As noted earlier, at least former FX trader thinks the narrative about China’s tightening efforts and ongoing struggle to rein in leverage and risk-taking is “all nonsense.”
At least where that’s being viewed as some kind of policy mistake or deliberate attempt to tank the economy and disrupt the commodities complex. Here’s the quote:
Markets have been in an absolute tizzy over the China/commodity nexus. China is tightening. How can they justify this when the Shanghai composite is falling? They’ll crater everything, the global commodity complex will collapse bringing down producer economies around the world and inflation targets will become impossible dreams. It’s made for a great story. It’s also nonsense.
Well, we’d generally agree that is has indeed “made for a great story,” but we’re not entirely sure “it’s all nonsense.”
Moving to hike OMO rates and crack down on shadow banking almost certainly acts as a giant margin call for all types of financing channels that are used to speculate in different assets. When you start squeezing those channels, you get chaos. Just look at what happened in summer 2015 when leverage was squeezed out of the Chinese equity market.
But more generally, China is the sole source of the global credit impulse, so you know, when that rolls over, it’s bound to cause problems. Especially for EM. This is something we’ve been keen on emphasizing for weeks.
On Friday, Citi is out with an interesting take on all of this. Read below as the bank explains that “China’s ‘monetary put’ is now in reverse.”
Rising real rates hurting EMFX. EMFX underperformed unexpectedly in the aftermath of the first round of the French election. The blame goes largely to the commodity sell-off, which tends to be even more disruptive for EMFX when global rates are rising at the same time. Another way to say the same thing is that rising real yields have been negative for EMFX. After all, significantly rising real yields are usually the result of rising nominal yields and falling inflation break-evens. And break-evens typically drop when oil prices are falling. This explains the relatively strong correlation seen in Figure 4.
China macro should remain a negative for commodities… Figure 5 shows the China monetary condition index and how it relates to the CRB commodity index (as a deviation from the 200dma). Clearly, we have seen peak stimulus out of China for this cycle. Moreover, we can probably extrapolate from the recent comments from senior policymakers that the direction of the MCI remains downward sloping, especially following President Xi’s unexpected speech on financial stability during a Politburo study meeting last month, which provided political sanction to regulators to stamp out excess leverage throughout the economy. This does not bode well for commodities, and is particularly true for the China-sensitive commodities of copper and iron ore.
…even as inventory adjustment already on the way. Rising money market rates in China have (a) triggered the initial unwind of reflation trades in the China’s commodity futures markets, (b) added pressure on leveraged physical traders to liquidate inventories, and (c) accelerated the shift of the downstream inventory cycle from restocking to destocking. These trends are already somewhat advanced – especially in the case of copper, where inventories were much above average early this year, but are at this stage back to their seasonal average level (see Figure 6). We would have a bias to believe that there is more to come, and Citi Strategy is especially bearish on iron ore.
Look to China’s interbank markets & data for guidance. Sentiment in the commodity markets is unlikely to recover until it becomes clear that the pace of China’s ‘regulatory tightening’ will be modulated in response to economic indicators. The first signal of this will likely come from the liquidity markets: the repo-IRS curve tells us that domestic investors do not as yet see an end to the tightening (see Figure 7). It is thus likely that healthy activity data for April will reinforce expectations of escalating tightening pressure in China. The ‘Chinese put’ may now work in reverse: good news about the Chinese economy may be perceived as bad news for the market outlook.