"Someone Is Blowing Up": RBC Warns China-Induced Unwinds Are Escalating

Tyler Durden's picture

"Something is off," warns RBC's head of cross-asset strategy Charlie McElligott in the introduction to his latest market noting that the swing in US fiscal policy optimism is coming at a critical time as the China's liquidity tightening is spooking the reflation story.


Movement on US fiscal policy is currently driving US rates and equities higher, counteracting the tremendous negative implications of this ‘Chinese tightening / deleveraging’ story and the impact this is having upon commodities (industrial metals & crude) and thus, ‘inflation expectations.’


‘Connecting the dots’ between the crude oil / commodities selloff and a strong (negative) reversal in ‘mean reversion strategies’ both cross- and inter- sector (energy) within equities, as well as notable drawdowns in ‘momentum’ market-neutral strategies over the past few weeks.

*  *  *


The big +++ story overnight: Republicans are planning a ‘make or break’ vote on the ACA repeal today, as the GOP feels they now have the votes to pass the Trump campaign healthcare promise.  This sudden swing to ‘movement’ / optimism speaks to the ‘pessimistic overshoot’ seen across the Street with regards to the consensually negative view on ‘fiscal policy’ implementation, following the administration’s / Republicans’ self-inflicted wounds of the past few months.

NOW, this opens the door again to not just tax reform (as it creates a much more benign revenue ‘starting point’ for tax-cut offsets), but potentially infrastructure as well, which might too be bundled into the tax plan.  Yes, none of this is ‘imminent’ per se, but the sentiment-inflection here is swift and of extreme importance to the ‘reflation’ trade. 

As such, equity futures and US nominal rates are currently holding higher, despite what looks to be a total breakdown in crude oil and commodities turning outright ugly now.

And today is seeing the move accelerate...

with the biggest single day drop since Nov 2016...


This newly-found ‘US fiscal policy optimism’ could not have come at a better time for the ‘reflation’ camp, who have been sweating bullets in recent days because our much-discussed ‘Chinese tightening / deleveraging’ theme is playing-out real-time and wreaking havoc on global commodities--particularly with industrial metals (Dalian Iron Ore limit-down overnight -8.0% and reopening down another -5% today).  Look at the carnage on the Shanghai Futures Exchange, particularly in the MTD / QTD columns: 

This comes following the total meltdown in copper (-4.0%, and another -1.7% move this a.m.) during yesterday’s US session, while too we see the breakdown in the crude oil complex accelerating with WTI making YTD lows this morning while falling through its trend-support line dating back to last August.  BHP and RIO are the proxy for the breakdown in the equities-complex (while a popular US equities ‘inflation’ basket is crushed a massive -4.3% over the past five days), while too we see China- / resources- levered AUD come unglued in the FX space, now -2.3% month-to-date despite a very ‘meh’ USD.  At the same time, we’ve now seen weaker Chinese Manu PMIs and Caixin Composite PMIs over the past week, in conjunction with an ISM Manufacturing misses in US.

All of this is tied-into the enhanced Chinese efforts to deleverage the economy via ‘measured tightening’ (higher money markets rates—see O/N SHIBOR again making new 2 year highs last evening) and reduced liquidity (net removals as MLF loans roll-off versus now-smaller / not offsetting RR cash injections and OMO’s).  In conjunction with these quantitative efforts, the Chinese are also ‘cracking down’ on shadow financing and wealth management products, both of which participate in the liquidity / commodity-price feedback daisy-chain (to my point yesterday and in the past on higher short-term rates acting as ‘margin calls’ on ‘commodities as collateral’ financing trades).

Mark Orsley and I have been working on a “Chinese Liquidity Monitor” which tracks the PBoC’s various measures (repos, reverse repos, OMOs, SLFs, MLFs, Pledged Supplementary programs)—see below.  The key point here: it’s not just the sharp decline in the ‘rate of change’ of PBoC ‘lending’ / ‘financing’ / ‘credit creation’….it’s that liquidity is being outright REMOVED.

It makes total sense too—the Chinese have recently used the ‘air-cover’ of the Fed’s own tightening to conduct their own--so the current timing is perfect, as a June FOMC hike became that much more of a ‘lock’ after yesterday’s hawkish message was successfully delivered (looking through the Q1 data softness as “transitory”).

The simple fact is that global liquidity--and thus, financial conditions as well--are tightening.

US real rates are gapping-tighter, as 5Y TIPS yields have swung from -24bps on April 12th to this morning’s +13bps.  3m LIBOR has MORE THAN DOUBLED since June and currently sits at highs since March 2009.  As mentioned earlier, overnight SHIBOR printed another new 2 year high, same for Chinese 10Y government bond yields.  US nominals are back approaching the upper end of their recent range as well.  Yes, if this was a pure reflection of growth, it would be an outright ‘risk-asset positive.’  But it’s much more nuanced than that, especially from the Chinese ‘demand driver’ impact on the global economy.  Tighter financial conditions à slower growth à lower inflation.

From a risk-perspective though, this is then counter-balanced via by-and-large ‘still expansionary’ global PMIs, BIG corporate earnings growth and now, into the aforementioned (and SUDDEN) positive uptick in sentiment around US fiscal policy movement.  If fiscal can re-jigger ‘animal spirits’ (especially on the ‘optimism’- / confidence- side), then it becomes much more attractive to put those ‘reflation trades’ back on (rates shorts, long cyclicals / banks / value factor, potential to re-load USD length as well).  To this point, I will continue watching that 2.40 / .45 level (smack-dab btwn 50- and 100-dma’s in UST 10Y yields and the overhead resistance level since late-March—H/T Mark Orsley)…while still feeling confidence that this ‘Chinese tightening’ story (and the impact it is have on commodities and thus, global inflation expectations) will keep US rates ‘anchored’ despite the Fed’s hiking intentions.


In yesterday’s note, I pointed-out particularly acute ‘unwind’ price-action in US equity 1m ‘momentum’ factor market neutral strategies seen on Tuesday—as ‘momo leaders’ were splattered, while ‘momo losers’ squeezed sharply-higher.  We have now seen a ‘clustering’ of 1.5- to 2.0- standard-deviation drawdowns in the strategy over the past few weeks (almost dating-back to the start of the quarter frankly), which is anecdotally quite atypical in a ‘flat to up’ intraday tape.  It would be safe to surmise that there is either signaling a rotation that is playing-out in the market, or conversely, an unwind of some sort.

Looking back to the start of the quarter though, we haven’t really seen that sector- or factor-level rotation generally-speaking, as thematically, ‘growth’ factors / sectors continue to lead, while at the bottom, we see cyclicals / value / anti-beta still lagging, as they have all year.   But if looking at a strategy such as ‘prior quarter mean reversion’ you begin to see something interesting.

This is crude, but using a simple ‘Q1 mean reversion’ proxy (deployed in Q2), where I go long Energy (worst perf S&P sector Q1) vs short Tech (best perf S&P sector Q1), I see significant signs of ‘stress’ or outright unwind in recent weeks.  The above portfolio run $-neutral has experienced a near 5% swing over the past 3 weeks, with the loss doubling over the past week alone--it’s likely this ‘rate of change’ that is the problem from the risk management perspective.  This of course correlates with the breakdown occurring in crude oil, as WTI is now -11.8% over the past three weeks.

Sector-specific within energy, you see signs as well.  Energy equities trader Ryan Businski noted the following ‘unwind’ behavior across Texas shale plays: “Seeing long sales across the Niobrara names today forcing unwinds/covering in Bakken names. WLL, OAS, CLR rallying with no news Bakken related.”

With the sector now -10.4% YTD within the S&P / -20.3% within the Russell, alongside a lot of talk in recent-weeks of a number of multi-manager shops shuttering energy books, I feel comfortable in stating that somebody’s ‘mean-reversion’ strategy (likely a stat arb / quant fund) has triggered ‘stop outs’ as the underlying commodities space now ‘catches down’ to the behavior already exhibited across the energy equities space throughout the course of 2017.

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nope-1004's picture

Nice to see RBC subscribes to Hayman's newsletters.


johngaltfla's picture

Now the question is is it a province, a large regional bank, or all of the above?

J Jason Djfmam's picture

A wonderful display of doom chart porn.

johngaltfla's picture

Thankfully the Fed Unicorns are all warmed up and their asses loaded with Skittles so "What? Me Worry?"

waterwitch's picture

Welcome to the world of unlimited naked shorting bitchez!!!!!!

Mother Of All Bomb's picture

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... http://bit.ly/2jdTzrM

Hitlery_4_Dictator's picture

Sadly nothing is blowing up and even if it was, nothing would come of it.

HowdyDoody's picture

An interesting insight into Chinese thinking about the US and the manipulation of the USD, and how they react to the changes. It is from a military officer, who admits the limitations of his expertise, so it is from a national security prespective. It dates back to late 2015.


TahoeBilly2012's picture

The Fat Lady is still at the bar...

back to basics's picture

Stay calm, move on folks, nothing to see here......PMSL

Troy Ounce's picture


"It makes total sense too—"

I haven't seen this sentence for a long long time...

MD's picture

You mean "let the melt-up in US stocks and real estate begin?" Because weakness in China means capital is going to flow into the "least dirty shirt," US assets.

If you try and short US stocks now, you're gonna get fucked so hard over the next 12-18 months.

back to basics's picture

Congratulations, you discovered perpetual motion and I suggest you patient it.

Bad news in the US economy means higher stock prices. Good news in the US economy means higher stock prices. Good news in China means higher stock prices. Bad news in China means, well, you guessed it, higher stock prices.

To the moon Alice, to the moon....LOL. 

MD's picture

The powers that be, and the majority of the US population with retirement savings, want the stock market to go higher. They will get their 8% annual returns, even if it means devaluing the dollar to the value of toilet paper. The financial media will find any excuse to pump the market higher. The only thing that caused the 08-09 crash was a run on the financial system due to a liquidity crunch. Central banks will print trillions before the next crunch materializes.

But yes, have fun shorting the market, in response to this China non-story.

JRobby's picture

"devaluing the dollar to the value of toilet paper"

That was in 1998, what else of any value can you compare it to now? Nothing!!!

SeuMadruga's picture

Yeah !

And, eventually, to its dark side...

JohnGaltUk's picture

DOW could hit as high as 40

Bonds are done so the big money will park in premium equities. At least with equities you are buying an asset, with bonds all you are buying is a promise to pay on debt. Most folks dont remember that in 1932 all of Europe defaulted on their soverign debt which included China. Britain technically did not because they went into a moratorium.

Soon you are going to witness an economic event that will make 2008  look like a school boy playground scuffle.

The event will most probably caused by an EU accident because the area is so messed up, with a strong possible chance of war.

Text book stuff.

Yukon Cornholius's picture

The Balkans seem to be a good place to start that fire. Macedonia is Semitic for (((first domino))).

Lore's picture

Re: "At least with EQUITIES you are buying an ASSET."


I understand what you mean, and it makes sense within your context, but still... GROANNNN...  XD

bookofenoch's picture

Careful about that equity assumption!

DTCC and Cede Inc. have hundreds of rightful owners for every share.

Might want to check out "Miscreants Ball" for phantom shares as well.

Those ugly facts are essential to equity trades.

halcyon's picture

No no no. The big one is not here yet. Just basic jitters after too long a rally. And people seeing ghosts everywhere....

kellys_eye's picture

The two largest economies with the two biggest issues have now found the one common denominator and potential (albeit temporary) saviour of their economies - step forward NK.

post turtle saver's picture

impossibru... China is big strong man of Asia, China is the richest, China has all the gold, China China China... C H I N A

BigFatUglyBubble's picture

How great Marcia is, how wonderful Marcia did this, Marcia, Marcia, Marcia!

post turtle saver's picture

yep, Marcia's a great gal... she lives in best country of 'merica :D

Vlad the Inhaler's picture

The only "fun" you're going to see is buying more tech stocks on the dip, and buying any and all lame beaten down sectors to prop up the market despite the steady stream of bad news.

sudzee's picture

Saudi Arabia must just be a little upset that their ace in the hole, Aramco, turning out to be just another hole. May have to list in China or Russia. Peg about to fall. PM shortcover will be epic.

Dangerclose's picture

I've been waiting on that peg to uncouple for 17 months since Jim Rickards got me all excited about it in Jan 16. I finally closed that short on the Riyal just days ago. I have come to the belief that they won't depeg until after the IPO is launched.

I'm going to play in Kyle Bass' sandbox and short the yuan.

JRobby's picture

Planned event to fist fuck the Saudis (wrist watch, no Crisco)

small axe's picture


Probably too much to ask that GS is the blower-upper.

A boy can dream though

mily's picture

Some folks have just found out china is not safe place to invest from interview with Kyle Bass on BBG

Dg4884's picture

Damn!  I am waiting on my APMEX shipment.  Bought a day too early.

Mustafa Kemal's picture

Make sure to dispose of those blue boxes appropriately. I take mine to the dumpster in the next town at night.


Dg4884's picture

Mine go in the Beef O'Bradys dumpster. 

JRobby's picture

Guy down the street stacks them up on the front porch full of those big spring loaded rat traps

sessinpo's picture

A few days to early. I think we have about a week of more pressure.

geno-econ's picture

You mean the Steroid Economy is having a Steroid Cycle ?

Consuelo's picture



It's the down-cycle bro - replete with Big Gyno and no estrogen inhibitors...   BAD!

BigFatUglyBubble's picture

Bob loved me because he thought my testicles were removed too. Being there, pressed against his tits, ready to cry. This was my vacation... and she ruined *everything*.

katchum's picture

Who doesn't want things to become cheaper?

mayhem_korner's picture

Those who bought things hoping to profit, that's who.  Same folks calling the CBs for summoar printing.

sessinpo's picture

Those that make those things but have already invested in the materials at higher prices that make those things (like China)

Also those that don't have any money to begin with don't give a fuck. The can't afford it no matter the price.

Sky flyer's picture

Black swans incoming muthafuckers! This is gonna be good. Watch crude and buy up all the shiny you can afford.

Quantum Bunk's picture

When China blows up, it will sell treasuries and dollars.

mayhem_korner's picture

To whom?  Who is the last bagholder?

We Are The Priests's picture

The ESF has pretty deep/dark pockets.