Rabo: "Everything Can Appear 'Hunky-Dory'...Until The Real Money Runs Out"

Authored by Michael Every via Rabobank,

Where's The Beef In This Word Salad?

It’s summertime, and the living isn’t easy – except for the lazy analysis in the summertime market analysis ‘word salads’ we are being fed, which miss the real beef of what is going on,

The US dollar had another bad day Wednesday. No doubt about it, it was mostly unloved. Not against all EM FX, however. TRY, for example, is this morning at 7.05 at the time of writing, and is likely to test much lower yet if the underlying fundamentals --like not having any FX reserves-- don’t change. (Which also means EUR/TRY has moved from 6.67 to 8.42 year-to-date by the way.)

One of the big differences for USD this time round, however, was that the Chinese currency suddenly decided it was a developed currency and not an EM one. It also decided to show that widespread --and very real-- concerns about the underlying fundamental of a lack of USDs in its vast economy too (at least in relative terms to is size) are misplaced, honest guv: just look at the never-ever-changing USD3.xx trillion in FX reserves! Indeed, USD/CNY was at 6.94 this morning. (Which means EUR/CNY is handily at 8.24, up from 7.81 at the start of 2020. Europe will love that.)

Here’s some of the beef: CNY or CNH are not markets that operate as other markets do, which today is no longer saying as much as it once did, sadly. Both are a political virtue-signalling device rather than something based on real supply and real demand. And right now it suits China to look virtuous ahead of the 15 August phase one trade deal review.

Here’s the rest of the beef: the same global markets that were so desperate for USD back in March that the USD had to extend hundreds of billions of USD in swap-lines to keep them from crashing are now apparently hating the USD so much that we see report after report about how the Dollar is unloved and it’s day is over.

Provided that we all pretend that our economies have fully healed from Covid-19 with no major structural damage, and that central-bank and government stimulus can carry on paying us 80% of salary to go on holiday as normal, and that the US will continue to always bail everyone out as needed with no questions asked, then yes, feel free to sell USD and kick it while it is down (all the way to the level before the crisis began on broad trade-weighted terms).

Just don’t’ forget what you will come screaming for as soon as we see that there is no proper recovery, that there is major structural damage, that government stimulus cannot carry on paying us 80% of salary forever, and neither can the US will continue to always bail everyone out as needed with no questions asked.

And, delicious as they are in hot weather, please don’t eat the word salads. Bloomberg offers this crunchy green take today, for example, repeated in full here:

USD/CNH is heading lower in the near term and is protected against a sharp correction by the high cost of shorting the yuan. With less than three months to go until the US elections the yuan will be on alert for rhetoric which could weaken it. Yet, thanks to contrasting monetary policies between the Fed and PBOC there is a built in defense mechanism. One year CNH forward points are running at the highest since late 2017, even though spot USD/CNH has been steadily falling for several weeks. The forwards reflect lower USD yields and the PBOC putting rate cuts on hold. And with the PBOC moving away from expansive monetary easing that will sustain relatively high yuan yields. In contrast the Fed is in no position to end its very accommodative policy with the U.S. economy in contraction. Which means it is expensive to short the yuan and that could deter some traders from selling aggressively in the near term. As long as the PBOC continues to maintain an orderly fixing regime the downside for CNH is limited.

Some of the ingredients above are true, and I have seen so, so many reports that are so, so much worse. Pages must be filled I suppose. (Look who’s talking! I just filled a whole in and most of you didn’t notice! J) To dismantle this salad:

Yes, China has higher rates, which strangely didn’t matter in FX two days ago…but it hasn’t slashed rates because it CAN’T; and it can’t because it is trying to hold a soft peg against USD with not enough FX reserves to back it up, relatively even with capital controls. Yes, there is going to be a US election --and a trade deal review-- and this is virtue signal to say ‘we are playing nice!’…because they know what happens if they don’t: it isn’t CNY positive at all. Yes, it is expensive to short CNY, just as it is to short TRY, which has not saved it once the US ran out, has it? And, yes, the PBOC certainly has “an orderly fixing regime” – which is another way of saying it IS NOT AN ACTUAL FREE MARKET, but one where we are TOLD what the value is and where capital controls prevent any ‘haggling’. Why is this obvious fact slathered in layers of mayo to try to disguise how unpalatable it actually is?

Is this all clear on a hazy summer day? Allow me to summarise again:

We are deluding ourselves that we are recovering back to the status quo ante. We aren’t. We are deluding ourselves stimulus to shield us can be sustained forever everywhere. It can’t. We are deluding ourselves the US will be there next time for everyone as desired. It won’t be for some. So, yes, word-salad chefs, everything can look hunky dory due to marvellous, magical , magnificent central-bank liquidity, not the day-to-day jiggery-pokery,…right up until the REAL money runs out; which as Turkey and Lebanon prove, and China is desperate not to prove, is still USD and not the local equivalent. (And as Brazil, with rates art just 2% and negative real rates also risks showing - again.)

Or, if you are a real USD bear, then it is gold and not any fiat currency at all. In which case, real businesses should be panicking and markets collapsing, because a wrenching deflationary accounting and international-trade adjustment that will make the Covid crisis look like a normal day in the office is what looms for years during the transition away from fiat. Yes, you can buy stocks and gold in tandem and do well in the short term – but logically it’s word salad as an end-game.

Anyway, I leave you all to ice-cream, sun-cream, cold beer or wine, and what will no doubt be another very generous serving of word salad from the media today.