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Recent trends in Asian financial markets are certainly cause for alarm over the intermediate term.


***Note: wk/wk price action is from the five trading days ending on 10/4. Additionally, we’ve moved the price tables to the end of the note to increase ease of reading.***


From a wk/wk perspective, Asian equity markets are largely in negative territory, closing today down -2.9% on a median basis and -3.4% on an average basis. Hong Kong, which we’ve been explicitly bearish on since late May, closed today down -10.4% on a wk/wk basis and is now down -29.5% for the YTD – leading all other Asian equity markets to the downside over this timeframe.

Asian currencies continued their recent string of declines vs. the USD, as the global Flight to Liquidity trade ensues.  The Aussie dollar (AUD) led the way to the downside (-4.6% wk/wk vs. the USD) largely due to the RBA’s hint that it could potentially cut interest rates at some point over the intermediate term – a view we authored in early 2Q. Australian 1yr interest rate swaps acted on the news, falling -25bps wk/wk and are now trading a full -83bps below the RBA’s 4.75% target cash rate. On three-month basis, the AUD is down nearly -12% vs. the greenback – tops amongst all Asia-Pacific currencies over this duration.

Far beyond individual currencies, we’d like to call your attention to one of the more noteworthy moves in Global Macro in a very long time. Specifically, Asian currencies, as measured by the Bloomberg-JPMorgan Asia Dollar Index, just wrapped up their worst month since December 1997 (falling -4% in Sept). This is particularly meaningful given that Dec ’97 was mid-way through the Asian Financial Crisis! In recent months, we’ve been keen to flag the risks associated with the rapid buildup in external debt we’ve seen out of various emerging market debtors over the past 2-3 years and we continue to do so now.

While we haven’t yet done enough work to feel comfortable making a call for AFC 2.0, we do have conviction in suggesting that a stronger U.S. dollar (vs. debtor currencies), a rising cost of capital for global corporations, and a contracting European banking sector will combine to create meaningful liquidity headwinds for many developing Asian debtors. Email us for more detailed analysis on this subject; we’ve been circulating a compendium of notes on the subject on a one-off basis to clients and we’d be happy to send them your way.

Looking to Asian credit markets, the key moves we’d like to flag are the backup in yields across India’s sovereign debt curve and the jump in Chinese CDS. Indian interest rates – which are being dragged higher by the combination of hawkish commentary out of the RBI and the market coming to the realization that the government is quite likely to miss its FY12 deficit reduction target (a view we authored in late February) – backed up +11bps, +22bps, and +16bps on 2s, 10s, and 30s, respectively.

China, whose banking system is coming under increasing international scrutiny, saw its 5yr CDS widen +45bps wk/wk (+29.2%) to just shy of the 200bps mark. Beyond mere Sovereign Debt Dichotomy speculation, credit investors are indeed starting to sniff out the possibility that the Chinese government may have to dramatically expand the public balance sheet to help recapitalize ailing banks at some point over the long-term TAIL.


***In an effort to make this piece more easily digestible, we’re simply going to flag key data points and our analysis in bullet point format and offer only our [brief] thoughts at the end of each country capsule. We’re always happy to follow up in greater detail; simply reply to this note to open up a dialogue on anything you see below.***


  • Dollar-denominated debt of property developers rated below investment grade fell -19.9% in 3Q11 – the steepest quarterly decline since 4Q08.
  • Unable to refinance through more traditional sources of funding, property developers have turned to private trust companies for loans costing around 16-25% per an official at Beijing National Trust. Such financing has accounted for roughly half of the total amount of credit extended to developers YTD, per a recent Credit Suisse report. In addition to being deprived of commercial bank credit, property developers have been shut out of international bond markets since May, per Bloomberg data.
  • AAA corporate credit spreads widened +46bps in 3Q11 to close the quarter at 221 bps wide – just shy of the 5yr+ high 226bps registered on 9/26.
  • Chinese corporations have issued only 494 billion yuan of bonds in 3Q11 – down -17% YoY and down -14.1% QoQ.
  • Twenty-eight percent of local government financing vehicles have negative cash flow, roughly 22% of them have debt/asset ratios north of 70%, and their average ROE is only 4.4% (vs. an average of 8% for Chinese corporations at large), making it hard for them to access new capital for refinancing, per a study published by the country’s official bond clearing house.
  • Dim-sum bonds, or yuan-denominated notes traded in Hong Kong, fell -4% MoM in September, driving yields up +105bps on average.
  • Savings deposits at Chinese banks are nearing their first quarterly decline since 1992, which threatens to exacerbate the liquidity headwinds currently squeezing the Chinese economy. Through the first half of September, deposits for China’s four largest lenders fell -420 billion yuan; through August, deposit growth for the banking system at large was running at a -98% YoY clip. Negative real interest rates (-270bps currently) are a key contributor to this issue, which may ultimately limit the scope of any monetary easing the out of the PBOC  – if any – over the short-to-intermediate term.
  • Slowing deposit growth and plunging equity prices (down -20.5% over the last six months) has forced Chinese banks to debt markets for sources of liquidity. In 3Q11, the sector issued 388 billion yuan of debt – up over +57% on a YoY basis! The glut of supply has contributed to a predictable backup in borrowing costs; 5yr commercial bank bond yields backed up +69bps in 3Q11 to 5.92% – the highest level since Sept ’07. Spreads over similar-maturity sovereign debt widened +49bps in 3Q – largest quarterly jump on record – to 216bps.
  • Manufacturing PMI ticked up in Sept to 51.2 vs. 50.9 prior.
  • Non-Manufacturing PMI ticked up in Sept to 59.3 vs. 57.6 prior.
  • The 21stCentury Business Herald reported that nearly 80% of China’s rail projects have been put on an indefinite hold as banks concerned about loan repayment have stopped extending credit to the industry. They are reported to be awaiting further clarification of the government’s updated policies for the industry in the wake of late-July’s fatal bullet train accident.
  • Senator Chuck Schumer (D-NY) and 18 of his endowed colleagues have introduced a bill designed to force the Treasury Dept. to issue a biannual report identifying currency manipulators, as well as authorizing the implementation of protectionist measures towards those countries found guilty. The bill is being vehemently opposed by over 50 U.S. business groups, including the Chamber of Commerce, the National Retail Federation, and the Financial Services Roundtable. The bill is expected by some to eventually become bottled up the House Ways and Means committee, which has authority over trade legislation.
  • In response to Schumer’s bill, the PBOC issued a stern rebuke on its website today, saying, “Passage of the legislation may lead to a trade war that we don’t want to see… The [legislation] won’t solve U.S. problems of insufficient savings, a trade deficit, and an elevated jobless rate.” The PBOC, which boasts claim to the largest currency appreciation vs. the USD of any other emerging market nation over the past five years (+24%), per Bloomberg, supports opposition claims that punitive legislation towards China won’t contribute at all to U.S. employment growth. Rather, job losses in China will likely be offset by job gains in other low-cost developing market producers.

Hedgeye’s take: In terms of having concrete numbers to crunch or floated policy recommendations to analyze, it’s too early to wrap our heads around the true size and scope of the headwinds facing the Chinese banking system as a result of property developer and local government financing vehicle credit quality. That said, however, this is an acute risk we will no doubt continue to monitor closely going forward…


Elsewhere, we see that Chuck Schumer and his political cronies are at it again attempting to infuse their dogma on the U.S. economy – despite a bevy of key business groups and actual industry players speaking out against it. Big Government Intervention continues to: a) shorten economic cycles and b) amplify market volatility. A marked and expedited yuan revaluation would spell short-term economic disaster for the U.S. economy in the form of import price inflation for a bevy of key consumer goods.

Hong Kong:

  • Export growth came in flat in Aug at +6.8% YoY.
  • Import growth accelerated in Aug to +14.1% YoY vs. +10.2% prior.
  • Trade Balance growth slowed in Aug to -HK$22.9 billion YoY vs. -HK$5.4 billion prior.
  • Retail Sales growth slowed in Aug to +20.7% YoY vs. 22.4% prior.

Hedgeye’s take: Though stale (it’s Oct), Hong Kong’s August economic data does continue to support our bearish view of the economy insomuch that growth is continuing to slow.


  • Small Business Confidence ticked up in Sept to 47.2 vs. 46.4 prior.
  • The ruling DPJ party proposed at ¥9.2 trillion ($120 bil.) “temporary” tax increase to help fund the third post-quake “stimulus” package of about ¥12 trillion. The bill, which is now being negotiated with opposition LDP lawmakers, calls for corporate tax rates to be raised in the next fiscal year (starting April 1, 2012) for three years and income tax rates to be raised in January 2013 for a full 10 years. Additionally, tobacco levies will increase in October 2012.
  • Retail Sales growth slowed in Aug to -2.6% YoY vs. +0.7% prior.
  • Overall Household Spending growth slowed in Aug to -4.1% YoY vs. -2.1% prior.
  • Japanese corporations issued ¥2.7 trillion ($28.4 bil.) worth of debt this quarter – up +17.5% QoQ after 1H11 brought on the lowest level of issuance on six-month basis in five years. The surge in supply is not being met with a commensurate backup in yields, as demand from Japanese banks (holders of ~50% of the nation’s corporate debt) increased as a result of deposits outpacing loans by ¥163.3 trillion in August – just shy of the record ¥166.7 trillion spread recorded in June.
  • Manufacturing PMI ticked down in Sept to 49.3 vs. 51.9.
  • Unemployment Rate fell in Aug to a 33-month low of 4.3% vs. 4.7% prior. We continue to point out that Japanese employment is being overstated on a relative basis to other economies, given that the Japanese labor force is shrinking aggressively and is now at lows last seen since October of 1987.
  • Industrial Production growth accelerated in Aug to +0.6% YoY vs. -3% prior. MoM growth also accelerated: +0.8% vs. +0.4% prior.
  • The Finance Ministry unveiled plans to raise the issuance limit for bills to fund intervention in the FX market by +¥15 trillion to ¥165 trillion total, as well as extending the monitoring of FX positions through year-end (from an initial plan until the end of 3Q).
  • Tankan Quarterly Business Survey came in better on the margin, but still below the pre-catastrophe levels of 1Q11: large manufacturer sentiment and outlook improved to 2 and 4, respectively (from -9 and 2); large non-manufacturer sentiment and outlook improved to 1 and 1, respectively (from -5 and -2). On a sour note, the All-Industry CapEx Guidance component dropped to +3% from +4.2% – signaling a tempering of corporate intentions to act upon the improved sentiment.
  • Japanese corporate 5yr CDS, as measured by the Markit iTraxx Japan Index widened to 209bps yesterday – the highest since July ’09.

Hedgeye’s take: It’s clear from recent data that expenditures on quake reconstruction are eating into the everyday consumption patterns of Japanese consumers. Natural disasters are, at best, a zero sum game – a point we strongly stressed in the face of consensus buying Japanese stocks on hopeful expectations for rebuilding in 2Q11... Alas, the Japanese economy – awash with corporate cash like its U.S. counterpart – remains mired in a classic liquidity trap as a result of a dim long-term outlook for the economy.


Japanese officials continue to completely miss the boat as it relates to why the yen remains at elevated levels, saying recently that, “There’s no reason for the Japanese yen to be targeted as a safe-haven currency or flight-to-safety currency.” As long as Japanese policymakers continue to fundamentally misunderstand the mechanism by which the yen trades (a mechanism imposed by the BOJ’s ZIRP, btw), expect more misguided FX intervention upon JPY exchange rates.


  • RBI governor Duvvur Subbarao unleashed a string of hawkish commentary at recent press events: “Inflation has been fairly stubborn.”… “Above a threshold, you can’t accept high inflation to have higher growth. The price limit is as much as 6% for the nation.”… “A premature change in the policy stance could harden inflation expectations, thereby diluting the impact of past policy actions (+350bps of rate hikes since March ’10 – the fastest round of tightening since the central bank was established in 1935).”
  • Manufacturing PMI ticked down to a 2.5yr low of 50.4 vs. 52.6.
  • Despite the rupee’s region-best -9.5% YTD decline vs. the USD, Subbarao stated plainly that “intervention in forex markets brings unexpected consequences”, suggesting to us that central bank aid to support the rupee might be limited going forward.

Hedgeye’s take: Subbarao’s latest statements underscore our view that Indian inflation will remain sticky enough to keep the central bank from cutting interest rates in a proactive manner to stem the tide of slowing growth – as evidenced by the PMI data.

South Korea:

  • Consumer Confidence came in unchanged in Sept from Aug at an index level of 99.
  • The Korean government, citing fiscal woes in Europe, plans to cut its fiscal deficit by ½ in the next year to 1% of GDP (~12.25 trillion won). It also will seek to balance the budget by 2013 and post a surplus of 0.3% of GDP by 2015.
  • Manufacturing Business Survey reading came in flat in Oct at 86.
  • Non-Manufacturing Business Survey reading increased in Oct to 86 vs. 83 prior.
  • Industrial Production growth accelerated in Aug to +4.8% YoY vs. 4% prior.
  • Service Industry Output growth accelerated in Aug to +4.8% YoY vs. +3.8% prior.
  • Trade Balance growth slowed in Sept to -$3 billion YoY vs. -$727 million prior.
  • CPI slowed meaningfully in Sept to +4.3% YoY vs. +5.3% prior.
  • Manufacturing PMI ticked down in Sept to an 11-month low of 47.5 vs. 49.7 prior.

Hedgeye’s take: As we’ve outlined in our work on the Korean economy in the YTD, Korean economic growth remains resilient. On balance, Korean economic growth is flat-to-down, but still hanging in there much better than most of its Asian counterparts.


While we certainly admire the Korean government for recognizing an global phenomenon and attempting to strengthen its already-pristine balance sheet (debt/GDP = 22.7%), we do question their ability to achieve next year’s target given that it relies on the aggressive assumption of +9.5% YoY revenue growth and roughly a tenth of the deficit reduction coming in the form of revenues from state asset sales. As we saw in India this year, state asset sales get canceled when capital markets are under duress – which they very well could be in 2012. 


  • HIA New Home Sales growth accelerated in Aug to +1.1% MoM vs. -8% prior.
  • Building Approvals growth accelerated in Aug to -5.5% YoY vs. -14.3% prior.
  • Manufacturing PMI ticked down to a 27-month low of 42.3 vs. 43.3 prior.
  • TD Securities unofficial CPI gauge slowed in Sept to +2.8% YoY vs. +2.9%.
  • Trade Balance growth accelerated in Aug to +A$757 million YoY vs. +A$270 million prior.
  • Corporate borrowers in Australia have cut bond issuance to the least since 4Q08 (A$16.5 billion), driven lower by reduced demand for debt capital out of Australian banks who saw term deposits surge to record A$469.5 billion as recently as July.
  • 10yr sovereign bond yields fell -15bps in September to close the quarter at 4.22%, capping the longest stretch of monthly declines on record (dating back to 1978).
  • The move in the Aussie bond market coincides with the RBA keeping the benchmark policy interest rate on hold at 4.75% for the 10th-consecutive month – the longest pause since a 13-month hiatus ended in May ’06. In accordance with the policy announcement, RBA governor Glenn Steven’s commentary came in noticeably dovish on the margin relative to recent months: “An improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.”Stevens also admitted to weakness in the Aussie labor market and the potential dousing impact that would have on labor costs – a key area of concern for the central bank as it relates to the long-term outlook for inflation.
  • Treasurer Wayne Swan, perhaps in response to the -600bps decline in his boss’ approval rating over the last two weeks, stated that policymakers are discussing ways to alter the tax code to address the country’s two-speed economy. Per Swan, nothing will be “off limits” at the two-day tax forum (starting today in Canberra).

Hedgeye’s take: The Aussie housing market, which remains under substantial duress, has exhibited a classic dead-cat bounce off the lows. We continue to think the trend in this market is one that is negative over the long-term TAIL – particularly if Stevens continues to remain stubbornly hawkish on interest rates. Australia’s economic growth continues to slow alongside a waning of inflation pressures out of the once-tight Aussie labor market – which is exactly why the interest rate swaps market is pricing in a full -161bps of cuts to the benchmark rate over the NTM (per a Credit Suisse index)… We don’t have any edge on this tax meeting, but any growth-negative fiscal policy in the form of higher taxes might be incrementally bearish for the Australian economy.


  • Indonesian CPI slowed in Sept to +4.6% YoY vs. +4.8% prior.
  • Thailand CPI slowed in Sept to +4% YoY vs. +4.3% prior.

Hedgeye’s take: As our theme of Deflation the Inflation continues to play out across key commodity markets, we continue to expect that reported inflation trends down on a global basis – particularly in emerging markets. At a price, this will be a very positive development for global consumer stocks. Timing, however, remains the key factor to solve for – particularly on the emerging market front, given the potential for FX headwinds to erode the profits of foreign-based investors.

Darius Dale


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