Great chart: China excess liquidity (6M Lead) vs. Australia housing market

In the past few years, a significant amount of economists and practitioners have warned of a potential hard landing in the Australian housing market, as property prices have been growing at unsustainable rates with first-home buyers having difficulties saving a significant deposit to get a foothold in the market. According to the Australian Bureau of Statistics, the total value of residential property in Australia is now exceeding 7 trillion USD, by far the economy’s largest asset. As there are no ‘vehicles’ to short the Australian housing market as during the US subprime crisis, two alternative ways to short the property market was through either going short the Australian Dollar or short the banks.  Prior the Covid19 crisis, banks’ mortgages were equivalent to approximately 80% of the country’ GDP, with most of them piled into the top 4 banks (Commonwealth, WestPac, ANZ and NAB).

Even though house prices were starting to decline significantly in 2018 and the beginning of 2019, with investors speculating that it was the start of the ‘hard landing’, the reversal in the global stance of monetary policy (from quantitative tightening to quantitative easing) combined with the surge in Chinese liquidity have generated strong support for the Australian property market in the past year. This chart shows an interesting co-movement between China excess liquidity (6M lead), which we compute as the difference between real M1 money growth and industrial production, and the Australian housing market. It seems that the downside risk in the Aussie property market should remain limited as money growth keeps accelerating in China.

Source: Eikon Reuters, RR calculations

2020 onwards: struggling economy, more QE?

In the past cycle, central banks have been constantly intervening in the market to counter the strong disinflationary force coming from the 3D: Debt, Demographics, Disruption. Figure 1 shows that between the beginning of 2008 and early 2020, the assets from the major 5 central banks grew steadily by a annual pace of $1.25tr per year, for a total of $15tr in 12 years.

As a response to the Covid19 shock, central banks just printed more in order to prevent the economies from falling into a deflationary depression, which resulted in a 7-trillion-dollar increase in central banks’ assets in the past 8 months. The titanic liquidity injections resulted in a significant rebound in equities, especially in the US with the SP500 trading over 100 points above its February high.

With most of the European economies entering a second lockdown, and restrictions also expected to be announced in the US (as the elections are now over), governments will again run aggressive fiscal policies and extend the furlough schemes in order to avoid the rise of social unrest, which will result in more money printing from central banks in the coming months.

Is it as simple as this: the worst the economy gets, the better it is for stocks as it will result in more liquidity injections?

Source: Eikon Reuters, RR calculations

Eyes on Yellen (and global macro)

As we are getting close to the FOMC statement release, we were reading some articles over the past couple of days to understand the recent spike in volatility. Whether it is coming from a ‘Brexit’ fear scenario, widening spreads between core and peripheral countries in the Eurozone (German 10Y Bund now trading negative at -0.5bps), disappointing news coming from US policymakers this evening or more probably from something that we don’t know, we came across some interesting data.

First of all, we would like to introduce an indicator that is getting more and more popular these days: Goldman’s Current Activity Indicator (CAI). This indicator gives a more accurate reflection of the nation’s GDP and can be used in near real-time due to its intra-month updates. It incorporates 56 indicators, and showed a 1-percent drop in May to 1.2% due to poor figures in the labor market and ISM manufacturing data (see chart below).

Chart 1. Goldman CAI (Source: Bloomberg)

The implied probability of a rate hike tonight is less than 2% according to the CME Group FedWatch, and stands only at 22.5% for the July meeting. If we have a look at the Fed Dot Plot’s function in Bloomberg, we can see that the implied FF rates curve has decreased (purple line) compare to where it was after the last FOMC meeting (red line), meaning that the market is very reluctant to a rate hike in the US.

Chart 2. US Feds Dot Plot vs. Implied FF rates (Source: Bloomberg)

June hike, why not?

Many people have tried to convince me of a ‘no June hike’ scenario, however we try to understand why it isn’t a good moment for Yellen to tighten. Oil (WTI CL1) recovered sharply from its mid-February lows ($26/bbl) and now trades slightly below $48 (decreasing the default rate of the US high-yield companies), the US Dollar has been very quiet over the past 18 months (therefore not hurting the US companies’ earnings), the SP500 index is still trading above 2000, the unemployment rate stands at 4.7% (at Full employment) and the Core CPI index came in at 2.1% YoY in April.

However, it seems that US policymakers may have some other issues in mind: is it Eurozone and its collapsing banking sector, Brexit fear (i.e. no action until the referendum is released), CNY series of devaluation or Japanese sluggish market (i.e. JPY strength)?

The negative yield storm

According to a Fitch analysis, the amount of global sovereign debt trading with negative yields surpassed 10tr USD in May, with now the German 10Y Bund trading at -0.5%bps. According to DB research (see chart below), the German 10Y yield is the ‘simple indicator of a broken financial system’ and joins the pessimism in the banks’ strategy department. It seems that there has never been so much pessimism concerning the market’s outlook (12 months) coming from the sell-side research; do the sell-side firms now agree with the smart money managers (Carl Icahn, Stan Druckenmiller, Geroge Soros..)?

Chart 3. German 10Y Bund yield (Source: DB)

10Y bund DB.jpg

ECB Bazooka

In addition, thanks to the ECB’s QE (and CSPP program), there are 16% of Europe’s IG Corporate Bonds’ yield trading in negative territory, which represents roughly 440bn Euros out of the outstanding 2.8tr Euros according to Tradeweb data. If this situation remains, sovereign bonds will trade even more negative in the coming months, bringing more investors in the US where the 10Y stands at 1.61% and the 30Y at 2.40%. If we look at the yield curve, we can see that the curve flattened over the past year can investors could expect potentially LT US rates to decrease to lower levels if the extreme MP divergence continues, which can increase the value of Gold to 1,300 USD per ounce.

Chart 4. US Yield Curve (Flattened over the past year)


(Source: Bloomberg)

Poor European equities (and Banks)

However, it seems that the situation is still very poor for European equities, Eurostoxx 50 is down almost 10% since the beginning of June, led by the big banks trading at record lows (Deutsche Bank at €13.3 a share, Credit Suisse at €11.70 a share). The situation is clearly concerning when it comes to banks in Europe, and until we haven’t restructured and/or deleveraged these banks, systemic risk will endure, leaving equities flat (despite 80bn Euros of money printing each month). Maybe Yellen is concerned about the European banks?


Another issue that could explain a status quo tonight could be the rising fear of a Brexit scenario. According to the Brexit poll tracker, leave has gained ground over the closing stages, (with 47% of polls for ‘Brexit’ vs. 44% for ‘Bremain’). This new development sent back the pound to 1.41 against the US Dollar, and we could potentially see further Cable weakness toward 1.40 in the coming days ahead of the results. Many people see a Brexit scenario very probable, raising the financial and contagions risks and the longer-term impact on global growth. It didn’t stop the 10Y UK Gilt yield to crater (now trading at 1.12%, vs. 1.6% in May), however a Brexit surprise could continue to send the 5Y CDS to new highs (see below).

Figure 1.  FT’s Brexit poll tracker (Source: Financial Times)


Chart 5. UK 5Y CDS (Source: Bloomberg)


CNY devaluation: a problem for US policymakers?

Eventually, another problem is the CNY devaluation we saw since the beginning of April. The Chinese Yuan now stands now at its highest level since February 2011 against the greenback (USDCNY trading at around 6.60). we are sure the Fed won’t mention it in its FOMC statement, but this could also be a reason for not tightening tonight.

Conclusion: a rate hike is still possible tonight

To conclude, we are a bit skeptical why the market is so reluctant for a rate hike this evening, and we still think there is a chance of a 25bps hike based on the current market situation. We don’t believe that a the terrible NFP print (38K in May) could change the US policymakers’ decision. Moreover, even though we saw a bit of volatility in the past week (VIX spiked to 22 yesterday), equities are still trading well above 2,000 (SP500 trading at 2,082 at the moment) and the market may not be in the same situation in July or September.

Quick review of the Chinese Yuan history

Back in November 2014, we wrote a quick summary of our favorite currency: the Japanese Yen. It was a very useful exercise for me first of all, and we hope it provided interesting information for our readers.

We think this time an interesting story of a particular currency that we tend to watch every morning is the Chinese Yuan or ‘Renminbi’. The difference between the two names: the Yuan is the name of a unit of the renminbi currency (i.e. you can say that a slice of pizza cost 10 Yuan, but not 10 renminbi.

The ‘Dark’ Beginnings… 

The Renminbi, which literately means ‘people’s money’, is the official currency of the People’s Republic of China (PRC). It was first issued on December 1st, 1948 by the PBoC, Public’s Bank of China, the country’s central bank. The bank was established on the same date under the Chinese Communist Party ruled by the Chairman Mao Zedong (also known as the founding father of the PRC). China experienced a massive monetary inflation between 1937 and 1945 (end of WWII) in order to fund the war with Japan. Studies showed that between 70 and 80 percent of the annual expenditures were covered by fresh printed money during that period. Therefore, the country suffered from a Great Inflation in the same years that was reflected on the exchange rate. Here are some figures (coming from the work of Richard M. Ebeling, the Great Chinese Inflation, 2010):

  • In June 1937, one US dollar was traded at 3.41 against the Yuan
  • By December 1961, the exchange rate of USDCNY rose to 18.93 in the black market
  • At the end of WWII, the Yuan depreciated dramatically to 1,222 (vs. the greenback)
  • In May 1949, USDCNY reached a dramatic 23,280,000

In the 1950s, the Chinese economy was so cut off from the rest of the world that it is difficult to find data on a potential meaningful exchange rate. All the information we have so far is that a second issuance of Renminbi took place in 1955 and replaced the first one at a rate of one new CNY to 10,000 old CNY.

The World Bank published an annual average middle exchange rate for US Dollar to Chinese Yuan since 1960. Between 1960 and 1971, one US dollar was worth 2.4618 Chinese Yuan, which makes me believe that China was ‘also part of’ the Bretton Woods agreements (we are speculating on that information based on the ‘pegged’ exchange rate). Then, after the Nixon ‘shock’, the exchange rate started to depreciate and reached a low of 1.8578 in 1977 before starting to soar to 2.40 in 1980.

The 1980s reform and RMB Devaluation:

With China’s economic reform in the 1980s, the Yuan started to become a more easily traded currency (exchange rate was therefore more realistic), thus data became public. The following historical exchange rates are based on Bloomberg (ticker: CNY BGN Curncy).

Starting with a grossly overvalued exchange rate in 1980, the Chinese Yuan experience a series of devaluation until the late 1990s until the Chinese authority settled the rate 8.27 CNY/USD.

As you can see it on chart 1, the rise of the US Dollar under the Reagan Administration (as a consequence of the Fed rising interest rate to 20% to counter inflation coming from the second oil shock) pushed the USDCNY exchange rate  from 1.65 to roughly 3.00 in September 1985 (before the Plaza Accord on September 22nd). In contrast, the real exchange rate was more much stable and remained virtually constant between 1981 and 1985 (during this period, the Renminbi was pegged to a back a basket of internationally traded currencies weighted according to their importance of China’s trade).

Between 1987 and the end of 1990, the Chinese Yuan was relatively pegged to the US Dollar, with a 26% Yuan devaluation that took place in the last quarter of 1989. However, these devaluations were not sufficient with the emergence of a black market pricing a much higher USDCNY exchange rate (i.e. cheaper Yuan currency against the US Dollar). Therefore, the ‘unofficial’ floating rate (a swap market rate) has constantly driven the ‘official’ rate (nominal rate on chart 1) until the massive devaluation of 1994 (and the official and ‘unofficial’ rates were eventually unified).

1995: The start of a new regime

One the two rates were unified, the Chinese currency was pegged to the US Dollar from 1995 to 2005 at an exchange rate of 8.28 Yuan per US Dollar. Therefore, the PBoC was ready to intervene (i.e. buy or sell Yuan) in the market to keep that rate steady. This policy was combined with a policy of restricting international capital flows, where the citizens were not allowed to convert savings into US dollars, Japanese Yen or British pound.

In consequence, the low exchange rate lead to political issues between US and China as many studies concluded that the Chinese Yuan was an undervalued currency. Exports were growing dramatically in China (see appendix 1), from 160 million US dollars in 1995 to 600 million dollars in 2005 according to the General Administration of Customs. The economic modernization, cheap labour costs in addition to a more ‘transparent’ exchange rate led to a surge in Foreign Direct Investment during the 1990s and 2000s. The economy average an average annual growth rate of 9-10% between 1995 and 2005 (appendix 2).

China’s economic growth and trade liberalization led to a sharp expansion in US/China commercial ties, and a constantly increasing US trade deficit with China. If we look at table 1, the US trade balance deficit widened from USD 10.4bn to USD 201.6bn in 2005, damaging the US economy. There are many reasons why China could have resisted from international pressures to maintain it peg during that period, but the two main ones that come to our mind is that China was mostly financing the US deficit (i.e. purchasing US Treasuries) and the US manufacturing was benefiting from cheap labour costs for goods produced in China.

The 2005 peg removal

Eventually, the PBoC removed the peg on July 21st 2005 and allowed a first one time appreciation of 2.1%, pushing the dollar down to 8.11 CNY. From there, China allowed its currency to float within a range determined in a relation to a basket of currencies (authorities told the world that it ran a ‘managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies’). The basked was dominated by its main trading partners – US Dollar, Euro, Japanese Yen and South Korean Won – with a smaller proportion of other currencies (GBP, AUD, RUB, CAD, THB and SGD). Until Q3 2008, USDCNY fell roughly 18% before the reintroduction of a de facto peg during the financial crisis from 2008 to mid-2010 at around 6.80 Yuan per dollar.

June 2010: A return to the daily trading band limit:

In June 2010, after a two-year peg, China allowed once again USDCNY to trade within a 0.5% band (daily limit for appreciation or depreciation of the CNY against the USD) amidst major pressure from international trade partners. The Yuan’s trading band was then widened to 1 percent in April 2012, which led to further appreciation of CNY (USDCNY fell another 11.60% to reach a low of 6.01 in January 2014).

The Yuan crisis in Q1 2014

In the start of 2014, we saw a little Yuan crisis with USDCNY erasing most of its Jun-2012 / Jan-2014 fall (62% roughly if we look at chart 2). There are many stories that could describe this sudden CNY collapse:

  • the PBoC willingness to join the global currency war and enhance export
  • the carry trade unwinds from structured products build on the hypothesis that the Yuan will appreciate continuously (FX Target Redemption Forward story for instance)
  • other thought that the PBoC was paving ‘the way for further liberalization of the Yuan exchange rate’

We think the carry trade unwinds is the most appropriate based on the one-way market positioning concerning the Yuan before that crisis. Products were structured by banks on the hypothesis that the Chinese Yuan will constantly rise against the USD until it eventually reached its ‘fair value’ which was estimated between 5 and 5.5 at that time (BEER, FEER fair value models). We know that carry trade currencies tend to depreciate gradually during some period so that carry traders could benefit from the interest rate differentials, however the risk-off aversion (i.e. carry unwind) is sudden and very drastic.

In mid-March 2014, the PBoC widened the range to 2 percent (allowing the exchange rate to rise or fall 2 percent from a daily midpoint rate that the central bank sets each morning). Until the August 11 devaluation that occurred the following year, the Chinese Yuan oscillated at around 6.20 against the Dollar.

August Devaluation

On August 11th, the PBoC suddenly allowed the Yuan to depreciate by nearly 2% against the USD, its largest devaluation in the past two decades amid slower economic growth and a depressed highly-volatile stock market. As you can see it on Chart 3, the Shanghai Shenzhen Index (CSI 300) started to enter into a bear market in June 2015 after it reached a high of 5,380. In the beginning of August 2015, the market was almost down 2,000 pts. and the fear of a ‘Chinese bubble collapse’ raised concerns over global investors. A second PBoC move was done the consecutive day and pushed the total devaluation to nearly 4 percent (from 6.21 to 6.44 USDCNY, see chart 4).

Watch the CNY – CNH spread

As China has been opening up its economy to the RoW (Rest of the World) since the late 2000s, the officials’ goal was to internationalize its currency to the market to settle trade and financial transactions. As you know, the CNY – or on-shore Yuan – is not allowed outside of China and is only convertible in the current account (i.e. trade) and not in the capital account (i.e. for investments and banking flows). Thus was born the CNH in 2009 – offshore Renminbi – which circulates in offshore markets such as Hong Kong (China Mainland Hub). Since then, there has been a rapid expansion of offshore clearing centres in financial cities like London or Frankfurt and the RMB has begun direct currency trading against the Euro, GBP, NZD in addition to USD, JPY or AUD.

The important criteria of the CNH is that it is allowed to float freely with no restrictions on cross border trade settlements, therefore we usually like to watch the CNY – CNH spread just to see the divergence sometimes that happens in the market (See chart 5). In the beginning of the year 2016, we saw a massive divergence between USDCNY and USDCNH, with the offshore Yuan (CNH) was depreciating at a much faster pace than the on-shore Yuan (CNY). On January 6th, the spread reached 14 figures, with USDCNY trading at 6.55 and USDCNH at 6.69. Eventually, the situation stabilized and the two exchange rates converged.

We think that by looking at the spread between the two rates, you can gauge the market’s perception toward the currency and its confidence in the PBoC’s policies.

Will the Yuan continue to weaken in the near term?

It has been a few years now that a group of investors have been watching closely China, especially its highly-leverage banking system. Over the past decade, China has expanded its credit market from 5tr USD to 35 trillion USD; for an economy of roughly 10tr USD, the banks’ total-assets-to-GDP ratio stands at 350%. China is massively exposed to the housing market, which represents roughly 15 percent of the country’s GDP (it was 5% in the US before GFC). Therefore, if the housing market halts or starts to decline (which it has already according to some housing market index), the country could be exposed to a non-performing loans cycle and therefore would be forced to recap its banking system, pushing the PBoC to increase its balance sheet. As China doesn’t offer short positions in equities (not very common from our knowledge) and no structured products or derivatives to short the housing market, people are positioned in the currency, expecting a ten to twenty percent depreciation. This scenario could bring the currency USDCNH somewhere between 7 and 8.

Chart 1. Historical USDCNY exchange rates (Source: Bloomberg)


Chart 2. The 2014 USDCNY ‘crisis’ (Source: Bloomberg)

Chart 3. CSI 300 Index (Source: Bloomberg)

Chart 4. China CNY devaluation – August 11th


Chart 5. CNY – CNH spread (Source: Bloomberg)


Appendix 1. Exports (Source: Trading Economics)


Appendix 2. Growth (Source: Trading Economics)


Table 1. US trade with China (US ITCD)


Quick Macro update: China and Commodities

  1. China continues to shake the markets

The first chart that we want to start this analysis is the Shanghai CSI 300 Index (see below), down 40% since its previous high (5,380) reached on June 9th 2015. As you know, news from China has been the major ‘driver’ of the financial market, giving a harsh time for European and US fund managers. The index is approaching the psychological support of 3,000 and its August low of 2,952, two critical levels for the Chinese economy.


(Source: Bloomberg)

The volatility in China (which will affect global markets overall) is coming from its too-leverage banking system, which we believe cannot survive if we enter a Bear market in the EM world. As Kyle Bass from Hayman Capital reported in his late interviews, China bank assets totalled 31tr USD in 2015, up from 5tr USD in 2006 if we look at the chart below. If we express it as a share of the country’s GDP (roughly 10tr USD), the banking system (total assets) is 350%.


(Source: Hayman Capital)

The consequence of a [sharp] decline in equity and property markets will lead to a constant surge in NPLs in the medium term, therefore putting the whole banking system into huge troubles.  Housing starts have fallen by almost 20% in 2015 (based on an average estimates) and the excess of inventory unsold properties have surged dramatically (Standard Chartered estimates the number at 9 million, with a further 40m to 50m homes being held vacant as investments). This is clearly problematic as it is widely known that China’s household wealth is mostly concentrated in housing, which account for 15% of the country’s GDP. To give you an idea, the 2003-08 housing market in the US represented barely 5% of the US GDP.

We believe that China is poised to print constantly lower-than-expected GDP growth rates due to this instability, therefore being the main risk factor for global markets in 2016 (Q4 GDP came in at 6.8% QoQ vs. 6.9% est.). One interesting chart to look at this year is the USDCNH – USDCNY spread analysis. Since the PBoC devaluation, we can see that spread off the offshore/onshore currencies has been very volatile, moving up to 1400 pips (i.e. USDCNH was trading at 1400 pips above USDCNY).


(Source: Bloomberg)

2. Commodities update: where is the low? 

As we gave a quick [bearish] review on China, we have to give an update on commodities, which are still trying to find a new low. As you can see it in the chart below, the Bloomberg Commodity Index (BCOM) broke below its March-99 low of 74.24 yesterday and is down almost 70% since its July 2008 high. We wouldn’t see this new low as a buying opportunity as long as we don’t visualize any upside coming from the EM economies.


(Source: Bloomberg)

The end of this commodity super-cycle is dramatically hurting many energy companies, and corporate default is clearly becoming the biggest financial threat for this year. For instance, Glencore 2021 and Noble 2018 bond price recently plummeted to new lows yesterday, trading at 64.4 and 56 cents on the par and increasing the probability of bankruptcy.

3. The death of the commodity currencies… 

This commodity meltdown has sent the Aussie (candles) to (almost) a seven-year low against the dollar, trading at 69 cents against the dollar, and the USDCAD (yellow line) has reached a 12.5-year low and is currently trading at 1.4530, down 25% in a single year. We will always remember Stanley Druckenmiller words from the Ira Sohn Conference in May 2013 when he talked about the Commodities Conundrum. He said he was betting that it was the end of the ‘supercycle’ for commodities (referring commodity currencies as ‘dead’) and he was already warning of a potential financial crisis in China. We have to admit thatwe would never have imagined such a drawdown; however, today we am still thinking there is potential downside risks.


(Source: Bloomberg)

Just to let you know, this article is just a quick-start of a series of more detailed analysis of economic areas (Japan, US and Euro), coming up in the next couple of weeks.

Global Macro: trade on China’s weak signs and Draghi’s Will to Power

This article deals with a few current hot topics:

  • The main one gives an update on weakening signs of giant China
  • The second one reviews the ECB Thursday’s meeting, presented with a couple of FX positioning
  • The last one is on the debt ceiling debate and risk-off sentiment

China desperately flowing…

As I am looking at the current news in the market, there has been a lot of interesting topics to study over the past couple of months. I will first start this article with an update on China and its weakening economy. Since the Chinese ‘devaluation’ on August 11th, I have been focusing much more in the EM and Asian Market as I strongly believe that the developed world is not yet ready for a China & Co. slowdown. I heard an interesting analysis lately, which was sort of describing the assets that had performed since the PBoC action more than two months ago. As you can see it on the chart below, Gold prices (XAU spot) accelerated from 1,100 to a high of 1,185 reached on October 14th, and Bitcoin recovered from its low of 200 reached in late August and now trades at $285 a piece.


(Source: Bloomberg)

One additional explanation that I have for Gold is that I believe that the 1,100 level could be an interesting floor for long-term investors interested in the currency of the last resort. The weak macro, loose monetary policy, low interest rates and more and more currency crisis in EM countries will tend to bring back gravity in Gold, especially if prices become interesting (below $1,100 per ounce) for long-term buyers.

Looking at the CSI 300 Index, we still stand quite far from the [lower] historical high of 5,380 reached in the beginning of June last year. Since then, as a response, we had a Chinese devaluation, the PBoC cutting the minimum home down payment for buyers in cities last month (September 30th) from 30% to 25% due to weak property investment, and then a few days ago the PBoC cutting the Reserve Requirement Ratio (RRR) for all banks by 50bps to 17.50% and its benchmark lending rate by 25bps to 4.35%. Looking at all these actions concerns me on the health of the Chinese economy; it looks very artificial and speculative. In a late article, Steve Keen, a professor in economics explained that the Chinese private-debt-to-GDP ratio surged from 100% during the Great financial crisis to over 180% in the beginning of 2015, amassing the largest buildup of bad debt in history. Its addiction to over expand rapidly have left more than one in five homes vacant in China’s urban areas according to the Survey and Research for China Household Finance. Banks are well too exposed to equities and the housing market, and it looks that they have now started a similar decline as the US before 2008 and Japan before 1991. To give you an idea, the real estate was estimated to be at 6% of US GDP at the peak in 2005, whereas it represents roughly 20% of China’s GDP today.


(Source: Forbes article, Why China Had to Crash)

I wrote an article back last September where I mentioned that the Chinese economy will tend to slow down more quickly than analyst expect, therefore impacting the overall economy. We saw that GDP slide to 6.9% QoQ in the third quarter, its slowest pace since 2009 and quite far from the 7.5%-8% projection in the beginning of this year.

Draghi’s Will To Power

One fascinating event this week was the ECB meeting on Thursday. Despite a status quo on its interest rate policy, leaving deposit rate at -0.2% and the MRO at 5bps, a few words from the ECB president drove immediately the market’s attention. He said exactly that ‘The degree of monetary policy accommodation will need to be re-examined at our December policy meeting’, therefore implying that the current 1.1 trillion-euro program will be increased. As you can see it on the chart, EURUSD reacted quite sharply, declining from 1.1330 to a low of 1.0990 on Friday’s trading session, and sending equities – Euro Stoxx 50 Index – to a two-month high above 3,400. Italy 2-year yield was negative that day (hard to believe that it was trading above 7.5% in the end of November 2011).


(Source: Bloomberg)

 I am always curious and excited to see how a particular currency will fluctuate in this kind of important events (central banking meeting usually). One thing that I learned so far is to never be exposed against a central bank’s desire; you have two options, either stay out of it or be part of the trend.  I think EURUSD could continue to push to lower levels in the coming days, with the market slowly ‘swallowing’ Draghi’s comment. I think that the 1.0880 level as a first target is an interesting level with an entry level slightly below 1.1100 (stop above 1.1160).

USDJPY broke out of its two-month 119 – 121 in the middle of October down to almost 118, where it was considered as a buy-on-dip opportunity. It then levitated by 3 figures to 121.50 in the past couple of weeks spurred by a loose PBoC and ECB. The upside looks quite capped in the medium term if we don’t hear any news coming from the BoJ. The upside move on USDJPY looks almost over, 121.75 – 122 could be the key resistance level there.


(Source: Bloomberg)

Potential volatility and risk-off sentiment coming from the debt ceiling debate

On overall, with US equities – SP500 index – quietly approaching its 2,100 key psychological resistance with a VIX slowly decreasing towards its 12.50 – 13 bargain level, I will keep an eye on the debt ceiling current debate in the US, which could trigger some risk-off sentiment in the next couple of weeks (i.e cap equities and USDJPY on the upside). Briefly, the Congress has to agree on raising the debt limit to a new high of 19.6tr USD proposed (from 18.1tr USD where it currently stands). The debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing obligations, and the current debt ceiling proposal’s deadline is November 3rd. No agreement would mean that the US government could default on its debt obligations, which could potentially increase the volatility in the market.

The chart below shows the increase of the debt ceiling since the early 1970s, after the Nixon Shock announcement which led to the end of Bretton Woods and the exponential expansion of credit.


(Source: The Burning Platform) 

Quick update on China ahead of the FOMC meeting…

Ahead of the FOMC meeting this week, I thought a quick update on China would be useful to review the major data on a global macro perspective.

Over the past few years, Chinese slowdown has massively impacted commodity prices, which are still ‘trying’ to find a bottom according to the late analysis I read. The chart below shows the historical moves of the Bloomberg Commodity Index (BCOM), a broadly diversified commodity price index (22 commodity futures in seven different sectors) that I like to watch quite a bit. As you can see it, the index has been trading below the 2009 lows since the beginning of the year and is now approaching the 2002 levels.


(Source: Financial Times)

If we look at Iron Ore monthly prices for instance (see chart below), we can see that the commodity has lost more than three times its value since its high in February 2011. It fell from 187.18 (US Dollars per Dry Metric Ton) at that time to 56.40 (for the September 2015 Futures contract). There has been a few topics on the table that could have describe this drop – US rising rates and Dollar strength, Grexit fear, Oversupply issues – however the decrease in Chinese growth and productivity are the most important factors to the commodity market in general.

Iron Ore

(Source: indexmundi website)

How fast is China slowing?

First of all, if we look at the country’s annual growth rate over the past five years, China GDP decreased from approximately 12% in early 2010 to 7% in the last Q2 update. And looking at the major’s institution forecasts (IMF, World Bank, see below), it is more than likely that we are going to see lower and lower figures in the next few years, and therefore constantly weigh on export-driven economies. Based on the forecasts below, we are looking at a 5.5%-6% annual growth rate in 3 to 5 years.


(Source: knoema website)

Salaries increase in China, a secular change?

For decades, China has mostly been competitive based on its cheap labour and low-cost raw materials, and has been profitable based on its export-driven economy combined with an ‘undervalued’ exchange rate. However, with wages and transportation costs on the rise, the country’s economic projection has changed and I don’t know if the rest of the World is yet prepared for it. According to some financial analyst experts, compare to the mid-2000 levels, China needs twice the amount of Capital or Debt to create a 1-percent growth today.

Based on the International Labour Organization’s 2014 Wage report for the Asia Pacific published at the end of the first quarter of this year, Asia annual growth in real wages has been outperforming the global average over the past decade (6.0% vs. 2.0% in 2013). And East Asia (driven by China) reported at 7.1% increase in 2013, therefore indicating a growing consumer spending power. And between 1998 and 2010, the average annual growth rate of real wages were approximately 13.8% (Carsten A Holtz, 2014). Since 2010, real wages have grown by 9%, outperforming productivity which has grown by 6-7%, therefore reflecting negative signs about the economy.

Availability of a large pool of labour combined with low production costs have been one of the major pros of China, however the constant increase in labour costs will narrow the difference in manufacturing costs between China and a developed economy (such as the US) to a degree that is almost negligible.

As a result, no hike in September…

My view goes for a neutral FOMC statement this week, but no hikes from the Fed based on the weak current market’s conditions. If we look at it, we have more and more EM countries facing a currency crisis (Brazil, Russia, Malaysia…), low oil prices affecting highly leveraged US Shale oil companies, US debt ceiling ‘threat’ at the end of the month, China selling its USD FX reserves, US equities showing a sign of fatigue… These are all negative elements that the US policymakers will take into account at the September meeting (16th / 17th of September). The upside for currencies such as the Euro, the Swiss or the Sterling pound will be quite limited until the release of the FOMC Statement, however we could see some Dollar weakness in case of a status quo.

Reviewing Market Carnage 2.0

Back in the middle of October last year, I wrote an article to summarize and explain the Market Carnage. It was never published on my blog, therefore I added it in the Appendix section. This morning, it seems that we experienced another ‘Black Monday’, triggered by some disappointing news coming from China. The PBoC surprised the market with no RRR cut (while a 50-100 bps cut was ‘expected’ by the participants), and then followed a market collapse with the Shanghai composite down as much as 9% at one point (the most since 1996). US Equities were down as well, trading below 1,900 as you can see it on the chart below, while USD/CHF (blue line) is down 5 figures in one week flirting with the 0.9300 level when I was writing the article.


(Source: FXCM)

I personally believe that you can learn a lot from a trading session like today, that tells you that the market can go anywhere. While the sell-side research was telling me that EURUSD has nowhere to go but down and that US 10Y rate will never go back below the 2% level and that it could be interesting to start buying oil at $40, last week’s session and today in particular prove you that you can have it all wrong. One thing that I am ‘happy’ to see is that the Swissie has really acted as a safe haven currency, something that I understood after the SNB removed the EURUSD floor on January 15th (and consider it as a historical event).

Volatility was considered so high that the NYSE invoked ruled 48 to avoid a panic selling at the US Opening. The rule, approved by the SEC on December 6 2007, says that market makers ‘will not have to disseminate price indications before the bell, making it easier and faster to open stocks’.

Insane moves were seen on the currency market, to begin with NZDJPY that totally collapsed from 81.50 to 72.50 earlier today (that’s a 11-percent move in a single day!). USDJPY registered a 6-figure move down to 116 (mid-January lows), and EURUSD went North breaking the 1.17 level and gaining 300 pips in hours with a huge lack of liquidity (See Chart 1).

Reaction is expected now from China in order to calm down investors, and hopefully bring the situation back to normal. I am sort of convinced that the situation will stabilize within the next couple of days, however those market flash crashes kinda worry me about the global macro situation in most of the countries. As I mentioned it in some of my previous articles, I am persuaded that the Fed is not comfortable with those types of trading sessions. Coming now to the September hike, it is much less obvious that US policymakers will start a tightening policy based on the market’s attitude on trading days like today.

The question now is: ‘What sort of tools has China got in its advantage to calm this ‘panic’ (and the BoJ and SNB) in the coming week?’ I am currently working on a article about China’s economic and financial situation and its relation to the commodity market that I will try to publish soon.

In my current FX positioning, I am long USDCHF at 0.93 and short EURUSD at 1.1665 as a believe we will see a calmer afternoon.

Chart 1 (EURUSD)


(Source: FXCM)


For the past few years that I have been trading, I believe Wednesday was by far the most volatile and swingy session of all. It first started very quietly in the UK morning session, and then it really went out of control before the US opened. I don’t even know where to begin…

Equities continue their correction: Eurostoxx 50 index is down more than 12% (French and German market are off 12.5% and 13.5% respectively), the Footsie and the S&P 500 both down by 9.5% since the highs reached on September 19th.

If we have a look at the chart below, we can see that the VIX, which measures the 30-day volatility implied by the ATM S&P500 options prices, surged and breached the 30 level and is now trading back to November 2011 levels, taking the equity (S&P) down with him. There is clearly more room for further correction, no buy-the-dip scenario this time unfortunately.

SPVIX(Source: Reuters)

One currency that continues to strengthen in reaction to the risk-off sentiment (a real one this time) is the Japanese Yen. After the nice August/September momentum, USDJPY, which reached its peak of 110.08 on October 1st, was sold to 105.21 in the early afternoon before recovering back to 106.00. Our favourite [carry trade] pair keeps tumbling and is now trading at a 7-month low slightly below the 93.00 level. As I usually say ‘it is all about the Yen’, you better watch carefully where the currency is going at the moment [more strength!] as it will give you an idea of the overall market.

Another big ‘surprise’ was of course the 10-year US yield (blue line) that tumbled below the 2% level down to 1.86% approximately (May 2013 levels), before ‘recovering’ to 2.1%. I always ask myself ‘where does the market like to see the 10-year yield?’ Obviously not too high, but below 2% clearly means that the market participants are not confident [at all]. On the other hand, Gold (yellow bars) continued its rally, up to 1,250 before edging lower to 1,240. The 10-minute-period chart below (USDJPY in red bars) shows you that asset classes moves clearly ‘together’ under a ‘stressed market’.

GOldYenYields(Source: Reuters)

End of POMO, what to expect from the next FOMC meeting (October 28th)?

While we are ‘kindly’ approaching the last days of QE with the Fed stepping out of the bonds market at the end of this month (October 28th, see chart in appendix), I think we may have a couple of dovish FOMC meetings concerning the central bank’s ST monetary policy. To me, it looks like the US policymakers have made a ‘mistake’ by expressing themselves on that point [rate hike] as they should have let the market swallow a period without QE. True, Fed officials are willing to start tightening. For instance, we heard San Fran Williams (one of the most dovish and apparently seen as a good ‘barometer of the views of Yellen’) saying that he would hope the Fed can tighten, mentioning 9 months to see the first hike. However, it looks to me that the higher rates world is just an illusion…

In order to avoid the ON/OFF calls that we have seen since the beginning of the year (RBNZ, BoE and now the Fed), there need to be a sort of global monetary policy coordination. Otherwise, we are going to see other sharp fluctuations and especially in the FX market (remember, nobody wants a high exchange rate, not even the US, aka the Fed).

On the top of that, oil is plunging; coincidence? WTI November 2014 futures contract is now down more than 20pts since June trading slightly above 80 (as Zero Hedge mentions: ‘if Oil plunge continues, now may be a time to panic for US shale companies’). As I believe that Oil prices and the equity market are the Fed’s two most important components, I don’t only see cheap oil prices only as a benefit (stimulus) for consumers, therefore adding pressure on Yellen’s [and Co.] team.

My view goes for a Dollar pause, and I will carefully wait for the October (28th) FOMC meeting to see how US policymakers are going to deal with the current situation. An important figure to watch will be the Inflation report next Wednesday. US CPI is expected to remain steady at 1.7% YoY in September, however I think we could see some disappointment…

Unknown(Source: NY Fed)

The ‘Obama’ Dollar Rises…

Over the past few weeks, I had several discussions with some friends of mine to try to understand and clarify the US Dollar ‘pause’ we have seen since the middle of March. A dovish stance from the Federal Reserve, which obviously led to a status quo at the June FOMC meeting, may have halted the Dollar bulls, but it seems to me that the market is getting more and more confident about this year’s lift-off.

Based on the forecasts made in June, the Fed Staff expect policymakers to raise the Fed funds rate to 35bps by the end of the fourth quarter of 2015, which implies a one quarter-point hike this year (chances of an initial move at the September meeting stand roughly at 60%).

Quick recap’ on the macro figures

Even though the unemployment rate hit a 7-year low at 5.3% in June (with a strong NFP at 223K) and Q2 GDP came in at 2.3% (above the 2% ‘target’, but still below Wall Street’s consensus estimate of 2.5%), the rest of the figures and the overall macro/geopolitical situation both don’t look quite good. US inflation has average 0% since the beginning of the year (0.1% YoY in June), consumer spending YoY declined for the third consecutive month and both business fixed investments and net exports stayed soft. On a broader scale, the commodity-meltdown continues as demand from China may slow even further on the back of a weak manufacturing activity (Chinese PMI fell to 47.8 in July, its two-year low). For instance, NYMEX WTI September futures are trading near levels not seen since March, with September contract at $46.30 per barrel.

In addition, even though the Economic and Financial Affairs Council (ECOFIN) approved a 7.1bn-euro bridge loan to Greece last month (July 17th) given through the EFSM so that the country could meet its short-term obligations including a 3.5bn-euro payment to the ECB on July 20, Athens has no money left. That is problematic as a second big 3.2bn-euro payment is coming on August 20 to the ECB and there are talks that they may miss it as the bailout timeline is ‘unrealistic’.

Chinese economic slowdown, low oil prices, deflation and Greek payments are all subjects that I try to follow closely as it is the topics I believe that US policymakers are watching as well. However, I think this time the Fed officials are quite ready for a lift-off in September, and now I have been questioning myself about the US Dollar rally.

The Dollar Rallies…

The chart below shows the three dollar rallies that occurred since the collapse of the Bretton Woods system. The first big one is the Reagan dollar rally in the early 80s, fueled by the tight monetary policy. As a result of the second oil shock in 1979, chairman Volker orchestrated a series of interest rate increases that took the federal funds target from 10 to nearly 20 percent. If the Euro had existed then, the single currency would have depreciated by roughly 60%. The rally was eventually halted in September 1985 by the Plaza Accord signed by five governments to depreciate the US Dollar in relation to the Japanese Yen and the Deutsche Mark.

The Clinton Dollar rally started in the mid 90s fueled by the US Tech bubble and capital inflows into the US equity market in addition to the US government running federal surpluses. This surge brought the Euro down to 0.8230 against the greenback and USDJPY was trading at a high of JPY135 at the end of the rally (late 2001).

The recent Obama rally has started in early July last year as a result of monetary policy diverge between the US and the rest of the World. The commodity meltdown will continue to weigh on commodity currencies and especially on the Dollar-Bloc (CAD, AUD and NZD), as Greece will continue to make the headlines until Bailout#3 is eventually agreed.

As you can see on the chart below, I added a downtrend line that was broken in the beginning of the year. The US Dollar index hit a high of 100.80 in mid-March before its March-May consolidation. It looks to me that the greenback is gradually recovering from its quick contraction.

DXY avec MA

Source: Reuters

Despite a low volatile market at the moment, I am convinced that the US Dollar will gain strength in the end of this second semester. I will try to add a currency-detailed article by the end of the week with my new levels on the main currency pairs.