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China: Why Did the PBoC Cut? (Will It Even Matter?)

Takeaway: The PBoC’s surprise rate cut confirms our bearish thesis on the Chinese economy, but may portend brighter days ahead.

Editor's note: This was originally published November 21, 2014 at 13:26 in Macro. To learn more about becoming an individual subscriber click here.

Chartreuse and Spoos: The Global Central Planning Spree Continues

As you can probably tell by the overnight action in the spoos, a central bank in Asia eased monetary policy. This time, it was China – i.e. the economy responsible for 16% of global GDP and 30% of global GDP growth (on a PPP basis). Yes, the same China where 2014 Real GDP growth is tracking at the slowest pace since 1990!

 

From a forward-looking perspective, this is a good thing only if it signals a sustained move away from the “proactive fiscal policy and prudent monetary policy” they’ve been guiding to and implementing for over two years now. Recall that amid incessant cries for Western-style monetary easing, the PBoC has refrained from cutting interest rates since July of 2012 (excluding the removal of the lending rate floor). It has not [broadly] lowered RRRs since May of 2012.

 

China: Why Did the PBoC Cut? (Will It Even Matter?) - DD1

 

In and of itself, this rate cut will hardly do anything to arrest the rate of decline in Chinese economic growth; nor will it offset the “increasing downward pressure” upon the Chinese economy over the NTM, as most recently reiterated Xu Shaoshi (head of the National Development and Reform Commission) just two days ago.

 

Chinese growth is effectively crashing at this point. Our model points to a continued slowdown of Real GDP to +7.1% YoY in 4Q – and that’s being polite (i.e. conceding their made-up numbers). The reality is that Chinese growth is far shy of that number, making the 2nd derivative impact much more severe for economies and businesses that rely on Chinese demand. Pull up a 2Y chart of Standard Chartered (STAN) if you want the real story on Chinese growth. 

 

So Why Cut Now?

There are two primary reasons why the PBoC surprised everyone by cutting rates today (-25bps on the benchmark household deposit rate; -40bps on the benchmark lending rate):

 

  • Economic growth – which had already been slowing precipitously, as evidenced by the sea of red in the table below – fell off a cliff in October. This is most easily confirmed by the rate of change in Total Social Financing growth and Macau’s mass business, which was down -8% YoY (from +15% in September). That was the first annual decline in mass revenues in over five years!
  • Amid increasingly large capital outflows (see: declining FX reserves and negative “hot money” flows) and trending disinflation, the real cost of 1Y capital in the Chinese banking system has actually risen to fairly high level of late, rising to roughly 1.4% from ~0% at the start of the year.

 

China: Why Did the PBoC Cut? (Will It Even Matter?) - CHINA High Frequency GIP Data Monitor

 

China: Why Did the PBoC Cut? (Will It Even Matter?) - China Iron Ore  Rebar and Coal YoY vs. GDP

 

China: Why Did the PBoC Cut? (Will It Even Matter?) - China Real Interest Rate

 

Again, the PBoC’s decision to cut rates today makes a ton of sense to us, given China’s sustained #Quad4 setup, which calls for a dovish response from fiscal and monetary policymakers. We just didn’t see it coming given their official guidance; it's worth noting that Beijing is notorious for sticking to the script.

 

China: Why Did the PBoC Cut? (Will It Even Matter?) - CHINA

 

Cyclical Outlook: Still Very Negative, But Potentially Positive

You’ll note that in that our GIP Model has China going into #Quad1 for the first quarter. That’s primarily because of seasonality (fiscal expenditures and credit growth tend to be front-end loaded) and, obviously, very easy comps. That being said, China had these things working in its favor at the start of this year, but obviously the tightening we saw in the early part of 2014 trumped that setup (to the downside).

 

China: Why Did the PBoC Cut? (Will It Even Matter?) - China GDP Seasonality

 

A continued “recovery” in the Chinese property market – which had been truly crashing – is also supportive of any positive 2nd derivative delta for the Chinese economy in 1H15.

 

China: Why Did the PBoC Cut? (Will It Even Matter?) - CHINA Property Market Monitor

 

It’ll be interesting to see if the rebound in property development (read: fixed asset investment) is actually sustainable amid home price deflation accelerating to the downside on a trending basis. For now, it’s too early to tell; what we do know is that Chinese policymakers are very concerned about this segment of the economy and have ratcheted up support for the sector in recent months.

 

Investment Conclusions

All told, the PBoC’s surprise rate cut confirms our bearish thesis on the Chinese economy, but may portend brighter days ahead from a cyclical perspective.

 

That being said, long-term investors should NOT get involved with any “China recovery” trade that may percolate from this. China’s structural economic imbalances and official rebalancing agenda imply continued slowing over the long-term TAIL.

 

Feel free to ping us w/ any follow-up questions. Have a great weekend,

 

DD

 

Darius Dale

Associate: Macro Team


The Biggest Currency Crisis Since 1998

Editor's note: This is an excerpt from Hedgeye morning research. To learn more about how you can become a subscriber to America's fastest growing independent research firm click here.

*  *  *  *  *  *  *

The Russian Ruble is down -6% since Friday. It’s plunged -40% year-to-date. This is the biggest crash in currency land since 1998.

 

For the record, global macro market #Intereconnectedness mattered then, and it does now.

 

The Biggest Currency Crisis Since 1998  - 12.01.14 Chart

 

As Hedgeye analyst Matt Hedrick observed earlier today:

 

Russia remains a major area of global risk exposure...Energy still accounts for 20-25% of Russia's GDP, and energy prices have fallen ~30% in the last two months. Multiplying those two weightings would imply that Russia's economy is at risk of suffering a decline of 6-7.5%. 

 

Meanwhile... Russian stocks? They are down another -3.4% today to over -32% year-to-date.

 

#NoWorries right? Right?


Keith's Macro Notebook 12/1: Oil | Russia | Italy

 

Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.


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European Banking Monitor: Oil Move Priced Into Russian Financials Swaps

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 

 

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Key Takeaway:

Russia remains a major area of global risk exposure. Russia's largest bank, Sberbank, which holds roughly half of all retail deposits for the country, is now trading at over 400 bps on its credit default swaps. The "danger zone" is generally regarded as anything north of 300 bps. With oil continuing to plunge following OPEC's move to drive marginal shale producers out of business, the embedded risk in Russia's banking system is growing quickly. Consider this simple example. Energy still accounts for 20-25% of Russia's GDP, and energy prices have fallen ~30% in the last two months. Multiplying those two weightings would imply that Russia's economy is at risk of suffering a decline of 6-7.5%. Compare that with the 8.2% decline experienced by the US Economy in 4Q08 during the height of the US Great Recession.

 

European Financial CDS - Swaps also were mostly tighter in Europe last week. At the median, European swaps tightened by -8.5%.  Only Greek and Russian bank CDS widened modestly: Greece by about 3.1% and Russia by 2.5%. We would call out Russia's Sberbank, which is now north of 400 bps, reflecting the rising risk in the Russian economy.

 

European Banking Monitor: Oil Move Priced Into Russian Financials Swaps - chart1 euro financials CDS

 

Sovereign CDS – Sovereign swaps mostly tightened over last week. Spanish sovereign swaps tightened by -12.5% (-13 bps to 91 ) and American sovereign swaps widened by 8.9% (1 bps to 18).

 

European Banking Monitor: Oil Move Priced Into Russian Financials Swaps - chart2 sovereign CDS

 

European Banking Monitor: Oil Move Priced Into Russian Financials Swaps - chart3 sovereign CDS

 

European Banking Monitor: Oil Move Priced Into Russian Financials Swaps - chart4 sovereign CDS

 

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 tightened by 2 bps to 8 bps.

 

European Banking Monitor: Oil Move Priced Into Russian Financials Swaps - chart5 euribor OIS spread

 

Matthew Hedrick

Associate

 

Ben Ryan

Analyst

 

 

 



Commodities Weekly Sentiment Tracker

Note: Using the z-score in the tables below as a coefficient of variation for standard error helps us flag the relative market positioning of the commodities in the CRB Index. It is not intended as a predictive signal for the reversion to trailing twelve month historical averages. For week-end price data, please refer to “Commodities: Weekly Quant” published at the end of the previous week. Feel free to ping us for additional color.    

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1.       CFTC Net Futures and Options Positioning CRB Index: The Commodities Futures Trading Commission (CFTC) releases “Commitments of Traders Reports” at 3:30 p.m. Eastern Time on Friday. The release usually includes data from the previous Tuesday (Net Positions as of Tuesday Close), and includes the net positions of “non-commercial” futures and options participants. A “Non-Commercial” market participant is defined as a “speculator.” We observe the weekly marginal changes in the overall positioning of “non-commercial” futures and options positions to assess the directionally-biased capitulation risk among those with large, speculative positions.

 

The CFTC did not report its weekly positioning data with the shortened week. The table below represents the data released Friday, November 19th.

 

Commodities Weekly Sentiment Tracker - chart1 sentiment

 

2.       Spot – Second Month Basis Differential: Measures the market expectation for forward looking prices in the near-term.

  • The CORN, SUGAR, AND SOYBEANS markets are positioned for HIGHER PRICES near-term
  • The LEAN HOGS, COTTON, AND COPPER markets are positioned for LOWER PRICES near-term

Commodities Weekly Sentiment Tracker - chart2 spot 2nd month basis

 

3.       Spot – 1 Year Basis Differential: Measures the market expectation for forward-looking prices between spot and the respective contract expiring 1-year later.

 

  • The CORN, SUGAR, AND ORANGE JUICE markets are positioned for HIGHER PRICES in 1-year  
  • The LEAN HOGS, LIVE CATTLE, AND SOYBEANS markets are positioned for LOWER PRICES in 1-year  

Commodities Weekly Sentiment Tracker - chart3 spot 1 Yr basis

 

4.       Open Interest: Aggregate open interest measures the amount of opened positions in all actively traded futures contract months. Open interest can be thought of as “naked” or “directionally-biased” contracts as opposed to hedgers scalping and providing liquidity. Most of the open interest is created from large speculators or participants who are either: 1) Producers/sellers of the physical commodity hedging their cash market exposure or 2) Large speculators who are directionally-biased on price.

 

Commodities Weekly Sentiment Tracker - chart4 aggregate open interest         

 

Ben Ryan

Analyst


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