US Traders Walk In To Another Bloodbath
Lots of sellside squeals this morning following the epic bloodbath in China, where in addition to what we already covered hours ago, has seen at least five companies (China Development Bank, Shanghai ShenTong Metro, China Three Gorges Corp., Doosan Infracore China Co. and Chongqing Shipping Construction Development) delay or cancel bond offerings as the PBOC's admission of capital "misallocation" is slowly but surely freezing both bond and stock markets. And while the plunge was contained first to China, then to Asia, then to Europe (where the Spanish 10 Year once again surpassed 5% as expected following the carry trade unwind), with the arrival of bleary-eyed US traders the contagion is finally coming home.
In a redux of last week, 10 Year yields are shooting up, hitting as high as 2.63% a few hours ago, while equity futures are now at the lows of the session. It could turn very ugly, very fast, especially if the Hamptons crowd were to actually read the stunning BIS annual report released on Sunday, which not even Hilsenrath explaining "what the BIS really meant" will do much to change the fact that the days of monetary Koolaid are ending.
DB's Jim Reid summarized the angst among Wall Street quite well earlier:
There was plenty of weekend news to digest but most of it seemed to circle around three main themes: China, the implications of June’s FOMC and the situation in EM. Starting with China, domestic financial stocks (-4.0%) are seeing sharp losses this morning amid ongoing news flow around liquidity tightness in the interbank market.
In terms of the latest on bank liquidity, the PBoC posted a statement on its website today that said banking system liquidity remains at a “reasonable level”, but warned that Chinese banks must control liquidity risks from credit expansion. This came after China Development Bank, the country’s policy bank became the latest institution to cancel a bond sale (originally scheduled for tomorrow). The official state news agency, Xinhua, wrote over the weekend that "it is not that there is no money, but that the money has not reached the right places". The article suggested that a misallocation of funds into wealth management products had caused the tightness in liquidity in some banks. Indeed, Fitch noted last Friday that more than CNY1.5 trillion in WMPs - substitutes for time deposits - will mature in the last 10 days of June. Issuance of new products, and borrowing from the interbank market, are among the most common sources of repayment for maturing WMPs, and the recent interbank liquidity shortage complicates both.
China's mid-tier banks, are likely to face the most difficulty says Fitch, with an average of 20%-30% of total deposits in WMPs. This compares with 10%-20% for state-owned and city/rural banks. Fitch also noted that the PBOC’s hands-off response in easing the recent tight monetary conditions reflects in part a new strategy to rein in the growth of shadow finance by constraining the liquidity available to fund new credit extension.
Elsewhere in the region, we are seeing a continuation of the weakening trend in EM bonds and local currencies. Asian EM sovereign bonds and CDS are about 5-10bp wider to start the week. China CDS has given back more than what it gained on Friday and is 10bp wider overnight. Most currencies continue to weaken against the USD and the dollar index is 0.4% higher this morning. The Nikkei (-1.2%) is outperforming on a relative basis, helped by a 0.5% rise in USDJPY, after PM Abe's Liberal Democratic Party won a sweeping election victory on Sunday.
The LDP secured an overall majority in the 127-seat Tokyo metropolitan assembly with its coalition partner the New Komeito party. The victory is seen as a good sign for Abe’s government as it heads into upper house elections next month.
Returning to Friday’s session, for much of the day we had a continuation of the momentum that has gripped markets since last Wednesday’s FOMC. Indeed, the S&P500 was languishing at a low of -0.68% early in Friday’s session and was
poised to close weaker for the third straight session, before staging a comeback on the back of a couple of Fed headlines. The first set of headlines suggested that the Fed could delay QE tapering if worsening financial conditions, in the form of rising bond yields and lower stock prices, hurt the economy. There wasn’t much detail behind the headlines though, and the Fed sources were unnamed. As we discussed in our EMR on Friday, volatile markets could keep the Fed on hold for longer than they and the market now think. We continue to expect a difficult few weeks for risk followed by a realisation that the pace of tapering will actually be slower than flagged on Wednesday which in turn will eventually provide some good buying opportunities before the summer is out.
Several minutes after the first Fed headlines hit screens, the WSJ’s Hilsenrath was on the newswires again suggesting that the market had overlooked a number of dovish signals in Bernanke’s post-FOMC press conference. These signals included the Chairman hinting that rate rises would be gradual, and that “a strong majority” of Fed officials had concluded the Fed won’t ever sell its growing portfolio of mortgage-backed securities. This was followed by dovish comments from the Fed's Bullard who said on Friday that the decision to taper was “inappropriately timed” because inflation and economic output has been soft. Interestingly, 10yr yields continued to push higher despite the headlines, and managed to cross the 2.5% mark in the final minutes of Friday’s trading (closing 11bp higher at 2.53%). Selling pressure continued in EM equities despite the better tone in US equities. The MSCI EM index closed 0.88% weaker for its 4th straight loss. Across the EM world, bonds and currencies were generally weaker amid negative reports of outflows. Mexican and Turkish 10yr yields added 11bp and 32bp respectively.
Turning to the day ahead, we have little on the radar today outside of the latest monthly German IFO survey. Indeed, we have a relatively quiet week ahead of us compared with the events which have transpired over the course of the past seven days. Tomorrow, the data flow begins to pick up with US durable goods orders, new homes sales and consumer confidence in the US. On Wednesday, the third and final estimate of US Q1 GDP is scheduled. On Thursday, the UK’s Office for National Statistics will release its annual revisions of past data alongside its third estimate of first-quarter GDP. Other data on Thursday include US personal income /consumption and jobless claims together with an update on German employment. The 2-day European Council/EU Leader's summit starts on Thu with the agenda to consider country specific recommendations on economic policy + bank supervision. To round out the week, Japanese CPI, industrial production, unemployment and retail trade for the month of May is due out on Friday. In the US, the Chicago PMI will also be released on Friday. With the focus on yields, and the patchy demand in recent auctions, it worth keeping an eye on the UST auctions this week: We have US$35bn in 2-year notes on Tues, $35b of 5-year notes on Wed and $29bn in 7-year bonds on Thu. In addition, we get another round of post-FOMC Fedspeak with Fed Governor Powell and Atlanta FedPresident Lockhart speaking on Thursday, followed by regional Fed presidents Lacker, Pianalto and Williams on Friday.
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