Your “Unreal, Irrational, Herd Actions” Were Pissing China Off – But They “Fixed” It

Well, this was pretty easy to see coming.

When Moody’s downgraded China for the first time since 1989 earlier this week, it was readily apparent that Beijing wouldn’t just take it in stride and go on about their business.

See if you are a Chinese citizen and you go out and you do something that Beijing thinks could destabilize markets (or destabilize anything really), they will simply arrest you. Of course that’s not as easy if you’re not a Chinese citizen and it’s harder still if the offender is both not a Chinese citizen and not an individual person.

So the Politburo couldn’t arrest Moody’s (much to the Party’s chagrin) which means they had to do the next “best” thing: publicly shame the ratings agency by calling the downgrade absurd and then simply intervene in markets to control the fallout.

That latter point helps to explain why the SHCOMP is actually up on the week:

Well, this all unfolded just as the onshore yuan spot was deviating routinely (to the weak side) versus the fix and as the fix was routinely set higher than the strongest analyst forecast. Which means China needed that Moody’s downgrade about like they needed a fucking hole in the head.

To be sure, it was already clear what China was doing. Here’s what we said on Thursday:

The PBoC set the fixing at at 6.8695, which was stronger than estimates of 6.8795 from Nomura and 6.8750 from Scotiabank. This is a pattern.

Yes, “this is a pattern.” Or, put differently, this is the PBoC scrapping or at least temporarily sidelining the market’s role in determining how the onshore yuan trades. The last thing you want if you’re already destabilizing everything from the bond market to the stock market to commodities by squeezing your elephantine shadow banking complex, is for the currency to go into free fall again because then you’d have to add “accelerating capital flight” to the list of fires you’re trying to fight.

“Propping up the yuan has been a policy priority this year as Chinese authorities try to stem capital outflows and prevent financial shocks before an important leadership reshuffle in the ruling Communist Party at the end of 2017,” Bloomberg wrote this morning, adding that “the stakes have increased in recent weeks after the regulatory clampdown on leverage roiled domestic bond and equity markets.”

At the same time, a weaker currency could help to shore up the economy if the tightening effort ends up choking off growth.

Again, this is an impossible tightrope act – it’s a game of Whack-a-mole. Every problem you “solve” creates another problem and the only way to “solve” the new problem is often to un-solve the old ones.

Well anyway, thanks to Moody’s, the expedient thing to do for the PBoC was to move in and make the “fixed” fixings official, which is exactly what China did on Friday when Beijing added a hilariously euphemistic “counter-cyclical adjustment factor” to the calculation of the daily reference rate. Here are the details via Bloomberg:

China plans to change the way it calculates the yuan’s daily reference rate against the dollar, adding a “counter-cyclical adjustment factor” that may blunt the impact of big market swings, according to people familiar with the matter.
Under the new formula communicated to banks by the PBOC this week, institutions that provide quotes for the fixing will take into account the previous day’s official closing price at 4:30 p.m.local time, the changes in baskets of currencies, and the counter-cyclical adjustment factor
Banks are currently tweaking and testing their fixing models and will start to provide quotes using the new fixing formula soon, people say
Under current conditions, new formula would partly filter out the impact of excessive volatility in the spot market by reducing the closing price’s role in the next day’s fixing, people say
People asked not to be named as the matter is private

So that was earlier on in the overnight session. It would later be confirmed by China, who “explained” the move as follows:

China’s foreign-exchange market can be driven by irrational expectations, resulting in unreal supply and demand that increases the risk of overshooting. The counter-cyclical factor may ease herd actions and help guide investors to pay more attention to economic fundamentals.

Mmmm hmmm. I see.

You can translate that as follows:

If and when we think rolling back the whole market-based fixing thing is necessary to either i) advance whatever agenda we happen to be pushing at the time, or ii) mute the impact of something somebody else (like those fuckers at Moody’s) does, we will set the goddamn exchange rate. And that’s the end of this discussion.

Make no mistake, this is just the latest chapter in a completely ridiculous charade.

“The counter-cyclical adjustment factor sounds like an increased role for the fixing to be nudged away from where markets would set it,” Sean Callow, a senior currency strategist at Westpac in Sydney said on Friday.

That’s true, but then again, this whole thing was absurd from the start. Think about it for a minute. Back in August 2015, when the PBoC devalued, they supposedly transitioned to a more liberal, market-based system. But they really didn’t. Because they almost immediately moved in to liquidate FX reserves and intervene in the spot market. So basically, before August 2015 they manipulated the fix to control the spot, and then in the new “market-based” system, they simply manipulated the spot to control the fix.

On Friday, all they did was drift back towards manipulating the fix to control the spot and on top of that, multiple traders have reported policy banks selling dollars in the onshore market this week, which means Beijing is now manipulating all of it. The spot and the fix.

The end result is the onshore and offshore yuan rising to three-month highs.

The implication here is that if they start drifting back to leaning on the fix to stabilize the FX market, they won’t have to keep liquidating reserves to intervene in the spot market. As Bloomberg notes, “authorities may see the new fixing formula as a cheaper way to stabilize the yuan.” Or, as noted above, they could simply do both: set the fixes stronger and intervene in the spot market which is exactly what they did this week, explaining this:

Tim Condon, head of Asia research at ING Groep NV in Singapore is worried about what this might mean for Beijing’s effort to internationalize the yuan and eventually move to a free float:

If the yuan endgame is a free float like the other major currencies, refining the PBOC fixing mechanism is a retrograde step.

Trust me Tim, the number of fucks China gives about that “endgame” right now is: zero.

So that’s that story.

Meanwhile, the pound was under pressure overnight, falling against all of its 16 major peers after a poll showed the Conservative Party’s lead over Labour closing to just five percentage points with two weeks to go until the June 8 election.

“Sterling correlates well with anything that shows a Tory majority and vice versa, so if you’ve got this situation where the majority closes right down, it may come to a critical level where it may not have a sufficient number of seats in the house,” Neil Jones, head of hedge-fund sales at Mizuho Bank said, adding that “the market doesn’t like that.”

Nomura’s Jordan Rochester chimed in with this: “GBP is likely to continue to be under pressure now until the election is out of the way if polling continues to indicate it’s a tighter race [and] the worst outcome is if we have further uncertainty with the chances of a hung parliament.”

As for the greenback, the dollar dropped against most of its G-10 peers, with the yen leading gains. “Traders,” Bloomberg notes, are likely “squaring spot positions before a holiday weekend in the U.K. and U.S.”

Slumping crude in the aftermath of oil’s “sell the OPEC news” moment seemed to weigh on risk sentiment. Here’s a snapshot of global equities: