China Hard Landing Bets Rise As It Now Costs More To Bet On Renminbi Strength Than Weakness
About a week ago, Goldman Sachs closed its tactical short USDCNY Non-Deliverable Forward trade, which was opened on June 10, 2010 and which expired a year later for a 4.2% gain. Goldman added: "Our view has not changed. The necessary adjustments to global imbalances demand a weaker US Dollar, and especially so vs the CNY. The cyclical and political backdrop remains supportive along those lines. Moreover, we expect $/CNY depreciation to continue/extend in the months to come. We remain positioned for the theme via our $/CNY NDF recommended Top Trade with longer initial maturity, expiring on 4 December 2012." Nonetheless, something appears to have shifted in the derivative CNY market, where as Bloomberg points out, it now costs more to bet on RMB weakness than strength. It adds: "China appears headed for a hard landing as the country’s housing market shows more signs of weakness. Currency traders have reduced their expectations for more appreciation of the yuan versus the dollar in the derivatives market, meaning they expect Chinese policy makers to fundamentally shift their approach to the currency due to economic softening. Other markets may soon follow currency’s lead." As the attached chart shows the USDCNY 3 Month 25 Delta Risk Reversal for the first time since September 2009, there appears to be some outright bearishness on the renminbi appreciation scenario. Does this mean that yesterday's decline in the official fixing rate to 6.4736 on Thursday, lower than the record high of 6.4683 on Wednesday is more than a one time adjustment and is the start of a new trend? We will find out soon enough.
More from Bloomberg:
A number of signs point to a decline in Chinese housing. The Bloomberg Brief Population Weighted National Home Price Index shows that while housing prices are still rising year over year, the rate of appreciation is diminishing as government tightening measures aimed at quelling the bubble have taken effect. Growth slowed to 4.1 percent in May from 5.9 percent in January, and is approaching the nation’s one-year deposit rate of 3.25 percent.
With inflation above five percent, this decline means housing has joined deposit rates in negative territory in real terms, reducing investor incentives to put money into real estate. Transaction volumes also appear to be slowing, which may point to lower prices ahead.
There are also declines in other related data series. Sales of excavators have fallen 9.6 percent year over year, and sales of heavy-duty trucks needed for building are down 22.4 percent.
All of this likely fed into Standard & Poor’s recent revision of its outlook on Chinese housing to negative from stable. S&P expects home prices to fall 10 percent over the next year.
A decline in home prices may cause significant wealth destruction in China. The country’s investors essentially have only three main options: bank accounts, equity markets, and property. With real deposit rates in negative territory since February 2010, many Chinese have been pushed into property and equity markets. According to a survey by Hurun reported on by Forbes in May, about 20 percent of Chinese millionaires get their money from the country’s “hot real estate market.”
Growing concerns about a hard landing are definitely on display in the currency market, where betting that the yuan will fall recently became more expensive than backing its appreciation for the first time since September 2009. US D/CNY three-month 25 delta risk reversals, which measure the skew of out-of-the-money options to determine the direction of the spot rate over the next three months, turned positive on June 13.
This is remarkable given that the yuan is largely a political tool in China, held at lower levels than it should be to encourage exports and allowed to appreciate only gradually by Chinese policy makers under pressure from foreign counterparts to lessen global imbalances. In a hard landing scenario, Chinese policy makers would likely stop allowing appreciation, as strong exports would become a more important tool for bolstering the economy.
Bloomberg's proposed solution to what may be the start of China's downturn? Why print more of course:
Eventual government action may borrow from Fed Chairmen Alan Greenspan and Ben Bernanke’s playbooks. Their moves to loosen monetary policy in response to faltering markets became known as the Greenspan and Bernanke puts. In China, support would likely include fiscal as well as monetary policies focused on increasing investment into low- and middle-income housing and infrastructure as outlined in the country’s 12th five-year plan, as well as the lifting of certain borrowing restrictions for new homes. This “Jiabao” put would help put the economy back on sounder footing while likely engineering a soft landing for China.
Luckily, the financial markets have already put the stranglehold on the "Jiabao" put, and unless China promptly agrees to commence the printing, the interbank liquidiy market as we have been showing for the past week, is about to die a gruesome death.