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On The Paradox Of Concurrent Chinese RRR Hikes And OMO Liquidity Injections (And A SHIBOR Update)
About two weeks ago we brought attention to the curious case of surging Chinese SHIBOR. Today we update on the short and longof it (literally). Indeed since the first post, the short end has dramatically tightened. However, just as importantly, the long-end continues to drift wider. As the chart below demonstrates the 1 Week SHIBOR has plunges from north of 6% to the mid 2% range in about ten days. However, both the 1 and 3-Month rates continue to be sticky and are well above recent averages. This will certainly portend continued liquidity scarcity in the months ahead. And speaking of, interest rates, we would like to bring attention to the seemingly paradoxical and contradictory action being taken by the PBoC, which on one hand has been hiking the Reserve Ratio Requirement (liquidity withdrawing) while concurrently adding liquidity via net liquidity injections through Open Market Operations. As Morgan Stanley's Steven Zhang suggests: "The PBOC’s purpose appears to be to substitute RRR hikes for PBoC bill issuance and repos with a view to enhancing the effectiveness while keeping the cost of liquidity management low." Yet even so, Zhang confirms that the end result will be one of incremental tightening, no matter how much the PBoC wants to moderate liquidity extraction. "Even if the spreads between reference and interbank spot yields were to narrow to acceptable levels, we don’t believe that the scale of open market operations would be restored to normal levels. In this tightening cycle, liquidity management will largely become a one-way operation - withdrawal." In other words, look for more pain in the Shanghai Composite over the coming weeks as mainland investors realize that the inflation party is, indeed, coming to an end (and that to Bernanke's chagrin, all attempts at exporting inflation to China will henceforth rebound with a magnified impact).
But first, here is SHIBOR and the divergence between the short and long end.
As for the far more relevant issue of a seemingly schizophrenic approach to liquidity management, here is what Zhang has to say regarding net liquidity injections via OMO on one hand, and withdrawals via RRR hikes, on the other:
PBOC Open Market Operations: After four consecutive weeks of floor-level bill issuance (RMB 2 bn per week of RMB 1 bn each for 1-Yr and 3-M bills) with suspension of repo sales, total issuance rebounded to RMB 92 bn (RMB 4 bn of PBOC bills and RMB 88 bn of repo sales) last week. However, given RMB 111 bn of redemptions (RMB 66 bn of bills and RMB 45 bn of repos) over the same period, net liquidity injection (through OMOs) extended into the eighth week.
Reference yields continued to rise: The PBOC raised the reference yields for the third consecutive week, after which 1-Yr and 3-M rates had risen by 37.8 bps and 44.6 bps to 2.722% and 2.259%, respectively, over the period. However, given the significant spreads with interbank spot rates (48 bps and 69 bps for 1-Yr and 3-M bills, respectively) (Exhibit 3), the recent hikes in reference yields seem far from sufficient to revive market participants’ interests in PBOC bills and repos, in our view. Even if the spreads between reference and interbank spot yields were to narrow to acceptable levels, we don’t believe that the scale of open market operations would be restored to normal levels. In this tightening cycle, liquidity management will largely become a one-way operation - withdrawal. In this context, the RRR would be superior to OMOs based on cost considerations (e.g., interest rate paid on required reserves is only 1.62%) and effectiveness (locking about RMB 350 bn of liquidity for every 50 bps of RRR hike). This is the reason behind the seemingly contradiction that the PBOC has hiked RRR for four times within two months but simultaneously continued to inject liquidity through OMOs. The PBOC’s purpose appears to be to substitute RRR hikes for PBoC bill issuance and repos with a view to enhancing the effectiveness while keeping the cost of liquidity management low.
As a result, the latest RRR hike, while seemingly still innocuous, is starting to have a substantial impact on investor behavior and interpretation of formal policy:
RRR hike again: On Friday 14, PBoC announced a 50 bps RRR hike effective Jan 20, the fourth rise in two months. This is in part a response to the reportedly aggressive credit expansion by Chinese banks so far this year, in our view. Moreover, this RRR hike should help to absorb the liquidity released from OMOs after the previous hike (Dec 20) and tackle the rising redemption pressure in the coming weeks given the paralyzed OMOs. This RRR hike, together with the rate hike made on Christmas Day, also indicates that China's monetary tightening will be front-loaded, reflecting Chinese authorities' intention to keep inflation expectations in check up front. China's monetary policy will be characterized by "tightening to keep inflationary pressures in check", "front-loaded tightening", and "non-transparent monetary policy implementation", in our view. We reiterate our call for caution over the next 3-6 months, as the risk/reward balance does not look favorable in view of the rather strong policy headwinds.
In conclusion, Morgan Stanley believes that over time the liquidity balance will increasingly shift to the liquidity withdrawal side of the equation.
Out of consideration for cost and effectiveness, we believe that RRR may continue to play the key role of liquidity management if the trend of one-way operation (withdrawal) of liquidity management continues. In this context, the swaps between RRR and PBOC bills & repos would continue in form of repeated RRR hikes to be accompanied with consecutive liquidity injections through OMOs. Besides the conventional RRR hike, we expect Dynamic Differentiated RRR to become a primary monetary policy tool in 2011.
And after all, who can blame China: unlike the US, they at least are starting to see the adverse consequences of inflation predicated by loose central bank monetary policy which has already claimed numerous lives in Africa, and soon likely, elsewhere.
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Off topic:
Sorry to hijack this thread, but i was wondering if any fellow zerohedgers have bought any Silver Keisers:
http://www.silverkeiser.net
They were suppose to give regular updates as to what was happening, but i've heard nothing since ordering.
They have sold all 171,250 ounces of silver at approx $33 an ounce, so that's $5.6m dollars sitting in someones bank account.
Anyone received their Silver Keisers as they were suppose to start delivering mid-January?
http://www.silverkeiser.net/FAQ_ep_40.html
From the website:
"
NOTE: Max Keiser has no involvement with the production of the "Silver Keisers" what so ever. Physical delivery of the "Silver Keisers" will commence in mid January and all pre-orders will be delivered no later than the end of January. They will be sold on a first come, first served basis. All questions and concerns should be directed to info@silverkeiser.com."
Let us know if you get them. I was considering ordering a couple, but didn't.
This article is above my head. Why the inflation rebound?
Funny how even the Communist countries and government controlled economies are unable to engage in Greenspan/Bernanke style "mop up" operations to "restore liquidity and confidence".....
The Ben Bernanke has that down pat. He can re-sky stocks or stop inflation cold "in 15 seconds"....
Premier Wen Jaibo and Premier Hu must be green with envy...
China is pulling a Nathan Rothschild on Europe and the world. You think the Chinese are Jewish?
The Federal Reserve is providing China with the liquidity to buy up Europe and the entire worlds assets. Self hating Jews?
A little history from 1815.
"Developing circumstances soon allowed the Rothschilds to formulate a plan which would guarantee them the financial control of Europe, and soon the world. It began with taking advantage of the outcome of the Battle of Waterloo, which was fought at La-Belle-Alliance, seven miles south of Waterloo, which is a suburb of Brussels, Belgium. Early in the battle, Napoleon appeared to be winning, and the first secret military report to London communicated that fact. However, upon reinforcements from the Prussians, under Gebhard Blucher, the tide turned in favor of Wellington. On Sunday, June 18, 1815, Rothworth, a courier of Nathan Rothschild, head of the London branch of the family, was on the battlefield, and upon seeing that Napoleon was being beaten, went by horse to Brussels, then to Ostende, and for 2,000 francs, got a sailor to get him to England across stormy seas. When Nathan Rothschild received the news on June 20th, he informed the government, who did not believe him. So, with everyone believing Wellington to be defeated, Rothschild immediately began to sell all of his stock on the English Stock Market. Everyone else followed his lead, and also began selling, causing stocks to plummet to practically nothing. At the last minute, his agents secretly began buying up the stocks at rock-bottom prices. On June 21, at 11 PM, Wellington's envoy, Major Henry Percy showed up at the War Office with his report that Napoleon had been crushed in a bitter eight hour battle, losing a third of his men. This gave the Rothschild family complete control of the British economy, and forced England to set up a new Bank of England, which Nathan Rothschild controlled."
PBoC is competing with China's 'underground economy' for dollars.
The loan sharks and racketeers pay more yuan for each dollar so the PBoC has no choice but to follow suit.
With US banks and Chinese businesses 'permitted' to hold dollars this means dollars are already circulating on the mainland. Buy black market dollars with yuan and lead Chinese onetary policy by the you know what.
John Mitchell said: "When you have them by the balls their hearts and minds will follow."
The rate of hyperinflation on the streets of China is probably ten- times the official rate or 5% per month. The central bank cannot risk pulling liquidity without ruining the elites in the country who have leveraged themelves to the eyebrows. The outcome is the charade of 'tightening'.
When Paul Volcker goes to China you will know the Hu government is serious about cutting hyperinflation. Otherwise the government will loot its savers and inflate away its debts; just the thing it accuses the deflation- ridden US of doing.
China will go bust and Ben Bernanke should be shitting his panties as stock markets are not essentially mopping up excess liquidity and buying stocks. With volumes extremely light it's only min/sec HFT trading supporting markets and some occasional billion dollar longs. It's all a confidence buy, now a bull-trap with dumb money buying marked up shares in the last mth or so.
China is in a monetary sense is far more inflationary than the US, yet their stock-market is one of the worst in the world.
Hedge funds bet China is a bubble close to bursting The world is looking to China as a springboard out of recession - but some hedge funds are betting the country's credit and growth levels cannot be sustained.
But even as he spoke a hedge fund manager in Mayfair was poring over spreadsheets of sovereign and corporate credit default swaps, interest rate and foreign exchange options with one aim: to “get short on China”.
The manager, who wanted to remain anonymous, said: “The Chinese delegation has said all week that there will be double-digit growth for years to come and the Brits have lapped it up. But the data doesn’t add up. We think we’ve experienced credit bubbles over the past few years, but China is the biggest. And yet the global economy is looking to China as not just a crutch but a springboard out of the recession. It’s crazy.”
He is not alone. Hugh Hendry, a former star of Odey Asset Management, has launched a distressed China fund at Eclectica Asset Management.
He follows Mark Hart of Corriente Advisors, the American hedge fund manager who made millions of dollars predicting both the subprime crisis and the European sovereign debt crisis, who started a fund based on the belief that rather than being the “key engine for global growth”, China is an “enormous tail-risk”.
There have been academics and analysts who have argued about the dangers of China’s economy overheating for some time. But for many, the fact that hedge funds, particularly those with track records on previous crises, are launching specific funds is the sign that the bubble is close to bursting.
One academic said: “Economists have contrarian views all the time. But these hedge funds have their shirts on the line and do their analysis carefully. The flurry of 'distress China’ funds is a sign to sit up.”
More analysts are becoming bearish too. Last week, Lombard Street Research put out a note warning of China’s “already dangerously home-grown inflation”.
The analysts said figures showing the continuing boom in China were far from welcome: “On the contrary, Chinese policymakers have to slam on the brakes.” The financiers are warning that rather than depending on China as the prop of the recovery plan, Britain needs to be braced for another shock.
A recent study by Fitch concluded that if China’s growth falls to 5pc this year rather than the expected 10pc, global commodity prices would plunge by as much as 20pc. China is the global price-setter for oil, coal and base metals.
According to Corriente Advisors: “We expect the economic fallout from a slowdown of China’s unsustainable levels of credit and growth to be as extraordinary as China’s economic outperformance over the past decade.”
The financiers’ arguments centre on the belief that China’s demand is not real but manufactured by the state.
The Mayfair hedge fund manager said he started work when he saw some news reports on China’s “ghost towns”. Last year Al Jazeera, the Middle Eastern television channel, aired a short report from Ordos Shi, a city in inner Mongolia built for one million people that is almost entirely empty. The report reveals empty streets, housing estates, shops and restaurants. The locals prefer the old town of Ordos and tell the cameras there’s no need to move to the new city.
According to Corriente, China has consumed just 65pc of the cement it has produced in five years, after exports. The country is outputting more steel than the world’s next seven largest producers combined. It has 200m tons of excess capacity.
In property, Corriente said it had found an excess of 3.3bn square metres of floor space in China – yet 200m square metres of new space is being constructed each year.
Despite the vast population, the property is generally out of the price range for most. House prices are around 22 times disposable income in Beijing. The IMF has said that house prices in eastern cities have become “increasingly disconnected from the fundamentals” but so far has said there is no nationwide bubble.
Professor Victor Shih of Northwestern University, Illinois, estimates that Chinese banks have lent $1.7 trillion (£1.1 trillion) to local state entities, many of which are not commercially viable and have used inflated land values as collateral.
Experts in China dismiss the hedge funds’ arguments as narrow and exaggerated. The Chinese government has implemented policy measures to curb credit and control inflation. Above all, they argue that China’s huge and modernizing population will fuel demand for years.
Even the hedge funds concede that their timing might not be perfect. Corriente warns that investors, who are required to put in a minimum of $1m each, should brace themselves for an estimated burn-rate of 20pc a year until the theory pays off. But it’s a risk that plenty seem willing to take.
http://www.telegraph.co.uk/finance/economics/8261740/Hedge-funds-bet-Chi...
China's $586 billion, $4 trillion Yuan, stimulus package ended last month and curbing inflation has become a real concern. However, just because the money is spent does not mean the work has ended and just because a rate is increased doesn't mean it has full scale, immediate impacts. The real collision course starts in 6 months as the rate hikes really kick in at the same time as the government stimulus projects drop off. $50 billion was spent on high rail transit, but what becomes of the workforce that built it?
Hu Jintao will announce yuan against floating basket (euro debt purchases) on his visit with obama
China doesn't need to increase rates to crash, they are running below 0 inflation adjusted.
Oil/food inflation will do the trick nicely, China wages stagnate, prices spike, Chinese start to save = crash
For all you Aussies on here, Australia's wheat belt just got destroyed, floods just knocked out coking coal (for china steel industries).
Rates say per mortgage rates in the States are higher than China...
I am going 3-6mth inflation crash China
Any takers? apart from Hendry buying up CDS's on Chinese companies
http://www.cnbc.com/id/15840232?play=1&video=1746897394
Airtime: Sun. Jan. 16 2011 | 0:00 ST ET
Discussing China’s moves to curb growth and inflation, Mun Hon Tham, regional strategist at Daiwa Capital, expects two more rounds of hikes in interest rates and banks’ RRR this year. He talks to CNBC's Oriel Morrison, Bernard Lo and Adam Bakhtiar.