Offshore Yuan Drops To 3-Week Lows As China Injects Another $70 Billion Liquidity

Following the afternoon weakness in US equities, Offshore Yuan has been limping lower into the fix, not helped by comments from a MOFCOM researcher that "China is able to withstand currency fluctuations" implicitly warning carry traders to stay away and suggesting the dollar's dominance would not last long. CNH is now at 3-week lows against CNY, over 300pips cheap – which prompted the major short squeeze last time. Chinese stocks are modestly lower but more worrying is the 7-day slide in Chinese corporate bond yields – the most in 2 months – hinting perhaps that the last bubble standing is bursting.

Having dismissed calls for large scale stimulus, the Year-end liquidity spigot is wide open…

*PBOC TO INJECT 440B YUAN WITH REVERSE REPOS: TRADERS

Consisting of 360bn 28-day and 80bn 7-day reverse repo.

As PBOC held the Yuan Fix "stable" for the 13th day in a row.

Offshore Yuan continues to weaken and diverge from the "relative" stability of onshore Yuan as MOFCOM resercher Mei Xinyu writes that China is willing and able to stand temporary fluctuations in currency rates to gain independence of its monetary policy,. adding that the Yuan couldn’t be pegged to dollar perpetually since China is the 2nd largest economy in world and a strong position of dollar won’t last long.

Is it us or does that sound a little more like a threat to dollar hegemony than a warning about volatility?

Chinese CDS continue to confirm Offshore Yuan's implied weakness – the last time CNY remained "stable" in the face of devaluation stress like this was in the pre-amble to August's collapse…

Finally, we draw attention to the fact that the "last bubble standing" – Chinese corporate bonds – appear to be cracking, having seen yields increase for the last 7 days – the most since mid November…

As Chinese stocks stumble:*HONG KONG'S HANG SENG INDEX FALLS 1.4% IN PREMARKET

None of which should surprise anyone, as BofAML's David Cui (chief China equity strategist) warned so succinctly:

I expect higher volatility in the markets and a much higher chance of financial system instability in China – debt/GDP ratio will be higher, growth will be slower and there will likely be more shocks to the system. Whether the financial system breaks down or not, I expect the risk of such a breakdown to be the dominant theme for China markets this year.

It’s true that since 2011 every year there had been a round of debates about this, and so far, the financial system has held up reasonably well (even though there had been scares from time to time). Many view the absence of any severe disturbance over the past few years as proof that the government is on top of things and believe that the risk has diminished over time. I think the opposite is true: the government has maintained a superficial stability largely by debt-funded stimulus and ever-greening of bad debts. We believe these have strengthened various implicit guarantees that have in turn generated powerful destabilizing forces beneath the surface – a classic case of short term stability breeding long term instability.

I think there are at least five: the guarantee on GDP growth, on RMB stability, on no sharp fall of the A-share market, on no major debt default and on no large housing price drop. A break of any of these guarantees may potentially destabilize the system in my view. And it’s a matter of time when some of these guarantees will be broken because they are inherently conflicting. For example, to hold up growth, the government has to run fairly loose monetary policy and very aggressive fiscal policy which means that RMB will increasingly come under pressure. The same is true with holding up the A-share market. The government has to borrow money from banks to buy A-shares, which boosts money growth and adds to asset bubble and RMB problems. If it reduces loans elsewhere to compensate, growth and debt may suffer. These are just two examples.

Leading him to forecast that it’s going to be tougher for China’s equity markets this year than last year.

We forecast SHCOMP to decline by about 30% to around 2,600 by yearend, and HSCEI to decline by about 7% to around 9,000.

Our year-end targets had not factored in a credit crunch scenario because the timing of which is difficult to predict. Should it occur, we expect the indices to end below the low bounds of our expected trading ranges, possibly way below (2,200 for SHCOMP and 7,400 for HSCEI).

None of which spell anything but contagion concerns for global levered carry trades.

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And what would a night in Asia be without the Japanese spewing forth more muppetry monetary policy magic…

The Japanese continue to desperately try to jawbone some momentum back into their markets, following this morning's spurious midnight Japane time headline, here is another: