New York City may be buried under more than a foot of snow, but global markets don't sleep, however judging by the color of futures this morning, today's respectable $2.25-$3.00 billion POMO will have a tough time digging US equities out of the red, following a tepid overnight session in which the traditional driver of futures levitation, the USDJPY, was flat as the BOJ disclosed unchanged policy despite some inexplicable hopes that Kuroda would increase QE as early as today.
While last night's almost unprecedented reverse repo liquidty injection into the Chinese banking system stopped the bleeding of short-dated money-market rates briefly, the likelihood remains that a shadow-banking system default will occur: As CASS's Zhang noted:
*CHINA TRUSTS AND SHADOW BANKING TO SEE DEFAULTS IN 2014; DEFAULTS WOULD BE GOOD THING
Perhaps that explains why China's CDS spread remains at its highest since the summer credit crunch, barely budging on last night's cash drop. At double the default risk of Japan, China appears far from out of the contagion fire.
The bubble of private debt that we have seen inflate in China since the Lehman crisis is unlike anything that the world has ever seen. Never before has so much private debt been accumulated in such a short period of time. All of this debt has helped fuel tremendous economic growth in China, but now a whole bunch of Chinese companies are realizing that they have gotten in way, way over their heads. In fact, it is being projected that Chinese companies will pay out the equivalent of approximately a trillion dollars in interest payments this year alone. That is more than twice the amount that the U.S. government will pay in interest in 2014. So will a default event in China on January 31st be the next "Lehman Brothers moment" or will it be something else? In the end, it doesn't really matter. The truth is that what has been going on in the global financial system is completely and totally unsustainable, and it is inevitable that it is all going to come horribly crashing down at some point during the next few years. It is just a matter of time.
One of the bigger stories overnight is Hilsenrath's latest communication from the Fed which once again simply paraphrases the status quo opinion, namely which is that the Fed will taper by another $10 billion on January 29, reducing the total monthly flow to $65 billion. "The Federal Reserve is on track to trim its bond-buying program for the second time in six weeks as a lackluster December jobs report failed to diminish the central bank's expectations for solid U.S. economic growth this year, according to interviews with officials and their public comments." Of course, should the Fed not do that, as the Hilsenrath turned to Hilsen-wrath after all those Taper rumors in September ended up being one giant dud, one can once and for all completely ignore the WSJ reporter, who will have lost all his Fed sources and is now merely an echo chamber of consensus. What is notable is that the result of the latest mouthpiece effort, the USD is stronger, which means USDJPY is higher, which means US equity futures are flying.... on less QE to be announced. We eagerly await for this particular correlation pair to finally flip. The other big story, of course, is the already noted well-telegraphed in advance PBOC liquidity injection ahead of the Chinese Lunar New Year, and ahead of a potential January 31 Trust default which will certainly shake the foundations of the Chinese shadow banking system to the core. Not helping nerves was last night's announcement by Zhang Ming, a researcher and director of the international investment department at the Chinese Academy of Social Sciences, that "trusts and shadow banking will see defaults this year, and this is a good thing." Let's circle back in 6 months to see just how good it is.
Despite all the reform policy imperatives to constrict credit and normalize and liberalize policy and rates, the PBOC just provided the largest liquidity injection to its banking system in a year - 255bn CNY. While this is not entirely unusual for a year-end, when Chinese banks have to confess their illiquidity sins and cover mismatches (and are always helped by the PBOC); this year, short-term money-market rates are triple that of last year and there is a very real chance of a very real default within the shadow banking system. Of course, the sell-side are desperately writing cover that this is all priced in and even if the PBOC "lets some Trusts go" then they will come to the rescue and any crisis will be "contained." However, no one knows who will be saved and therein lies the safety-first rub - now where have we heard "contained" before?
Markets have started the week on the back foot, despite a brief rally following a better-than-expected Q4 GDP print in China. Indeed, Asian equities recorded a small pop following the GDP report, but the gains were shortlived as the general negativity on China’s growth trajectory continues to weigh on Asian markets. In terms of the data itself, China’s Q4 GDP (7.7% YoY) was slightly ahead of expectations of 7.6% but it was slower than Q3’s 7.8%. DB’s China economist Jun Ma maintains his view that economic growth will likely accelerate in 2014 on stronger external demand and the benefits from deregulation. The slight slowdown was also evident in China’s December industrial production (9.7% YoY vs 10% previous), fixed asset investment (19.6% YoY vs 19.9% previous) and retail sales (13.6% vs 13.7% previous) data which were all released overnight. Gains in Chinese growth assets were quickly pared and as we type the Shanghai Composite (-0.8%), HSCEI (-1.1%) and AUDUSD (-0.1%) are all trading weaker on the day. On a more positive note, the stocks of mining companies BHP (+0.29%) and Rio Tinto (+0.26%) are trading flat to slightly firmer and LME copper is up 0.1%. Across the region, equities are generally trading lower paced by the Nikkei (-0.5%) and the Hang Seng (-0.7%). Staying in China, the 7 day repo rate is another 50bp higher to a three month high of 9.0% with many investors continuing to focus on the Chinese shadow banking system following the looming restructuring of a $500m trust product that was sold to ICBC’s customers.
Last week we were the first to raise the very real and imminent threat of a default for a Chinese wealth management product (WMP) default - specifically China Credit Trust's Credit Equals Gold #1 (CEQ1) - and its potential contagion concerns. It seems BofAML is now beginning to get concerned, noting that over 60% of market participants expects repo rates to rise if a trust product defaults and based on the analysis below, they think there is a high probability for CEQ1 to default on 31 January, i.e. no full redemption of principal and back-coupon on the day. Crucially, with the stratospheric leverage ratios now engaged in such products, BofAML warns trust companies must answer some serious questions: will they stand back behind every trust investment or will they have to default on some or potentially many of them? BofAML believes the question needs an answer because investors and Trusts can’t have their cake and eat it too. The potential first default, even if it’s not CEQ1 on 1/31, would be important based on the experience of what happened to the US and Europe; the market has tended to underestimate the initial event.
Overview of the major forces shaping the investment climate.
While manufacturing and services PMIs disappointed, the big problem in big China remains that of an out-of-control credit creation process that is blowing up. As we previously noted, instead of crushing credit creation, the PBOC's liquidity rationing has forced distressed companies into high-interest-cost products in the shadow-banking world. Investors on the other side of "troubled shadow banking products" had assumed that 'someone' would bail them out but this evening Reuters reports that ICBC has confirmed that it will not rescue holders of the "Credit Equals Gold #1 Collective Trust Product", due to mature Jan 31st with $492 million outstanding. The anxiety from contagion concerns of the first shadow-banking default has pushed the Shanghai Composite back near 2,000 for the first time since July - and to its narrowest spread to the S&P 500 in almost 8 years.
When it comes to the topic of China's epic credit bubble, we have beaten that particular dead horse again and again and again and, most notably, again. However, since in China the concept of independent bank is non-existent, and as all major financial institutions are implicitly government backed, by the time the "big" bubble bursts, it will be time to hunker down in bunkers and pray (why? Because while the Fed creates $1 trillion in reserves each year, and dropping post taper, China is responsible for $3.6 trillion in loan creation annually - yank that and it's game over for a world in which "growth" is not more than debt creation). But just because the big banks can continue to ignore reality with the backing of the fastest marginally growing economy in the world (inasmuch as building empty cities can be considered growth), the same luxury is not afforded to China's smaller lender, such as its peer-to-peer industry. That particular bubble seems to have just popped: "The main reasons are the intense competition in the P2P industry, the liquidity squeeze at the end of the year and a loss of faith by investors," said Xu Hongwei, chief executive of Online Lending House. He estimated that 80 or 90 per cent of the country’s P2P companies might go bust. Oops.
Chinese borrowers are facing rising pressures for loan repayments in an environment of overcapacity and unprofitable investments. Unable to generate cash to service their loans, they have to turn to the shadow-banking sector for credit and avoid default. The result is an explosive growth of the size of the shadow-banking sector. The PBOC thought it could control this by limiting liquidity but underestimated the effects of its measure. Largely because Chinese borrowers tend to cross-guarantee each other’s debt, squeezing even a relatively small number of borrowers could produce a cascade of default. The reaction in the credit market was thus almost instant and frightening. Borrowers facing imminent default are willing to borrow at any rate while banks with money are unwilling to loan it out no matter how attractive the terms are. Should this situation continue, China’s real economy would suffer a nasty shock.
"Paper and digital markets levitate, central banks pull out all the stops of their magical reality-tweaking machine to manipulate everything, accounting fraud pervades public and private enterprise, everything is mis-priced, all official statistics are lies of one kind or another, the regulating authorities sit on their hands, lost in raptures of online pornography (or dreams of future employment at Goldman Sachs), the news media sprinkles wishful-thinking propaganda about a mythical “recovery” and the “shale gas miracle” on a credulous public desperate to believe, the routine swindles of medicine get more cruel and blatant each month, a tiny cohort of financial vampire squids suck in all the nominal wealth of society, and everybody else is left whirling down the drain of posterity in a vortex of diminishing returns and scuttled expectations."
- 'Life-threatening' cold bites Midwest, heads east (Reuters)
- Gold Analysts Get Most Bullish in a Year After Rout (BBG)
- Asian Stocks Fall Most in Three Weeks on China Services (BBG)
- Angela Merkel in skiing accident, cancels visits (Reuters)
- High-Speed Traders Form Trade Group to Press Case (WSJ)
- Toyota and Honda post record China sales (FT)
- China Shadow Banking Risks Exposed by Local Debt Audit (BBG)
- J.P. Morgan to Pay Over $2 Billion to U.S. in Penalties in Madoff Case (WSJ)
- Corruption trial of Trenton, N.J., mayor starts Monday (Reuters)
- Car Makers at Consumer Electronics Show Tout Ways to Plug Autos Into the Web (WSJ)
All signs point to serious trouble for the Chinese economy. The best ways to play a China downturn: short-selling Australian banks, China property and the yuan.
The world has depended on Chinese and American stimulus for years, and, as Caixin's Andy Xie notes, one implication of their tightening is a slowing global economy in 2014.