Yen

While all eyes and ears will conveniently and expectedly be on the Fed announcement and press conference in a few hours, the real action continues to take place in China, where the liquidity crunch is becoming unbearable for the local banks (and will only get worse the longer Bernanke and Kuroda keep their hot money policies). The CNY benchmark money-market one-week repo rate was 138bp higher overnight to a 2 year high of 8.15%. The 7 day Interest-Rate swap rose for a record 13th day in a row jumping +10 bps to 4.08%, the highest since September 2011. China sold 10 Year bonds at a 3.50% yield, above the 3.47% expected, and at a bid to cover of 1.43 which was the lowest since August 2012. Moody’s commented that local government financing vehicles (LGFVs) pose significant risks to Chinese banks. LGFVs accounted for 14% of loan portfolios at end-2012 according to Moody’s.

While many impartial observers have been lamenting the death of Abenomics now that the Nikkei - essentially the only favorable indicator resulting from the coordinated and unprecedented action by the Japanese government and its less than independent central bank - has peaked and dropped 20% from the highs, Wall Street was largely mum on its Abenomics scorecard. This changed overnight following a scathing report by Goldman which slams Abenomics, it sorry current condition, and where it is headed, warning that unless the BOJ promptly implements a set of changes to how it manipulates markets as per Goldman's recommendations, the situation will get out of control fast. To wit: "Our conclusion is that the positive market reaction initially created by the policy has been almost completely undone. At the same time, a lack of credible forward guidance for policy duration means that five-year JGB yields have risen in comparison with before the easing started, and volatility has also increased. It will not be an easy task to completely rebuild confidence in the BOJ among overseas investors after it has been undermined, and the BOJ will not be able to easily pull out of its 2% price target after committing to it."

The Vietnamese Central Bank sold another 25,700 taels (37.5 grams, 1.2 troy ounces) at a gold bar auction on Friday in order to try and satiate the massive public demand for gold in Vietnam.

The Central Bank hopes that the sale of gold into the market will reduce the very high premiums paid by gold buyers in Vietnam, the largest buyer of gold in Southeast Asia after Thailand and one of the largest physical buyers of gold per capita in the world.

Vietnamese people hold gold as a store of wealth for protection against war, inflation and currency depreciation. In recent months, the bursting of bubbles in the stock market (see chart) and property market and the continuing devaluation of the dong has led to record demand in Vietnam and a surging premium over the spot price of gold.

Today, the premium was close to 5.5 million dong which is the equivalent of a very high premium of $217 per ounce over spot. 

Overview of these week's key developments

Things have been a little erratic lately here in US, but not really headline-worthy. The economy continues to grow, sort of, houses continue to sell and stock and bond prices fluctuate but can’t seem to follow through in either direction. We are not, in short, engulfed in any kind of crisis. But out in the world, especially in once-hot emerging markets like Brazil and China, the story is very different. So can the US stay placid when the rest of the world turns chaotic? Highly doubtful. There’s a market phenomenon in which one investment play blows up and forces those on the wrong side of the trade to dump their liquid assets to raise cash. Which causes the high-quality assets to fall as much or more than the junk. As Noland notes, the world’s premier liquid asset is the Treasury bond. If the developing world’s need to raise cash is a factor in the recent spike in US interest rates, this implies a feedback loop in which rising US rates further destabilize emerging markets, forcing the sale of more Treasuries, and so on.

Tryingto make sense of the price action in the foreign exchange market.  The dollar was heavier than we anticipated and there is no compelling sign of a turnaround, but the key is the FOMC meeting.  

The answer is no as higher rates on developed world debt would crush their economies. And it would hurt less indebted emerging markets too.

Thursdays may be the new Tuesdays (if only this week), but so far Fridays are still just Fridays, and no mysterious overnight levitation is here to open the market 0.5% higher. The Nikkei 225 retraced a fraction of Thursday’s losses overnight as the positive close on Wall Street and a dovish interpretation of Hilsenrath’s WSJ piece yesterday allowed the Japanese indices to recover from the worst levels of the week. USD/JPY has pared Thursday’s bounce and trades lower as the Bank of Japan’s minutes showed one member of the board proposing the advantages of limiting the bank’s QQE program to just two years in order to avoid financial imbalances. Overnight in China, as we warned yesterday, the liquidity situation got even worse, when the PBOC's attempt to drain liquidity failed to sell some 30% of the planned 15 billion yuan in 273-day bills (more on this shortly), leaving the banks screaming Uncle and on the verge of a full-blown liquidity crisis: we expect rumors, and news, of more banks failing to roll over overnight liquidity to hit the tape shortly.

We are trying to remember when the last time the BOJ minutes were important for global risk assets, and are drawing a blank. That's how messed up the financial markets have become. That said, here are the highlights from the BOJ's May minutes which appear to have spooked the Nikkei some 10 minutes ahead of the open.

• HIGHER VOLATILITY MAY ACCELERATE JGB SELLING - Remember the "VaR shock?" 
• L-T RATE RISES DUE TO WEAK YEN, HIGHER OVERSEAS RATES - And higher overseas rates due to weak yen, also known as a Circular iteration
• FEW MEMBERS: BOJ SHOULD WATCH FED POLICY EFFECT ON JAPAN YIELDS - We have several non-lemmings
• ONE MEMBER:MUST KEEP FISCAL DISCIPLINE TO ENSURE BOND STABILITY - And a dissenter

And perhaps that quotes that spooked the market:

• ONE MEMBER: TIMELINE SEEMED TO BE INCREASING BOND VOLATILITY - i.e., the longer it goes on, the more we lose control
• FEW MEMBERS: BOJ SHOULD WATCH FED POLICY EFFECT ON JAPAN YIELDS - Get to work, Mr. Chairman

Nikkei down 200 in minutes.

Liquidity overcame common sense and economic fundamentals for a time. A lot of money was made and a huge amount of leverage was put on. Everything rose with the tide. Look around you though; look carefully. We think the tide is beginning to go out. We believe recession in Europe will spread to America as the severity of the European crisis becomes more and more apparent. Upcoming economic data in France is also going to be quite troubling in my opinion and the contagion will become apparent in the United States.

In the brief but tempestuous fight between Abe and the "deflation monster", the latter is now victoriously romping through an irradiated Tokyo, if last night's epic (ongoing) collapse in the Nikkei is any indication: down 6.4%, crushing anyone who listened to Goldman's "buy Nikkei" recommendation which has now been stopped out at a major loss in three days, and now well in bear-market territory, it would appear that a neurotic Mrs. Watanabe is finally with done with daytrading the Pennikkeistock market, and demands Shirakawa's deflationary, triumphal return to finally clam the market. Only this time the Japan's selling tsunami is finally starting to spill, if not to the US just yet (it will) then certainly to Asia, where the Shanghai Composite which was down 2.7%, and is once again well down for the year, and virtually all other Asian stock markets. Except for Pakistan - the Karachi Stock Exchange is an island of stability in the Asian sea of red.

This week, the US Ministry of Propaganda presented a patently absurd gem of a news article in which it equated a growing percentage of US workers quitting their jobs in April as a sign that Americans’ confidence in the US economy is returning.

Foreigners are net buyers of Japanese stocks in the most recent week.  When they have bene sellers it has been very small amounts.  Japanese investors for their part continue to sell foreign assets and at arond the average pace seen over the last several months.  

We showed yesterday the truly dreadful state of this economic recovery had one odd bright (green) spot, US auto production (and sales). While cash-for-clunkers started it, and easy money from the Fed expanded it (via credit for an ever-growing cohort of subprime borrowers), the car companies have now reached back into the bag of old tricks that blew them up before - incentives in May jumped to 8% of market value - or almost $2,500 per vehicle - the highest in over 2 years. If things are going so well in this 'recovery' why are the car makers forced to squeeze margin for volume... The problem, as BusinessWeek reports, is that increasingly rich incentives aren't moving the needle much on sales.

Wednesday may be the new Tuesday (which halted its relentless and statistically impossible streak of 20 out of 20 up DJIA days last week), if only in terms of the overnight no news stock futures ramp, which today is back with a vengeance. In a session that was devoid of any news, the e-Mini is up enough to practically erase all of yesterday's losses. Whether this is due to a relatively calm Nikkei trading session, to no further surge (or collapse) in the USDJPY, or to the 10 Year trading flat inside 2.20% is unclear. What is clear is that the bipolar market swings from extreme to extreme on speculation about the largely irrelevant topic of whether the Fed will taper (because if it does, it will be very promptly followed by an untapering once risk assets around the world implode.)