Flagging Asymmetric Risk in the Chinese Yuan and Dim Sum Bond Market

Conclusion: Given the asymmetry of both the pricing setup and fundamental outlook, secular yuan weakness and a bearish re-pricing of the Dim Sum bond market are two long-term TAIL risks we are flagging to you at the current juncture.


The most topical news out of Asia this morning came with the PBOC’s decision to widen the yuan’s trading band (vs. the USD) to up to 1% from its daily reference rate (from 0.5% prior). In theory, this should increase the volatility of the yuan, especially given the central bank’s desire to “promote price discovery” by enhancing the “two-way flexibility” of the currency. The PBOC did, however, state that they will keep the yuan “basically stable at an adaptive and equilibrium level” – denoting no change from their 2012 policy outlook statement or their actions (the yuan is down only -14bps vs. the USD since the start of the year).


We strongly caution against joining in the consensus hoopla which is still largely stuck on the secular yuan appreciation story. In fact, we are of the view that the China’s currency will likely weaken over the intermediate term as declining trade flows and a dramatically-subdued inflation environment gives the PBOC cover to pursue easing policy in the form of currency devaluation – a method of monetary easing that doesn’t necessarily undermine the State Council’s oft-restated goal of quashing speculation in China’s domestic property market. For a more in-depth look at each of those trends, please refer to our APR 10 piece titled, “China Is Boring”.


Jumping back to the consensus yuan appreciation story, the China Securities and Regulatory Commission’s decision to meaningfully expand its Qualified Foreign Intuitional Investor (QFII) and Renminbi QFII quotas ($80B from $30B; CNY50B from CNY20B) and a rebound in the country’s FX reserves in 1Q12 (+3.9% QoQ after posting their first quarterly decline in 4Q11 since 2Q98) are each contributing to a consensus view that China will continue to allow the yuan to appreciate as it seeks a greater international role for its currency amid unrelenting political pressure.


Flagging Asymmetric Risk in the Chinese Yuan and Dim Sum Bond Market - 1


Per Bloomberg consensus forecasts, the yuan is likely to gain an additional +2.7% vs. the USD through year-end and an additional +4.3% in 2013. Looking to the premium/discount spread for offshore (Hong Kong) vs. onshore (Shanghai) rates, the buy-side is also bullish on the yuan in aggregate – assigning a +12bps premium to obtain yuan in Hong Kong, though down from +58bps in JAN. Because international investors are generally limited to obtaining offshore yuan for exposure to China’s currency, the premium/discount they apply to the onshore rate can be a colorful tool in determining how [collectively] bullish/bearish the buy-side is on the yuan at the present moment.


Lately, however, a noteworthy divergence has emerged in the relationship between the yuan’s present outlook with its future outlook. 1yr non-deliverable forwards (settled in USD) for both the CNY (onshore) and CNH (offshore) USD crosses are trading at a -0.6% and -1.2% discount, respectively, to their present rates – signaling that investors are increasingly hedging for yuan weakness, rather than strength, over the NTM.


Flagging Asymmetric Risk in the Chinese Yuan and Dim Sum Bond Market - 2


The present-day bullishness on the yuan and recent yuan strength (Asia’s best-performing currency vs. the USD and EUR over the LTM) have been a boon the Dim Sum bond market, which are denominated in yuan and traded in Hong Kong (named after the territory’s famous cuisine, which also happens to be this ex-offensive lineman’s favorite food). Per Bank of America Merrill Lynch’s index(s), Dim Sum bonds have returned a record +3.4% in 1Q12, with average yields on corporate bonds falling -63bps YTD to 4.89%. Mean reversion has also been supportive here; Dim Sum bonds fell -3.9% in 2011 according to a Bank of China Ltd. index amid record new supply ($23.7B in ’11; on pace for $33.8B in ‘12), waning demand (yuan deposits in Hong Kong peaked in NOV), and increased scrutiny regarding their creditworthiness (only 37% of Chinese company issues are rated in the BofA index; Moody’s raised “red flags” on all 61 companies it examined in a JUL ’11 report).


Flagging Asymmetric Risk in the Chinese Yuan and Dim Sum Bond Market - 3


Flagging Asymmetric Risk in the Chinese Yuan and Dim Sum Bond Market - 4


Despite those headwinds, a consensus desire to seek exposure to China’s currency appreciation story by any means necessary has contributed to a fair amount of price dislocation in China’s corporate bond market, with top-rated onshore issuers paying an average of 4.81% on their bonds vs. 2.54% for investment-grade Dim Sum issuers. To the extent that the secular, one-sided yuan appreciation story is peaking/has peaked, we would expect to see some degree of arbitrage here over the long-term (i.e. the yuan appreciation premium inherent in Dim Sum bonds is unwound) – especially if the Chinese yuan actually starts to exhibit the two-way flexibility the PBOC claims it seeks.


While we can’t know for sure at the current juncture, who’s to say the Chinese yuan isn’t dramatically overvalued, especially given that capital account flows (while minimal) have been as one-sided [inbounding] as China’s trade flows have been over the last decade or so? What if during the process of China’s liberalization of its capital account its large stock of domestic savings begins to flow offshore in search of higher risk-adjusted real rates of return? Currently, China’s domestic savers’ options for investment are rather limited and unattractive: property market speculation (policy headwinds there); domestic equities (Shanghai Composite Index was down -14.3% in 2010 and another -21.7% in 2011); and savings accounts (negative real interest rates locked up at systemically risky banks). If capital outflows ever sustainably exceed China’s trade and investment income – which are likely both headed lower over the long-term as the country rebalances towards increased consumption (lower net exports) – a secular bear thesis for the Chinese yuan wouldn’t be that difficult to justify.


Flagging Asymmetric Risk in the Chinese Yuan and Dim Sum Bond Market - 5


At the bare minimum, we think those are questions and scenario analyses that neither the buy-side nor sell-side has begun to explore en masse, and given the asymmetry of both the pricing setup and fundamental outlook, secular yuan weakness and a bearish re-pricing of the Dim Sum bond market are two long-term TAIL risks we are flagging to you at the current juncture.


Darius Dale

Senior Analyst

European Banking Monitor: SMP – Another Goose Egg

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .


Key Takeaways:


* Spanish sovereign swaps continue to climb. At 502 bps this morning, they are up 102 bps from a month earlier and are up 38 bps vs. the prior week. Italian swaps stand at 435 bps, up 17 bps week over week and up 80 bps vs. a month earlier. For reference, Spanish swaps just hit an all time high as of this morning, narrowly eclipsing their highs of November last year (497 bps). Italian swaps are still a good bit below their prior highs.


* Both American and European Bank CDS were wider WoW. Bank swaps are reflecting the deterioration in creditworthiness in Spain, an economy roughly 5x as large as that of Greece. Get ready for 2011 all over again as we watch Spanish swaps climb and climb and concerns surrounding that rise escalate. 


* Euribor-OIS has ceased tightening. After steadily falling since the start of the year, the risk measure has essentially flattened out at the 40-41 bps level. This had been a key measure we were using to gauge the perceived risk in the counterparty system.


* High yield rates rose 4 bps last week underscoring increasing risk in the market. 



Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was flat ending the week at 41 bps.


European Banking Monitor: SMP – Another Goose Egg - Euribor


ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  Banks deposited €742.8 billion in the latest reading.


European Banking Monitor: SMP – Another Goose Egg - 11. facility


European Financials CDS Monitor –  Bank swaps were wider in Europe last week for 37 of the 40 reference entities. The average widening was 5.6% and the median widening was 4.8%.


European Banking Monitor: SMP – Another Goose Egg - 11. banks


Security Market Program – For a fifth straight week the ECB's secondary sovereign bond purchasing program, the Securities Market Program (SMP), purchased no sovereign paper for the latest week ended 4/13, to take the total program to €214 Billion.


February-to-date the Bank has purchased a mere €210 Million versus €2.2 BILLION in the week ended 1/20 and €3.8 BILLION in the week 1/12.


The standstill comes as market risk returns.  While there are other channels to suck up sovereign bond issuance, including through funding from the two 36-month LTRO programs, the SMP’s lack of buying may send a negative signal to market participants that are already weary of the sovereign and bank risks bubbling in Spain.


European Banking Monitor: SMP – Another Goose Egg - 11. SMP


Matthew Hedrick

Senior Analyst


Revising April projection a little lower 



Not surprisingly, average daily table revenue (ADTR) increased week over week with the opening of Sands Cotai Central (SCC).  We would’ve expected a bigger week over week increase than 2% as the past week included four days of SCC.  However, we have heard that SCC may have held low in its first few days of operations.  Either way, it’s way too early to make any conclusions about the performance of SCC and its impact on market growth.


We are slightly lowering our monthly projection to HK$23.5-24.5 billion which would represent YoY growth of 18-23%. 




Despite the opening of SCC, LVS lost 60bps of MTD share in the past week but share remains close to trend.  Wynn picked up the most share sequentially, up to 13.2% and well above trend.



get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.


The most important meal of the day.










Comments: Keith booked a gain in BWLD on Friday in the Hedgeye Virtual Portfolio. His quantitative model was indicating that the stock was oversold on an immediate-term TRADE duration.  Our bearish fundamental view remains unchanged.





Commentary from CEO Keith McCullough


Bulls were looking for a Monday morning bounce – not happening; inflows are dead:

  1. EUROPE – the DAX is testing an intermediate-term TREND line breakdown of the 6614, so I’ll be watching that line closely as a barometer for what the correction in US stocks could look like (Germany’s jobs and fiscal situation is stronger than in the US); Spain and Italy look awful; we re-shorted France on Thursday as we think mean reversion there is to the downside
  2. COMMODITIES – getting blasted ever since the US Dollar stopped going down (2wks ago); got interconnectedness? We call this Deflating The Inflation, or unwinding Bernanke’s Bubbles (commodity bubble – see our slide deck). Gold and Copper down hard this morning after failing at $1675 and $3.73 levels of support last wk – both are in Bearish Formations (bearish on all 3 of our risk mgt durations)
  3. BOND YIELDS – 10yr UST yields snapping my intermediate-terrm TREND line of 2.03% last wk is very bullish for Treasuries until it isn’t. This happened in conjunction with a spike in weekly jobless claims (380,000) = Growth Slowing.

SP500’s immediate-term risk mgt range = 1.





THE HBM: CMG, DPZ - subsector





CMG: Chipotle was awarded the 2012 GRANDY Award by Creative Artists Agency for its animated short film “Back to the Start”.  “‘Back to the Start’ was never intended to be an ad; it was meant to be a short film to invite people on a journey with us to a more sustainable future,” said Mark Crumpacker, CMO at Chipotle.


DPZ: Domino’s was raised to “Buy” from “Hold” at Miller Tabak & Co.  The 12-month price target is $41 per share, or 15.5% higher than Friday’s close.




YUM: Yum gained on accelerating volume on Friday.  Bulls are buying on the expectation that the US business has improved in 2012.


SBUX: Starbucks also gained on accelerating volume to close the week.


COSI: Cosi declined -4.8% on accelerating volume.







EAT:  Brinker traded higher on strong volume.  The company is our second-favorite casual dining name but we have advised taking a cautious stance on the name given its outsized returns during the last six months and its vulnerability in the context of a slowdown in industry sales.  BWLD is our favorite name on the short side in casual dining, along with CBRL, TXRH, and CAKE on strength.


THE HBM: CMG, DPZ - stocks



Howard Penney

Managing Director


Rory Green



Fiscal Picasso

“My mother said to me, 'If you are a soldier, you will become a general. If you are a monk, you will become the Pope.' Instead, I was a painter, and became Picasso.”

-Pablo Picasso


The Spanish painter Pablo Picasso had no shortage of belief in his intrinsic talent as a painter.  His point in the quote above was to basically say that if you are going to do something well, you should endeavor to do it better than anyone.  Something his nation is not currently doing well, let alone better than any other nation, is managing their sovereign debt load.


As we wake up this morning to another week of managing risk in the global macro markets, Spain, as we highlighted in a detailed note last week, is once again front and center.  The leading indicator of an acceleration of sovereign debt woes in Europe is the Euro, which has dropped just below $1.30 versus the U.S. dollar for the first time in two months.


The Euro is moving in anticipation that there are a series of Spanish debt auctions this week that may not go quite as planned.  Specifically, tomorrow Spain will sell 12 and 18-month notes.  This will be followed on Thursday by longer term debt due in October 2014 and January 2022.  Watching these auctions will be critical in determining whether the European Union has the wherewithal to contain the once again accelerating crisis in confidence in the European sovereign debt markets.


To that point, if the debt and CDS markets for Spain are any indication, the Spanish sovereign debt issues are far from contained.  Spanish 10-year yields are now at 6.16% and at levels not seen since December 2010.  Meanwhile, Spanish credit default swaps are, literally, at all-time highs.


As we’ve previously written, Spain is a bigger concern than Greece for many reasons, but most specifically because its economy is almost 5x that of its Hellenic neighbor and is the 12th largest economy in the world.  Clearly, Spain is not an insignificant player on the world stage.


To be fair, Spain’s sovereign debt load is not elevated to a level that would suggest as much stress as we are currently seeing in its debt markets.  In fact, according to Euro Stat, Spain’s federal debt balance as a percentage of GDP was only 69% at the end of 2011.  Many sovereign analysts believe the number is a bit of a misnomer though and when regional debts are included, which are in effect a recourse to the federal government, the total amount of debt is closer to 90%.


Regardless, the more pertinent issue in Spain is the acceleration of debt.  By Spain’s own projections, the nation will add more than 10% to its debt-to-GDP ratio this year, taking that ratio closer to 80% on Euro Stat’s numbers. This will lead the industrialized world in growth in debt-to-GDP.


Spanish unemployment hit 23.6% at the end of February and the unemployment rate for the youngest demographic in Spain is literally at 50%.  Given the structural unemployment issue, Spain is literally unable to grow out of its debt issues.  This lack of growth potential is clearly what the markets are starting to bake in to Spanish yields.  That is, if there is a way out, it is not going to be easy and certainly won’t occur before the nation becomes substantially more indebted. 


This weekend Paul Krugman of the New York Times, in typical fashion, suggested adding more Keynesian stimulus to the mix.  Or, at the very least, Krugman suggests dispensing with the “insane” austerity.  If the United States is any case study, accelerating government spending does not appear to be the path to sustained economic prosperity.  


Krugman may actually get his way in France, where Socialist Francoise Hollande is extending his lead over Nicolas Sarkozy.  Currently, Hollande is expecting to win both the first round (April 22nd) and the second round (May 6th) of French elections.  Sadly, we actually know how Socialism ends as well. 


The other rumor out of Europe this morning is that Spain may re-instate a short selling ban.  That is a little counter intuitive to us.  Even if the markets are not giving you much in the way of confidence votes, changing the rules mid game is not going to increase confidence. 


In other global macro news this morning, we are also seeing increased evidence of growth slowing and inflation accelerating.  On the growth front, Sweden cut its 2012 growth outlook from +1.3% to +0.4% and the Bank of Korea cut its 2012 growth forecast from +3.7% to +3.5%.  Meanwhile, inflationary data from India continued to come in hot as wholesale prices “beat” consensus estimates coming in at +6.9% versus the +6.7% estimate.


Switching gears, and while we wouldn’t normally flag Barron’s as a leading indicator for tail risk, the weekly publication did do a nice job this weekend discussing the next impending debt disaster in the United States, student loans.  In terms of scale, the almost $1 trillion in outstanding student debt is larger than both the auto loan market and credit card market.  The most interesting statistic quoted in the article is that college tuition is up 300% since 1990, which far outstrips the increase in more traditional measures of inflation by a factor of 4x.


At the end of the day, though, the vast majority of the student debt is guaranteed by the federal government, so on some level it has much more security than the typical sub-prime mortgage.  Just make sure you add the $1 trillion asterisk when calculating the debt-to-GDP of the United States. Fiscal Picassos, we are not.


The immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen (vs USD), Euro/USD, and the SP500 are now $1, $118.63-122.36, $79.64-80.27, $80.12-82.34, $1.29-1.31, and 1, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Fiscal Picasso - Chart of the Day


Fiscal Picasso - Virtual Portfolio

Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.