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Yuan "Float" Turns 10-Years Old

On July 21, 2005, China surprised the world by abandoning its peg to the dollar that had been in place since 1995. It immediately appreciated by 2% and gradually appreciate until the financial crisis hit in 2008. It then looked to have been “re-pegged until late 2010, when it began appreciating again.

Since that fateful 2005 decision, the yuan has appreciated by a third against the US dollar in nominal terms. In real terms, it has been somewhat more as China has experienced somewhat faster inflation than the US. In terms of consumer prices, US inflation has averaged 2.1% since mid-2005 while China’s inflation has averaged 2.9%.

In the five years before the currency regime change, China’s trade surplus with the US (using BEA data), rose dramatically. It doubled from $63.8 bln in 2000 to $162.3 bln in 2004. Over the next 10 years, China’s trade surplus rose another 70% from $202.3 bln in 2005 to $343.1 bln in 2014. One clear implication is that currency appreciation alone as been insufficient to bring the trade accounts into balance.

From an even long-term perspective, note the sequence of events. When China began the liberalization process, there were several different exchange rates for the yuan. Overall the currency was being devalued. On the eve of the Plaza Agreement in 1985 to drive the dollar lower, there were a little less than three yuan to the dollar.

Chinese officials engineered a gradual depreciation of the yuan in the early 1990s and combined the exchange rates into a single one, engineered a sharp depreciation. At the beginning of 1994 there were 8.7 yuan to the dollar. Some accounts of the origins of the 1997-1998 Asian financial crisis emphasize this significant Chinese devaluation as a key factor changing the competitive landscape in East Asia.

The appreciation of the yuan since 2005 brings it back toward the levels that were prevailing prior to the large depreciation in 1994. The IMF has recently indicated that it no longer regards the yuan as under-valued. The US Treasury disagrees. Some US officials see the widening trade surplus as evidence that there is still room for currency adjustment.

As many pundits pronounced 9/11 as the end of globalization, China joined the World Trade Organization in late 2001. Chinese officials have gradually accepted the importance of market mechanisms. As a results of China’s own trajectory, encouraged by the Special Economic Dialog with the US, Chinese officials have indicated that they will no longer intervene in the foreign exchange market unless it needs to combat disorderly markets.

Unlike in earlier periods when its intervention was aimed at slowing the appreciation of the yuan, more recently, the PBOC seemed to act to avoid depreciation. China’s reserves have fallen four consecutive quarter, even though the trade surplus is still rising on a 12-month average basis. China appears to be experiencing net capital exports, which also represents a change from the past.

Given the tumultuous moves in the capital markets, with the sharp appreciation against the major currencies over the past year, the yuan has been remarkably steady against the US dollar. Since then, the euro has fallen nearly 20% and the yen by 18.5%. Sterling is off 9%. The yuan is off by 0.03% according to Bloomberg data.

Since the second half of March, the dollar has been trading in a range against the yuan CNY6.18-CNY6.22. And even this may exaggerate the range. It tested CNY6.18 one in late-March and has rarely been under CNY6.19. The CNY6.22 level has been approached slightly more often, but hardly trades above CNY6.21. The dollar is trading near CNY6.21 presently.

Some suspect that China is engineering a stable yuan because officials think that it will enhance the likelihood that it is invited to join the IMF’s Special Drawing Rights (SDRs). This goal may have also been behind last week’s decision to reveal its official gold holdings. A stable currency is not one of the official criteria the IMF uses for SDR purposes. It is more likely a defensive posture that avoids giving US critics more fodder for its reluctance to see the yuan in the SDR.

The key issue for inclusion in the SDR is not the level of the yuan — though the IMF’s assessment that it is near fair value is helpful. The decision will likely hang on whether the yuan is freely usable. Last week, while it was still deploying policies aimed at supporting the stock market, Chinese officials announced that foreign officials, including central banks, sovereign wealth funds and international financial institutions (e.g. IMF, World Bank, Asian Development Bank, AIIB) would not longer be bound by the quota system (QFII) and would have full access to the on-shore interbank bond market.

There is speculation that China may abandon its QFII and RQFII quota systems to inward-bound investment. That would seem to enhance the likelihood of the yuan’s inclusion in the SDR. Short of this, it would not be surprising to see other liberalization measures. One idea that gains some attention from time to time is for the 2% dollar-yuan band to be expanded. The other approved currency pairs trade in a 5% band. While a wider band is possible, it may be a distraction from demonstrating that it is freely usable. Although the yuan tested the 2% band limits against the dollar in Q1; since the beginning of Q2 the dollar has moved in a 1.0%-1.5% band.

As part of joining the SDR, China would be expected to adopt the best currency practices. This means reporting the currency composition of its reserves. It would report them in confidence to the IMF, which would incorporate them into its COFER report of allocated reserves. Using the COFER data, analysts would try to back into China’s currency allocation. It is generally assumed that China’s currency allocation is broadly in line with the global situation, with the US dollar accounting for a little more than 60% and the euro a little more than 20%.

Original Post

China Volatility No Game Changer; Greek Liquidity Improves

Your DAY’S Trading Inspiration: We begin what is expected to be a range-bound week across the majors with news that Australia’s Jason Day has clinched his first major, taking out the PGA Championship this morning. If you are ever looking for an inspirational story on persistence, practice and hard work to hit your trading goals then this man’s story is the one. Definitely worth doing some more reading.

Moving to markets and what we expect from the week ahead, the implication of the Chinese central bank’s moves are still being scrutinised by markets, while the media isn’t yet done running the headline either. The reality for the week is that the volatility caused by the PBOC unexpectedly playing with the yuan fix rate is behind us with no real effect on policy outside of China, most notably the US. The US actually seems to have welcomed the move, with suggestions that while the market may have been surprised, maybe the Fed had been given a bit of a tap on the shoulder beforehand.

Ma Jun, the chief economist at China’s central bank continued to cool things down over the weekend:

“The nation has no intention nor needs to be involved in currency war and the driver of future economic recovery will come from domestic consumption.”

“A more market-oriented pricing mechanism for the yuan will help to avoid excessive deviation from the equilibrium level and significantly reduce the possibility of sudden fluctuations.”

Sure… ‘Market oriented’.

Really all that matters is the way that the US perceives the weakening of the yuan, and time and time again, they have indicated that it is in no way a game changer. The price of a September rate hike scenario is firming by the day.

Back in the DAY: The weekend saw Greece accept the conditions that were laid out for them to secure that third bailout deal they desperately need.

A €26+ billion package will hit the Greek system this week pending the formality of the deal going through the various European parliaments. Germany has been one of the most outspoken against the package, but have reluctantly backed down to conclude the formalities.

Although it wouldn’t be hard, Greece is actually doing a lot better with even the ECB being able to lift its ELA ceiling. Liquidity inside the Greek banking system has improved and deposits/withdrawals are returning to normal. Christine Lagarde and the IMF are still not happy, but the wheels are well and truly rolling again:

“I remain firmly of the view that Greece’s debt has become unsustainable.”

On the Calendar Monday:JPY Prelim GDP (-0.4% v -0.5% expected)

USD Empire State Manufacturing Index

Chart of the Day: The AUD/JPY weekly chart continue to tease traders, breaking major trend line support, but then continuing to consolidate on the re-test.

AUD/JPY Daily:

AUD/JPY Daily Chart

AUD/JPY 4 Hourly:

AUD/JPY 4 Hourly Chart

Keep an eye on the Technical Analysis section of the Vantage FX News Centre today as we look at the above AUD/JPY charts in more detail.

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FOMC hawks guide USD bulls

Global Markets President of New York Federal Reserve, William Dudley, came to the rescue yesterday as his hawkish tone renewed some bullish sentiment within the Dollar. In the trading weeks of August, the major currency has been exposed to extended periods of weakness due to concerns that the long-awaited US interest rate hike might be postponed, but the Federal Reserve official was upbeat about the state of the US economy and reiterated that any interest rate rises would be data dependent. He did provide confirmation that it is very doubtful that the central bank would raise rates in September, but there were growing fears that the Federal Reserve would postpone raising rates altogether, or possibly unleash another round of Quantitative Easing. While the Federal Reserve official was explicit in stating that the case for a US rate rise next month was “less compelling”, the overall speech from Dudley yesterday was positive. Dudley further pushed back interest rate expectations by stating that the rate hike in September was less compelling, but reiterated that a US rate hike was data dependent. The US economy is performing robustly on a consistent basis, and the USD gained across the board after his statement because market participants saw this as an inadvertent message that a rate hike may be conducted in December. There has been a volley of positive news from the States which support this point, such as Consumer confidence on Tuesday printing at 101.5, whilst Core durable goods orders at 0.6% were both above expectations and showed that momentum within the US economy is still strong. Inflation was a topic which was also covered in the meeting. Concerns remain that the drop in commodity prices combined with the strong USD would lead to further low inflation in the United States, but Dudley was confident that this would not last in the long-term. I question whether inflation in the US will rise anytime soon, because not only will low commodity prices and the strong USD continue to weigh on inflation, but inflation expectations are likely to be further pulled lower by the devaluation of the Yuan which has made imports from China to the United States substantially less expensive. Overall, the main driver for the USD appreciation was renewed hope that a US interest rate rise is still possible before the end of 2015 and it feels like the USD has been offered another lifeline. With the emphasis on data dependency being strong, US economic data releases and specifically NFP reports will act as major drivers behind whether the Federal Reserve will raise rates before the end of 2015. It still appears inevitable that the Federal Reserve are going to begin raising interest rates in the future and Dudley’s tone indicated that it is a matter of timing on when the central bank chooses to do so, rather than if a hike will be postponed following the recent financial market volatility. EURUSD The EURUSD experienced a hefty decline to the downside yesterday as bullish sentiment was reimbursed within the USD. Prices closed above the 1.1300 level in yesterday’s sessions and have created an intraday incline into the new trading day. Technical leading and lagging indicators still suggest that EURUSD remains bullish on the timeframe with this decline acting as a correction. The pair trades in a delicate region with 1.1300 acting as the temporary trend defining level. A move back below here may suggest bullish weakness at it will also be below the 61.8% Fibonacci retracement level. GBPUSD The induced USD strength following the upbeat tone from Dudley caused the GBPUSD to plummet. From the near two-month high slightly above 1.58, the GBPUSD has dropped over 300 pips in two trading days. Due to optimism remaining strong that both the Federal Reserve and Bank of England can soon begin raising interest rates, this pair remains fundamentally flat but it is technically now bearish. The final confirmation for further declines may be a daily close below the sticky 1.5450 support. Prices have crossed below the daily 20 SMA and the MACD is about to move to the downside. Momentum has also taken the GBPUSD below the monthly pivot. If the pair moves below the 1.5450 support, the next relevant support will be 1.5330. If would require a complete reversal of yesterday’s losses to suggest the pair is losing bearish momentum. USDJPY This week the USDJPY has experienced unfathomable levels of volatility which took prices to the near 116.0 level. I remain bearish on the USDJPY as long as prices can keep at least below the 120.50 pivotal levels. A Fibonacci retracement was drawn from the highs of 125.3 to the lows just above 116.0. As long as prices stay below the 50% Fibonacci, the bears can still take control once more. The lagging indicators such as the MACD and daily 20 SMA agree with this statement. If prices do breach 120.50, then the next relevant level holds at 122.0 SilverAn accelerated decline has been experienced on Silver this trading week. It looks like the issue of China, in addition to fears over global growth have taken its toll on this precious metal. Silver is still technically bearish and a breakdown was experienced yesterday when prices broke through the 14.40 support. There may be a situation where previous support will become resistance which may entice Silver bears to take the metal all the way towards 11.50. It would require a move back above 15.00 to suggest the outlook is no longer bearish. With the MACD on the negative and prices below the daily 20 SMA, this is partially waiting game to see how prices react to 14.40.

USD/CNY: Sell In Beijing, Buy In Ankara, Sell After Lima

It’s been just over three weeks since China rocked the world with its devaluation announcement, prompting fears of an ominous drop in demand from the world’s biggest buyer of commodities and most important trading partner to much of the globe. The Chinese yuan depreciated by nearly 4.0% in two days before gradually gaining back 1.5% from August 12 to today. So when will we see renewed CNY weakness?

USDCNY Fix vs Onshore Rate 2010-2015

Initial Devaluation

The CNY devaluation was needed as there was no question the currency had been overvalued. The yuan had appreciated more than 10% against the US dollar between summer 2010 and winter 2014, during which China GDP slowed from 10% to 7%. Exports fell from a rate of +30% to -8% and credit growth plummeted. The initial devaluation was needed, especially as the currency was pegged to a rising US dollar. But then it stopped.

So why has the People’s Bank of China fought off further CNY weakness since mid-August? The main reason is to prevent an escalation of capital outflows from China, especially as the central bank is widely expected to engage in prolonged interest rate cuts, further eroding the yuan’s carry trade allure. Beijing was also careful in avoiding beggar-they-neighbour criticism from the world community at a time when the rest of the world is slowing markedly.

Timing is Crucial

The latter point is especially crucial in considering Beijng’s halting the yuan’s depreciation. September and October are filled with international meetings and the last thing needed is for Chinese president Xi Jinping to be on the defensive. This week is the G20 meeting in Ankara, where world leaders will discuss climate, disarmament, immigration and international trade/global economy. Finance ministers and central bank chiefs of these nations will also be present. At a time when global bourses are suffering their worst decline in four years, the last thing Beijing needs is a scapegoat for this too.

On September 16-20, China’s president will meet US president Obama in Washington. The topic of foreign exchange will best be avoided by China.

Finally, on October 8-10, the annual autumn IMF/World Bank Meetings will be held in Lima, Peru, another chance for G20 finance ministers and central bank chiefs to gather. By that time, expect the IMF to have made public another downgrade of global growth as well as a warning against US interest rate liftoff.

Come Haloween, the PBOC will remove its “steady-CNY” face mask and a policy of gradual depreciation would return, until 6.50-6.75 yuan/USD is reached. Further CNY weakness is unavoidable. The impact on commodities is not yet done. How it will go remains to be seen.

Loonie Weakness To Persist

  • A looser yuan peg and subsequent devaluation of other currencies in the emerging world took the trade-weighted USD to levels not seen in a dozen years. The dollar rally, though already extended, still has legs due to perging monetary policies between the Fed and other major central banks. Above-potential GDP growth slated for this year and continued strength in employment have got us ever closer to a first interest-rate hike by the Fed in almost a decade.
  • Interestingly, the USD’s gains in August were not at the expense of the euro and the yen, both currencies benefitting from unwinding of carry trades amidst the global stock-market rout. It’s unclear, however, if those low-yielding currencies can maintain the pace if financial markets stabilize. Both the Eurozone and Japan are seeing tepid growth and below-target inflation. So, expect the BoJ and ECB to continue running their printing presses at full speed over the next several quarters, something that should weigh on the euro and yen.
  • The Canadian dollar remains under pressure. The outlook for oil prices prices is dull due to excess supply and weak global growth. Monetary policy is also not favourable with a widening US-Canada yield differential likely to hurt the currency. The large current account deficit and dependence on short-term capital flows to finance it, are also not encouraging. Complicating matters is the upcoming federal elections, which promise to add a dose of uncertainty. We expect USD/CAD to trade in the 1.30-1.40 range through the end of next year.

Stéfane Marion/Krishen Rangasamy

Aftershock Of Yuan Devaluation: What’s The Deal 2 Months Later?

On August 11th, People’s Bank of China (PBOC) has shocked the markets by devaluing yuan to 6.23 against the U.S. dollar. For many investors, this was a surprising move that has raised a red flag for the growth prospects of the Chinese economy, whereas several markets around the world came under extreme pressure. Furthermore, fears for a regional currency war have mounted as, following China’s move, many markets in the Southeast Asia have collapsed.

Why China Devalued Its National Currency From 1994 to 2005, the yuan was pegged to the U.S dollar at 8.28 yuan per U.S. dollar. In July 2005, following pressures from its major trading partners, the Chinese government decided to internationalize the national currency by allowing it to enter a managed free-float system around a fixed rate determined by the movements of major world currencies, including the U.S dollar. From 2005 to 2008, the yuan appreciated by 21% at 6.83 to the U.S dollar. In July 2008, the declining global demand for Chinese products due to the global financial crisis led PBC to halt the yuan’s appreciation. On June 2010, China reentered the game, pushing the yuan up, leading to a cumulative appreciation of 12% to 6.11 by December 2013. Although it is hard to accurately calculate the exact percentage of undervaluation over the past two decades, it is certain that the currency is substantially undervalued.

PBOC’s move to set the official rate at 6.23 yuan per U.S. dollar has rattled investors, reigniting a narrative on whether China is providing an unfair advantage to its businesses. The move is widely viewed as an effort to keep the yuan at low levels in order to boost the competitiveness of the Chinese exports in the global marketplace. In fact, China is pegging the yuan against the greenback at artificially low levels, while it allows fluctuations within a range of 2% on either side of the reference rate. By allowing its currency to float freely, China accumulates U.S dollars by selling yuan. As of September 2015, China’s foreign exchange reserves is $3.51 trillion, down from $4 trillion in June 2014. However, the cut in foreign exchange reserves was made to support the devaluing yuan. In addition, the PBOC’s move indicates a shift in the Bank’s monetary policy, suggesting that China may be seeking a more market-oriented approach for its national currency in order to make its economy more responsive to global market forces.

Markets Respond To Yuan Devaluation The yuan has already declined by 5% in the global foreign exchange markets. Following the PBOC’s decision, Vietnam, China’s major trading partner, has decided to widen the dong’s (VND) trading band to 2% from 1%, allowing its national currency to trade in a range of VND 21,240 and VND 22,106 against the U.S. dollar. According to The State Bank of Vietnam, the decision is within a series of “comprehensive measures and policies to ensure stability of the dong and the currency market.”

Furthermore, in response to China’s move, Indonesian Rupiah (IDR) hit a 17-year low, declining by 0.44%. The Singapore Dollar (SGD) hit its five-year low, declining by 1.3%, Malaysian Ringgit (MYR) dropped by 0.7%, and the Thai Baht (THB) fell 0.8%, hitting its six-year lows. Similarly, Australian dollar (AUD) and New Zealand dollar (NZD) hit their six-year lows.

Global markets were also sent into a spin. The ASX 200 index declined to 5,001.3 points, down by 4.09%. The Shanghai composite index fell to 3,209 points, down by 8.5%, while the Nikkei slumped by 4.61%. The Dow Jones fell down to 588 points. NASDAQ and S&P entered a correction phase, down by 10% from their peaks. FTSE 100 suffered its bigger losses in the last six years and the European stock markets suffered their worst tumble since 2011.

Struggling Economic Activity In Emerging Markets China’s slowdown is expected to have an impact on the output growth of the emerging markets, mainly due to declining commodity prices and depreciating currencies. Additionally, Russia and Brazil endure high inflationary pressures which cause their currencies to depreciate against the currencies of developed economies, causing a further decline in commodity prices. Meanwhile, job cuts continue to impede consumer confidence and economic sentiment in these economies. The IMF has lowered its forecast of global growth to 3.1% for 2015, 0.2% down from its July estimates and to 3.6% for 2016.

Conclusively, China’s yuan devaluation happens on top of a sharp slowdown in the world’s second-biggest economy, while slumping commodities are hurting the emerging economies. The PBOC’s move has also raised political concerns in the United States, following China’s threats to displace exports from Asian and emerging market competitors. The yuan devaluation in not without implications and risks triggering capital outflows.

Interesting Week Ahead For China, Eurozone, U.S.

All falling into place

And so starts a very interesting week for China, the Eurozone, the United States and currency markets as a whole as we wait on some particularly interesting policy. China will find out today whether the IMF deems the yuan suitable enough to become part of its Special Drawing Rights, Thursday is an ECB meeting at which additional easing is not only expected but demanded by analysts while Friday sees the final US payrolls announcement of the year and possibly the data calendar’s only real shot of derailing a December rate rise from the Federal Reserve.

Asian markets have been relatively serene overnight, allowing G10 currencies to continue their recent trends i.e. losing ground against the greenback. The euro is obviously in the firing line in the lead-up to the European Central Bank’s policy decision and Draghi’s statement, and any rallies for the single currency due to positive data will likely be sold quickly.

Yuan strengthens suddenly

The major move overnight was a sudden 3 big figure fall in USDCNH as we wait for the news from the IMF. Whether this was a move by the People’s Bank of China to quickly shut the disparity between onshore and offshore yuan prices before the announcement we may never know, but intervention in thin markets could have easily driven that move.

As we wrote on Friday, it is uncertain what impact the yuan’s inclusion in the SDR will have on pricing in the short term; there are reasonable expectations of both gains, as investors take confidence in the currency – or losses – as the People’s Bank of China once again attempts to weaken yuan to garner higher export competitiveness.

Draghi has many hurdles to jump

It is that latter reason why markets are so focused on the euro into this week. Draghi and the European Central Bank policy makers are comfortable using the euro as their first choice pressure valve for the Eurozone economy and will be wanting to drive that euro weakness ever onwards. According to the people in the know, the levels of bets on a weaker euro have not reached the extreme levels we saw in March as markets dealt with deflation and Greek issues and therefore, in theory, has further to go.

Sterling not helped by dovish talk

As probably does GBPUSD. The cross is at a seven month low this morning as the pound battles the stronger dollar and responds to comments from the newest member of the Monetary Policy Committee Gertjan Vlieghe that he is “relaxed about waiting a little longer before we start,” hiking interest rates. On the basis that the Federal Reserve will hike in a little over a fortnight’s time we are still plumping for May from the Bank of England in accordance with our ‘Federal Reserve plus six month’ rule.

German inflation will be the key number today when released at 1pm, with overall inflation expected to remain very depressed well into 2016.

Why The Chinese Yuan Will Lose 30% Of Its Value

The stark truth is nobody wants yuan any more.

The U.S. dollar (USD) has gained over 35% against major currencies since 2011.

USD vs Major Currencies 1980-2016

China’s government has pegged its currency, the yuan (renminbi), to the USD for many years. Until mid-2005, the yuan was pegged at about 8.3 to the dollar. After numerous complaints that the yuan was being kept artificially low to boost Chinese exports to the U.S., the Chinese monetary authorities let the yuan appreciate from 8.3 to about 6.8 to the dollar in 2008.

This peg held steady until mid-2010, at which point the yuan slowly strengthened to 6 in early 2014. From that high point, the yuan has depreciated moderately to around 6.5 to the USD.

Chinese Yuan, Onshore and Offshore 2010-2016

Interestingly, this is about the same level the yuan reached in 2011, when the USD struck its multiyear low. Since 2011, the USD has gained (depending on which index or weighting you choose) between 25% and 35%. I think the chart above (trade-weighted USD against major currencies) is more accurate than the conventional DXY index.

Due to the USD peg, the yuan has appreciated in lockstep with the U.S. dollar against other currencies. On the face of it, the yuan would need to devalue by 35% just to return to its pre-USD-strength level in 2011. This would imply an eventual return to the yuan’s old peg around 8.3—or perhaps as high as 8.7.

Longtime correspondent Mark G. submitted this article China’s Subprime Crisis Is Here:

The dynamic is clear. A splurge of new lending can help to dilute existing bad loans, but only at a cost. This is a game that can’t continue forever, particularly if credit is being foisted on to an already over-leveraged and slowing economy. At some point, the music will stop and there will have to be a reckoning. The longer China postpones that, the harder it will be.

Mark also submitted the following commentary:

It seems the best way to assess the likely effects and outcomes is to look at what the Chinese government can control, and at what it can’t control. And we should observe at the start that the yuan is not a global reserve currency.

1. Beijing can control the amount of yuan in existence. It can therefore easily pay off all these bad internal debts, at least in a strict book keeping sense. And it can also recapitalize its bankrupt banks to any degree necessary, at least in yuan. The process of doing so involves assigning winners and losers. The latter group will comprise anyone earning a subsistence working wage in yuan and anyone whose assets primarily consist of savings in yuan.

2. Undertaking #1 will lead to a large increase in the amount of yuan in existence. Here Beijing will be acutely sensitive to any increase in food prices since this can swiftly lead to mass food riots and the concomitant rapid and bloody end of the regime. Therefore food prices have to be insulated somehow from this huge internal devaluation.

3. Beijing cannot permanently control the yuan-dollar exchange rate or any other FOREX rate involving yuan. It can do so in the short term but only to the limit of its usable foreign exchange reserves. This total is minus the FOREX working capital China needs to pay for imported raw materials and fuels. And also food: China’s Growing Demand for Agricultural Imports (USDA)

It appears that one certain outcome will be a huge depreciation in the value of yuan. Bailout of the bad bank debt is reason #1 to print yuan. The decline of yuan will lead to lower prices and a temporary relief of U.S.-based automation pressure on export market share. This begins to become a Reason #2.

How this will be received outside China is the immediate question. Probably not too favorably.

One way to paper over impaired loans is to issue a flood of new credit: this dilutes the problem and enables defaulted loans to be “paid down” with new loans that are doomed to default once the ink is dry: China Created A Record Half A Trillion Dollars Of Debt In January (Zero Hedge)

Here’s the larger context of China’s debt/currency implosion. From roughly 1989 to 2014—25 years—the “sure bet” in the global economy was to invest in China by moving production to China.

This flood of capital into China only gained momentum as the yuan appreciated in value against the USD once Chinese authorities loosened the peg from 8.3 to 6.6 and then all the way down to 6 to the dollar.

Every dollar transferred to China and converted to yuan gained as much as 25% over the years of yuan appreciation. Those hefty returns on cash sitting in yuan sparked a veritable tsunami of capital into China.

Now that the tide of capital has reversed, nobody wants yuan: not foreign firms, not FX punters and not the Chinese holding massive quantities of depreciating yuan.

This is why “housewives” from China are buying homes in Vancouver B.C. for $3 million. That $3 million could fall to $2 million as the yuan devalues to the old peg, around 8.3 to the USD.

Who’s left who believes the easy money is to be made in China? Nobody. Anyone seeking high quality overseas production is moving factories to the U.S. for its appreciating dollar and cheap energy, or to Vietnam or other locales with low labor costs and depreciated currencies.

For years, China bulls insisted China could crush the U.S. simply by selling a chunk of its $4 trillion foreign exchange reserves hoard of U.S. Treasuries. Now that China has dumped over $700 billion of its reserves in a matter of months, this assertion has been revealed as false: the demand for USD is strong enough to absorb all of China’s selling and still push the USD higher.

The stark truth is nobody wants yuan any more. Why buy something that is sure to lose value? The only question is how much value? The basic facts suggest a 30% loss and a return to the old peg of 8.3 is baked in.

But that doesn’t mean the devaluation of the yuan has to stop at 8.3: just as the dollar’s recent strength is simply Stage One of a multi-stage liftoff, the yuan’s devaluation to 8 to the USD is only the first stage of a multi-year devaluation.

Race To The Negative-Rate Bottom

Ability is a poor man’s wealth.

— M. Wren

If you had told inpiduals before 2009 that we would be living in a negative-rate environment in the near future, most would have treated you like a lunatic. Fast forward a few years and voila, bankers all over the world are embracing negative rates. China devalued the yuan once again, adding further fuel to the already blazing fire. The Fed will have no option but to lower rates and then Jump onto the negative-rate bandwagon. Don’t listen to the nonsense the Fed has been mouthing for months that ‘all is well’. We can already see the ‘all-is-good’ slogan breaking down to ‘it’s-not-as-good-as-we-thought’. And that will eventually change to the slogan: ‘it’s ugly out there’ and we need to lower rates to prevent a catastrophe. The same strategy has been used again and again; it works marvellously so why stop now. The masses have been well trained so there is absolutely no need to change the game plan. Keep the lie simple, repeat it over and over and folks will believe it. Crowd psychology clearly illustrates that the mass mindset is self-destructive.

The first experiment was to maintain a low-rate environment; the second was to flood the system with money, which was achieved via QE. The third phase was to get the corporate world in on the act of flooding the markets with money. This was achieved through massive share buyback programs. The next stage is to introduce negative rates to the world to fuel the mother of all bubbles, which is currently underway.

Central bankers are aware that people will save more and more due to fear. Uncertainty is a great catalyst, moving one from a state of calm to a state of panic rather rapidly. They know that many will continue to remain wary even when banks start charging them a fee to hold their money. People are saving more because of uncertainty; they don’t know what the future holds, so they save even though it means taking a loss. Experts will state that central bankers miscalculated, but the truth is that they did not miscalculate. This event was planned years in advance and with meticulous precision. Watch with surprise how the ‘rate-hike’ slogan transforms into ‘cut interest rates now’. Yellen already sounds more dovish with the passage of each day.

Many experts have said that negative rates are a bad idea, and that’s true to a degree. But it depends on the angle of observation. If you take no action, then the response is ‘yes, they’re terrible’. However, if you are proactive, you can use negative rates to your advantage. For example, one family gets paid interest on its mortgage instead of paying the bank. In other words, they’re getting paid to take a mortgage.

Stock Markets Will Trend Higher

Cheap Money leads to speculation and the stock market is the best place to speculate. Expect corporations to borrow even more money and use these funds to buy back their shares thereby artificially boosting EPS. There is no shred of decency left on Wall Street where bonuses are tied to performance. These chaps will do whatever it takes to boost share prices — even if it means creating an illusion that earnings are rising when, in fact, they could be flat or even dropping. We’ve covered this topic in detail over the past 12 months, saying that every pullback is to be viewed as a buying opportunity.

Property Prices Will Rise

Negative rates will lower the cost of mortgages as, in many cases, holders receive a check from their bank for interest payments. Negative rates are already fueling a property bubble in Sweden and real estate prices have surged significantly in the U.K. It’s only a matter of time before the same phenomenon occurs in the U.S. where banks will almost certainly lower lending standards. Barclays (LON:BARC), for example, recently announced 0%-down mortgages.

Improving GDP

While such a proclamation appears insane, the chart below clearly reveals the opposite to be true. Negative rates do create the illusion that the economy is improving and the masses seem to agree — silently.

The Illusion Of An Improving Economy

Denmark’s GDP started to rise, which was, of course, the whole purpose of the program. Note that shortly after the crisis of 2008-2009, rates were pushed lower faster than at any period prior to the last 20 years — the lower they fell, the higher the GDP. In fact, one can conclude that it’s in an uptrend.

Game Plan

China’s decision to devalue its yuan clearly illustrates that the ‘devalue-or-die program is being embraced worldwide. Nations will continue to devalue their currencies in a bid to stay competitive. The global economy is weak and only hot money is creating the illusion that all is well. Mass psychology indicates that the masses prefer a sweet lie as opposed to the blunt truth. In that sense, they will get what they desire — a market that looks magnificent from the outside but is rotten to the core. As the U.S. has yet to embrace negative rates, there’s a lot more upside to this market (no thanks to fundamentals). Indeed, fundamentally speaking, this market should be in the toilet. It will soar higher because of hot money. We expect property prices to continue trending up. And as lending standards are relaxed we expect another property bubble. As for the stock market, the sentiment is negative because more and more cash will flood the market once negative rates arrive. While the stock market is likely to trend higher, don’t expect it to do so in a straight line.

Traders should be prepared for wild swings in both directions.

The way of paradoxes is the way of truth. To test Reality we must see it on the tight-rope. When the Verities become acrobats we can judge them.

— Oscar Wilde

Markets Steady Ahead Of Chinese Data

We saw another relatively calm day in the markets yesterday and even though the spectre of trade tensions still looms large, the global stock markets are still trending well to the topside. We saw good gains across the globe yesterday as indices printed gains even in the Emerging Markets regions that have been suffering recently. We’ve seen a bit of stability in the currency world as well in EM’s with the Peoples Bank of China once more taking steps to calm the Yuan depreciation this time urging lenders to prevent “herd behaviour”. The Yuan did appreciate over yesterday’s session but is still sitting at vulnerable levels with a large risk event ahead today in the form of the Chinese Trade Balance data.

We did get the expected quiet RBA rate announcement and statement yesterday with the board sticking very close to its usual comments. There were some slight changes with inflation expectations edging lower and unemployment also expected to come off over the next couple of years, however these had little impact on the market and any change in rate is still not expected for at least a year and probably will be even further away. The Aussie dollar continued to trade below 0.7400 but did have a good rally late in the trading day with this being attributed more to options interest and a fatigued short market rather than any central bank influence.

We did hear a touch more on trade tensions overnight with the US advising that they will begin imposing 25% tariffs on an additional $16 bio worth of Chinese imports in two weeks’ time. The market reaction was fairly muted in terms of any downside moves but investors will be adding that to their portfolio of downside risk factors and keeping a close eye on developments on that front over the next few trading sessions.

Looking ahead to today’s trading and in Asia the focus will be on those aforementioned Chinese numbers, with investors looking for signs that US tariffs are starting to take effect. We also have Kiwi inflation expectation data due and after that are set to hear from RBA Governor Lowe as he speaks in Sydney this lunchtime. It’s fairly quiet in terms of data releases through the London session but we are due to hear from Fed Member Barkin in the New York time zone before the latest US Crude Oil inventories are released.

Also, note that the RBNZ have their latest Official Cash rate release due tomorrow morning. With no expectation of any rate change the focus will be on the Statement and later Press Conference, investors see the risk of a slightly more dovish sentiment coming through as data hasn’t been as strong recently. The Kiwi dollar is sitting just above yearly lows and could be vulnerable to a further pe if we do have a strongly Dovish hold.