Reverse Repo

The main story overnight is without doubt the dramatic plunge in the Yen, which following the breach and trigger of USDJPY 100 stops has been a straight diagonal line to the upper right (or lower for the Yen across all currency crosses) and at last check was approaching 101.50, in turn sending the USD higher in virtually all jurisdictions. However it is not so much the Yen weakness that was surprising - a nation hell bent on doubling its monetary base in two years will do that - but the accelerating response in neighboring countries all of which are seeing Japan as the biggest economic threat suddenly and all are scrambling to respond. Sure enough, midway through the evening session, Sri Lanka cut its reverse repo and repurchase rate to 9% and 7% respectively, promptly followed by Vietnam cutting its own refinancing rate from 8% to 7%, then moving to Thailand where the finance chief Kittiratt called for a rate cut exceeding 25 bps, and more jawboning from South Korea suggesting even more rate cuts from the export-driven country are set to come as it loses trade competitiveness to Japan. Asian financial crisis 2.0 any minute now?

The week ahead will be driven by the heavy end-of-month data schedule. In addition to the usual key releases like ISM and payrolls and ECB meeting, this week we also get an FOMC meeting - though it will hardly see much more than a nod to the weaker activity data of late. For the ECB meeting a full refi but not a deposit rate cut are priced now.  Outside the FOMC and the ECB meeting there will be focus on the RBI meeting in India, with a 25bp cut priced in response to lower inflation numbers recently.

In many Western industrialized nations, debt has overwhelmed or is about to overwhelm the economy's debt-servicing capacity. In the run-up to a debt crisis, bad debt tends to move to the next higher level and may ultimately accumulate in the central bank's balance sheet, provided the economy has its own currency. Many observers assume that, once bad debt is purchased by the central bank, the debt crisis is solved for good; that central banks have unlimited wealth at their disposal, or can print unlimited wealth into existence.

However, central banks can only create liquidity, not wealth. If printing money were equivalent to creating wealth, then mankind would not have to get up early on Monday morning. Only a solvent central bank can halt hyperinflation. The longer governments run large deficits, the longer central banks continue to monetize them, and the longer their balance sheets grow, the higher the potential for enormous losses and thus hyperinflation.

Necessary preconditions for hyperinflation are a quasi-bankrupt government whose debt is monetized by a central bank with insufficient assets. One way or another, owning physical gold is the safest and most effective way of insuring against hyperinflation.

• Italy Political Vacuum to Extend for Weeks as Bargaining Begins (BBG)
• Italian impasse rekindles eurozone jitters (FT)
• On Spending Cuts, the Focus Shifts to How, Not If (WSJ)
• Obama spending cuts strategy focused on waiting game (Reuters)
• BOE’s Tucker Says He’s Open to Expanding Asset-Purchase Program (BBG)
• Fed Faces Explaining Billion-Dollar Losses in Stress of QE3 Exit (BBG)
• Carney warns over lack of trust in banks (FT) - here's a solution: moar bank bailouts!
• Bundesbank tells France to stick to budget (FT)
• China to tighten shadow banking rules (FT)
• Saudis Step Up Help for Rebels in Syria With Croatian Arms (NYT)
• After election win, Anastasiades faces Cyprus bailout quagmire (Reuters)
• Just for the headline: Singapore’s Darwinian Budget Sparks Employer Ire (BBG)

While the rest of the world was blissfully enjoying its latest reflation experiment, one country that has hardly been quite as ecstatic about all the blistering free money entering its real estate market (if not so much the Shanghai Composite) still warm off the presses of the G-7 central banks, has been China. Because China knows very well that while in the rest of the world, free money enters the stock market first and lingers there, in China the line between the reflating house market and the price of hogs - that all critical commodity needed to preserve social stability - is very thin. As a result, last week China withdrew a record CNY900 billion out of the repo market - the first such liquidity pull in eight months. This move had one purpose only - to telegraph to the rest of the world that the nation, whose central bank has patiently stayed quiet during the recent balance sheet expansion euphoria, will no longer sit idly by as hot money lift every real estate offer in China. Moments ago we got the second sign that China is less than happy with the reflating status quo, when the HSBC Flash PMI index for February missed expectations of a 52.2 print by a big margin, instead dropping from the final January print of 52.3 to just barely above contraction territory, or 50.4. This was the lowest print in the past four months, or just when the PMI data turned from contracting to expanding in November of last year.

When one thinks of the US banking system, the one thing few consider these days is the threat of a liquidity shortage. After all how can banks have any liquidity strain at a time when the Fed has dumped some $1.7 trillion in excess reserves into the banking system? Well, on one hand as we have shown previously, the bulk of the excess reserve cash is now solidly in the hands of foreign banks who have US-based operations. On the other, it is also safe to assume that with the biggest banks now nothing more than glorified hedge funds (courtesy of ZIRP crushing Net Interest Margin and thus the traditional bank carry trade), and with hedge funds now more net long, and thus levered, than ever according to at least one Goldman metric, banks have to match said levered bullishness to stay competitive with the hedge fund industry. Which is why the news that at noon the Fed reported that Primary Dealer borrowings from its SOMA portfolio, which amounted to $22.3 billion, just happened to be the highest such amount since 2011, may be taken by some as an indicator that suddenly the 21 Primary Dealers that face the Fed for the bulk of their liquidity needs are facing an all too real cash shortage.

China’s monthly data dump was the main macro update overnight, which however with ongoing mockery of the Chinese data "goalseeking" and distribution methodologies, most recently by the likes of Goldman, UBS and ANZ, had purely political window dressing purposes for the new Chinese politburo. Sure enough, that all the data came precisely Goldilocks +1 was enough to put a smile on everyone's face. To wit - Q4 GDP growth came in just higher than consensus (+7.9%yoy v +7.8%). On a full year basis the economy grew by 7.8%, also a tad above expectations. Then we got industrial production, also just higher than expected (+10.3% v +10.2%) and retail sales - just higher as well (+15.2% v +15.1%). Much more important than meaningless, jiggered numbers, was the announcement from the PBOC that in light of the entire world going "open-ended" on easing, China - which now can't afford to lower rates for fears of rampant inflation together with importing everyone else's hot money - announced it will start short-term liquidity operations as additional tool for controlling liquidity, engaging in a reverse repo on a daily basis, which will have a maturity of less than 7 days. This way the central bank will be able to reacted almost instantly to any inflationary spikes across the economy, as it too has no choice but to ease although not by the conventional inflation targeting methods now used by everyone else.

While trading during US hours is all about the Cliff On/Cliff Off debate, the rest of the world is simple: the overnight session begins (and largely ends) with whether or not China has done another reverse repo (if yes, then PBOC will not lower rates, and inject unsterilized billions into the market) and whether the Shanghai Composite is up or down. Last night, after jumping by 3% the session before, it was down 0.13% to 2029. Was this it for the great Chinese "bottom?" Japan may or may not figure in the equations, although with the 10 Year future just hitting a record overnight, it is amusing to see how the bond complex is indicating record deflation just in time for the market to anticipate a surge in inflation. Ah, the joys of frontrunning central planning's monetization of government bonds. And then we move on to Europe, which is a whole new level of basket case-ness...

China's Manufacturing PMI missed expectations, coming in at 50.6 relative to a slightly expansionary 50.8 expectation, and up down from the 50.2 prior. This is the fifth month in a row of missed expectations but it has now risen for three months in a row, to the highest level in 8 months; but has now hovered within 0.6pts of the expansion/contraction knife-edge for six months. The PBOC's index remains above (more positive) than the HSBC version for the 20th month in the last 21 (which remains in the contractionary sub-50 range it has been in for 16 months). With the Shanghai Composite testing Jan 09 lows and the ongoing Reverse Repo delicate bank pumpathon, the relative stabilization in Services and Manufacturing PMIs is confirmed by this evening's data and provides hope for those bidding H-Shares to 16-month highs. Interestingly for all those who remain shocked at the divergence between the Hang-Seng and the Shanghai Composite, it seems clear that A-Shares investors remain skeptical of the PMI-based stabilization of macro and prefer to trust the weaker (and harder to tweak) Industrial Output data.

Another day, another melt up overnight wiping out all the post-Moody's weakness, this time coming courtesy of Europe, where following the French downgrade, the EURUSD filled its entire gap down and then some in the span of minutes following the European open, when it moved from 1.2775 to 1.2820 as if on command. And with the ES inextricably linked to the most active and levered pair in the world, it is is no surprise to see futures unchanged. It appears that the primary catalyst in the centrally planned market has become the opening of said "market" itself, as all other news flow is now largely irrelevant: after all the central planners have it all under control.

It was a week ago when we first observed that the defense of 1400 in the ES at all costs must go on, or else the only thing that is keeping the market propped up - psychology (now with the AAPL euphoria long gone), would be gone as would all support. But once again, the overnight session has proven that, with a little help from its central banking friends, 1400 (and 1.2900 in the EURUSD) can be defended. This was in danger of being breached until China reported two PMI numbers: an official one which printed at 50.2, or modest expansion, and up from 49.8, magically right on top of expectations of 50.2, and the HSBC PMI, which also rose to 49.5, from 47.9: the 12th straight contraction print, but the highest number in 8 months. The market spin is naturally that this is an indication of a rebounding China. Sadly, just like in the US, this is merely pre-party congress data manipulation. The only thing that does matter out of China: whether or not the country will actually ease as opposed to doing day to day reverse repo injections. Without the former, the Chinese economy will not rebound, and will not lead to an improvement in corporate outlook for US tech stocks, period, the end.

With the stock markets of the "developed world" in limbo for the second straight day and leaderless as New York is paralyzed, and the US was set to be closed for a second straight day, and with futures tumbling to their lowest level in over 2 months overnight, it was time for the East to step up. And step up it did! First, it was China's turn, which while still refusing to ease outright, conducted a massive 395 billion yuan reverse repo - this operation is the biggest on record, according to Bloomberg data going back to 2004, which in turn sent China's seven-day Repo rate plunging the most since January. And because this whopping injection would prove to be promptly internalized, a few short hours later Japan followed with nothing less than QE9! Just around 2 am eastern, the BOJ announced the 9th installment in its neverending monetary farce, when it said it would proceed to monetize an additional Y11 trillion in assets. From BusinessWeek: "The BOJ expanded its asset-purchase program by 11 trillion yen ($138 billion) to 66 trillion yen, the central bank said after a policy meeting today. The range of forecasts in a Bloomberg survey was from 10 trillion yen to 20 trillion yen." Of course, in this bizarro world in which intervention is the only thing left, the latest Japanese QE had an immediate and opposite effect of that planned, sending the USDJPY lower the second it was announced, as the amount announced was disappointing to most who had expected even more easing, and the halflife was for the first time in recorded monetary intervention history, absolute zero! But at least this failed intervention for Japan, helped America, sending ES from 1393, a full 13 ticks higher, where they are now. And so the epic defense of 1400 (and 1.2900 in EURUSD) continues for a 5th straight day!

Those holding their breath that the PBOC will finally relent and join its "developed world" central planning colleagues in easing - something the tech companies of the world, not to mention everyone else, desperately needs - will have to do so for quite a bit longer (and today's earlier latest reverse repo was merely confirmation of this). The reason is that the just released HSBC Flash PMI for October, the first preliminary snapshot of Chinese data, posted a material rise from 47.9 to 49.1. Yes, this was the 12th consecutive print in sub-50 contraction territory in a row, but the direction is one which may give the economy and the people hope that things are getting better. They most certainly are not, but remember: in China every data point is massaged, manipulated, and then massaged some more before it is finally telegraphed to represent only what the Politburo wants it to say. And as a reminder, China, like the US, has elections (in quotes of course) in two weeks. As such neither the economy will tip the boat, nor the PBOC will drive more inflation at a time when everyone else is already easing. In other words: goldilocks goalseeked data... which for the monetarists was the worst possible outcome, as it means no new and free money.

Overnight sentiment is decidedly negative, following the across the board cut of growth forecasts by the IMF late yesterday. The only bright light was the PBOC dumping 265 billion yuan ($42.1 billion) in reverse repos in an open-market operation (a liquidity adding operation) whose only purpose was to roll the massive reverse repo from before the Golden Week. The resulting 2% jump in the Shanghai Composite came as traders expect an imminent rate cut by the PBOC. The irony of course is that as long as Reverse Repos are the liquification instrument of choice, the local central bank will do nothing else in an economy which is once again overheating in several industries, the most important of which continues to be housing. Furthermore, as long as the spectre of a 15% surge in pork prices is over the horizon, the PBOC will do nothing. Period. Elsewhere, as BBG summarizes, FX is mostly modestly lower with the AUD outperforming on rising iron ore price. Metals mostly modestly lower despite the crippling South African strike which has now migrated to catch iron ore mines as well. Treasury yields moderately lower, partly in catch-up after yesterday’s holiday. Bund yields modestly higher sovereign-to German yield spreads mixed with mostly modest changes. Few if any macro economic news today.

After seeing its stock market tumbling to fresh 2009 lows, the PBOC decided it couldn't take it any more, and joined the Fed's QE3 and the BOJ's QE8 (RIP) in easing. Sort of. Because while the PBOC is prevented from outright easing as we have been saying for months now (even as "experts" screamed an RRR or outright rate cut is imminent every day while we warned that Chinese inflation has proven quite sticky especially in home prices and food and China's central bank will not attempt to push its stocks up as long as the situation persists, so for quite a while) it can inject liquidity on a ultra-short term basis using reverse repos (or what are called repos here in the US). And shortly after it was found that Chinese companies industrial profits fell 6.2% in August after tumbling 5.4% in July, we learned that the PBOC added a record 365 billion Yuan to the financial system in order to prevent a creeping lockup in the banking system. While this managed to push the Shanghai Composite by nearly 3% overnight, this injection will prove meaningless in even the medium-term as the liquidity is now internalized and the PBOC has no choice but to add ever more liquidity or face fresh post-2009 lows every single day. Which it won't as very soon it will seep over into the broader market. And as long as the threat of surging pork prices next year is there, and with a global bacon shortage already appearing, and food prices set to surge in a few short months on the delayed effects of the US drought, one thing is certain: China will need a rumor that someone- even Spain- is coming to its rescue.