama’s “off-ramp” de-escalation plan for the crisis in Ukraine was a so-called ‘observer mission’ by the Organisation for Security and Co-operation in Europe (OSCE) to ensure that all citizens were being treated fairly. That ‘plan’ has hit a wall this morning as PTI reports that pro-Kremlin gunmen blocked the obersver entry. Seems like another red line just got crossed.

 

Via PTI,

Pro-Kremlin gunmen kept foreign observers from entering Crimea today as Russia welcomed the prospect of the Ukrainian peninsula joining the country amid the worst East-West crisis since the Cold War.

 

A convoy of vehicles from the Organisation for Security and Co-operation in Europe (OSCE) — led by a police car and followed by two buses carrying the observers and a large number of cars waving Ukrainian flags — were stopped at a checkpoint manned by armed men as they tried to enter Crimea for a second day.

 

The observer mission is a crucial part of the so-called “off-ramp” US President Barack Obama is pushing to de-escalate a crisis in Ukraine that threatens to splinter the ex-Soviet nation of 46 million along its cultural divides.

With Gazprom threatening their gas supplies, we await President Obama’s response to this denial of his plan and the actions of his allies in Europe…

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We have long been pounding the table (certainly since mid-2012) that the US labor market has become a place where mostly older workers – those 55 and over – are hirable – something which has nothing to do with demographics, and everything to do with excess worker slack, and an employer’s market to pick and chose those workers that are most qualified for a job since older workers have the same wage leverage as younger ones: none. February was merely the latest confirmation of just this.

The chart below shows the age breakdown of the various age groups of workers hired in the past month. The vast majority, or 239K of the job gains(according to the Household survey), once again fell into the oldest group, those aged 55-69. The core demographic, those 25-54, rose by a negligible 29K. Everyone else, i.e., those 16-24, saw a total of 153K in job losses.

 

The good news (for them, and bad news for everyone else): the number of workers aged 55 and over just hit a fresh all time record high:

 

And finally, here is the full breakdown of “young vs old” jobs since the start of the Depression in December 2007: those 55 and older have gained 4.9 million jobs. Those under 55 are still some 3.1 million jobs below their December 2007 level.

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We noted last night that Iron Ore futures prices were in free-fall as the vicious circle of China's commodity-collateral-backed shadow banking system unwind hits home amid fears of contagion from the Chaori Solar default. The first domestic Chinese corporate bond default has retail investors running scared as surprise spreads that the local government did not come to the rescue. The deleveraging is now spreading to copper prices (remember the massive cash-for-copper schemes of last year) as borrowers are forced to sell to meet cash calls which in turn drops copper prices, reducing collateral values and tightening credit conditions even more. This is the biggest copper price drop since Dec 2011…

 

 

More on Chaori and the fallout…

As Deutsche Bank notes,

On the topic of China, according to the WSJ the country’s first onshore corporate bond default has occurred earlier today in the form of Shanghai Chaori Solar Energy’s missed/incomplete RMB89.8m coupon payment. As we have written over the last couple of days, the bond is relatively small (RMB1bn or US$160m in face value) and the issuer is small (US$1.2bn in assets) but it’s an interesting case for a number of reasons.

 

Firstly, it’s a bond where the majority of bondholders are retail investors (WSJ, citing company management) which widens the scope of the impact from the market’s typical institutional investor base. Weibo, China’s version of Twitter, is showing photos of retail investors at a local Shanghai government office protesting the authorities’ lack of action in assisting the issuer (21st Century Business Herald).

 

Secondly, it should be highlighted that Shanghai Chaori avoided a default on its annual coupon payment last year due to the intervention of a local Shanghai government who persuaded banks to roll over loans. This time around, the policy appears to have changed with no last-minute assistance on the cards. Indeed, state-affiliated news agency Xinhua wrote in an opinion piece that a default would be the “the market playing its own decisive role”.

 

Interesting, given that the Chinese solar energy market was heavily subsidised by the Chinese government in recent years. The Xinhua article also commented that Chaori was not going to be China’s “Bear Stearns moment”.

 

In addition, domestic media are reporting that the company’s bankers and bond underwriters will not be helping the company make interest payments (21st Century Business Herald). Though this is a relatively small bond, there are potentially wider ramifications.

 

Bloomberg reports that China’s renewable energy industry faces US$7.7bn in bond maturities this year, and already three domestic bond issuances have been postponed or cancelled in recent days according to Reuters. This is certainly a macro story to watch in 2014

And we warned of China's Bronze Swan last year…

Copper, as China pundits may know, is the key shadow interest rate arbitrage tool, through the use of financing deals that use commodities with high value-to-density ratios such as gold, copper, nickel, which in turn are used as collateral against which USD-denominated China-domestic Letters of Credit are pleged, in what can often result in a seemingly infinite rehypothecation loop (see explanation below) between related onshore and offshore entities, allowing loop participants to pick up virtually risk-free arbitrage (i.e., profits), which however boosts China's FX lending and leads to upward pressure on the CNY.

…

 

But what does it mean for the actual Copper Financing Deal? The below should explain it:

 

 

An example of a typical, simplified, CCFD

 

In this section we present an example of how a typical Chinese Copper Financing Deal (CCFD) works, and then discuss how the various parties involved are affected if the deals are forced to unwind. Exhibit 3 is a ‘simplified’ example of a CCFD, including specific reference to how the process places upward pressure on the RMB/USD. We believe this is the predominant structure of CCFDs, with other forms of Chinese copper financing deals much less profitable and likely only a small proportion of total deal volumes.

 

A typical CCFD involves 4 parties and 4 steps:

• Party A – Typically an offshore trading house
• Party B – Typically an onshore trading house, consumers
• Party C – Typically offshore subsidiary of B
• Party D – Onshore or offshore banks registered onshore serving B as a client

Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.

 

 

Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit. 

 

The conversion of the USD or CNH into onshore CNY is another key step that SAFE’s new policies target. This conversion was previously allowed by SAFE because it was expected that the re-export process was a trade-related activity through China’s current account. Now that it has become apparent that CCFDs and other similar deals do not involve actual shipments of physical material, SAFE appears to be moving to halt them. 

 

Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1. 

 

Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration. 

 

Copper ownership and hedging: Through the whole process each tonne of copper involved in CCFDs is hedged by selling futures on LME futures curve (deals typically involve a long physical position and short futures position over the life of the CCFDs, unless the owner of the copper wants to speculate on the price).

 

Though typically owned and hedged by Party A, the hedger can be Party A, B, C and D, depending on the ownership of the copper warrant.

As Goldman further explains, the importance of CCFD is "not trivial" – that is an understatement: with the implicit near-infinite rehypothecation in which the number of "circuits" in the deal is only a factor of "the amount of time it takes to clear the paperwork", there may be hundreds of billions, if not more, in leverage resulting from this shadow transaction that has been used in China for years. Now, that loop is about to end. The reality is nobody can predict what the impact will be, but whatever it is – i) it will extract tremendous leverage from the system and ii) it will have adverse impacts on both China's ability to absorb inflation and grow its economy.

 

Hence this…

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Having heard the great and good declare this morning’s “beat” on the headline NFP data as indicative of 1) the recovery is awesome; 2) the reason why stocks have been rallying; and 3) the recovery is awesome… it appears between a rising unemployment rate, tumbling average hourly earnings, and Gazprom’s threat in Europe, stocks are taking this “good news” as “bad news.” Confirmed by Hilsenrath that the taper is on – which is what bonds, gold, and the dollar appeared to be saying – the S&P 500 having spiked 10 points is now 13 points off its highs and in the red for the day…

 

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As we showed moments ago, the scariest chart of today’s nonfarm payroll report was the plunge in average weekly earnings. For those curious why US workers are unable to make any headway in obtaining higher wages, the following breakdown of just where the 175,000 (seasonally adjusted, because apparently now seasonal adjustments work again) February job gains were should provide some color.

Unfortunately, as has been the case for the past several months, well over half the total job gains in February were in industries that pay the least.

To wit:

• Education and Health: +33K
• Leisure and Hospitality: +25K
• Temp Help Services: +24K
• Government: +13K

Taken together, these 95K jobs amount to well over half of all job gains in the past month. It goes without saying that there is little wage growth of note one can hope for in these sectors.

Also of note: the high-paying information sector lost a whopping 16K jobs in February, following 8K losses the month before, while only 9K financial jobs were added this month (offsetting the 2K drop last month).

Finally, that US manufacturing renaissance? Stick a fork in it, with just 6K jobs added in February, the exact same amount as the month prior.

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The “good news” about today’s jobs report – the weather is no longer a factor and monthly jobs can resume ramping higher. Supposedly. Because the “bad news” – according to the BLS, is that  weather actually was a factor, however not for the number jobs but hours worked, which dropped to just 33.3 for production and nonsupervisory employeesm down from 33.5 in january and 33.8 a year ago. So there was a weather impact once again, but only for what looked out of the normal.

Ok fine – let’s ignore hourly earnings.

In order to normalize for the weekly hours worked, we decided to look at the big picture which ignores hours worked, and average hourly earnings. In February, this number was $682.65, down from $683.74 for production and nonsupervisory employees. However, the real impact of declining wages is seen nowhere better than in the annual increase in average weekly earnings. The chart below needs no explanation: when wage growth is at 1%, or half of the Fed’s inflation target, you will not get any sustained economic recovery.

 

And what if one looks at the average weekly earnings of all employees? Well, we just hit a new post-Lehman low. Five years into the “recovery”, weekly earnings growth is the lowest it has been in five years!

So with no wage pressures, employers can continue hiring as many people as they want: after all they are paying them at a rate reflecting of true economic growth.

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We have discussed the sword of Damocles that is hanging over the heads of the Ukrainian (and European for that matter) people for some time. The dominant role that Russia plays in providing energy is becoming critical, however, as Gazprom notes:

• *GAZPROM SAYS TODAY IS DEADLINE FOR NAFTOGAZ TO PAY FOR FEB. GAS
• *NAFTOGAZ OVERDUE PAYMENTS AT $1.89B FOR GAS SUPPLIES: GAZPROM
• *GAZPROM SAYS NAFTOGAZ ISN'T OBSERVING CONTRACT
• *GAZPROM: UKRAINE DEBTS CREATE 'RISK OF RETURN TO SITUATION AT BEGINNING OF 2009' (when Gazprom cut off Ukraine gas supplies)

Of course, the US agreed to $1b bailout yesterday – but that's not supposed to be used as a direct transfer payment to the Russians.

 

Via Interfax,

The debt that Ukraine's Naftogaz Ukrainy owes for Russian natural gas has risen to $1.89 billion, Gazprom CEO Alexei Miller told journalists.

 

"In fact, this means that Ukraine has stopped paying for gas," Miller said.

 

"This is completely at odds with the provisions of the contract and international trade practice. For our part, we have always met and will meet our contractual obligations. But we can't supply gas free of charge. Either Ukraine repays its debt and pays for current deliveries or the risk of returning to the situation at the beginning of 2009 will appear. We will notify the Russian government concerning the situation that is taking shape," Miller said.

 

"Today, March 7, was the payment deadline for February's deliveries of gas to Ukraine. Gazprom has not received payment on the debt. Including the price discount in effect in the first quarter, the overdue debt for gas has increased significantly and now totals $1.890 billion," he said.

It would appear this is the most important map in Europe once again…

 

and what happened in 2009…

Gazprom demanded a price hike to $400-plus from $250, Kiev flatly refused, and on New Year's day 2009, Gazprom began pumping only enough gas to meet the needs of its customers beyond Ukraine.

 

Again, the consequences were marked. Inevitably, Russia accused Ukraine of siphoning off supplies meant for European customers to meet its own needs, and cut supplies completely. As sub-zero temperatures gripped the continent, several countries – particularly in south-eastern Europe, almost completely dependent on supplies from Ukraine – simply ran out of gas. Some closed schools and public buildings; Bulgaria shut down production in its main industrial plants; Slovakia declared a state of emergency. North-western Europe, which had built up stores of gas since 2006, was less affected – but wholesale gas prices soared, a shock that was declared "utterly unacceptable" by Brussels.

Forget those sanctions…

The market is not happy – Ukraine is not fixed as June 2014 bond yields soar to 47%!!

 

 

The acting Premier is in panic mode:

• *UKRAINE NEEDS `URGENT' FINANCIAL AID, PREMIER YATSENYUK SAYS
• *UKRAINE SEEKS TO END TALKS WITH IMF AS SOON AS POSSIBLE: PM

We suspect, as the bond market makes clear, that any IMF money will go direct to Gazprom and not to debt repayment

 

 

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