China warns hot money – Japan reverses energy policy – A monkey wrench for the yen one-way bet?

Chinese leaders’ know well the danger of a hard landing via the transmission of cascading defaults on rising debt across companies in key industries. And they also understand the solution to this problem requires a delicate balancing act—they must deal with hot money and the Fed taper all the while their economy’s growth is decelerating in the face of reform.

China recently adjusted the unknown basket against to which their currency “floats” in order to show hot money players that one-way bets can be risky:

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In addition to the hot money problem, a weakening of the yuan also helps another problem nagging China—the massive depreciation of the Japanese yen adding unwanted competitive pressure on Chinese exporters:

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But the other side of this balancing act is that “taper thing.”  It is still unknown just how much liquidity might drain from China on Fed tapering and corresponding slowdown in growth.  Officially, China seems confident, but guarded, inward investment flows will remain strong in 2014:

BEIJING, Feb 25 (Reuters) - China is likely to see relatively big net capital inflows this year, though the U.S. Federal Reserve's tapering of its stimulus programme could help ease some pressures, the country's foreign exchange regulator said on Tuesday.

“…Especially when the QE tapering gradually takes effect, the pace of increases in the funds outstanding for foreign exchange may ease or even drop," SAFE said on its annual capital flow oversight report, referring to the Fed's quantitative easing programme involving massive bond purchases.”

The second paragraph above seems to hint the yuan may be on a weakening path and the recent weakening is more than a one-off to scare away some hot money.

What might be some trade ideas to glean from this information, adding one more tid bit--the Japanese government has reversed themselves on the nuclear policy.

  1. Long USD/CNY [weakening yuan]
  2. Commodities basket continues under pressure
  3. Oil seems especially exposed given the fact, i.e. future expected oil demand from Japan will require a re-write now on their move back to nuclear. 
  4. A shift back to nuclear will likely help the current account deficit in Japan, which means fewer yen sent out into the world.  This may throw a monkey wrench into the yen weakens “forever” theory. 
022714 usdjpy.png

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The IMF: Setting the bar low ...

We heard from the International Monetary Fund (IMF) this week.

What we heard was not good. But it was not surprising either. And that's the point, I think.

Conveniently, there's plenty to distract the market from the downward revisions the IMF made to global 2013 and 2014 growth forecasts plus the fact that the IMF believes:

  • Long-term global economic growth will run at subdued levels;  "A likely scenario for the global economy is one of continued, plausible disappointments everywhere."
  • Short-term US fiscal matters could shake-up the rest of the world
  • The European Central Bank must continue on with accommodative policy; "The ECB should consider additional monetary support, through lower policy rates, forward guidance on future rates, negative deposit rates, or other unconventional policy measures. Since these factors reinforce each other, a vigorous response on all fronts offers the best way forward. In the absence of a comprehensive policy response, matters could easily worsen."
  • Countries must use their exchanges rates to alleviate growth pressures, rather than unwind fx reserves to try and stem capital outflows
  • Some emerging markets are suffering what could be called stagflation
  • China's growth model -- dependence on exports, credit and investment -- has become exhausted and must change

Gee. How depressing.

But guess what -- the market doesn't care today. And it likely won't care too much about these comments down the road either.


Because the IMF has aired the dirty laundry. They have made know the growth head-winds and the financial risks. These things can not come as a surprise to anyone now. Ultimately, the only things that will impact the market are individual data points or trends that suggest policymakers and leaders cannot contain the risks to growth and financial markets.

Until then, investors are more than likely happy to give economic growth the benefit of the doubt.

Besides, we'd much rather focus on the charades in Washington D.C. 

Today it appears politicians are closer to a compromise than they were yesterday. Yesterday I believed ideological differences would push us past the debt ceiling deadline, force a market downturn and then generate a compromise and continuing resolution.

I tend to think we'll see the broad market, particularly US and global stock markets, slide before the month is over. I believe it will be sharp. But I also believe it will be relatively short-lived, barring a real surprise from the US debt standoff. 

The market is higher today. I'll be looking to sell into any follow-through strength early next week.

-JR Crooks



The market "reprieve" goes "full risk-on"

Last Thursday I wrote the following in Currency Currents:

"September is well known for being the worst month for US equity market performance. That may be reason enough to expect the opposite in the early going. After all, the catalysts for market weakness -- mainly concern for emerging markets and rising interest rates -- are probably overdone in the near-term.

"I expect a reprieve from general selling pressure in global equity markets and other risk assets over the next few weeks. In that environment, the US dollar probably will be pressured lower. Once the US dollar is again looked at as a dog, it should be about time for it to head higher as many have been quick to forecast in recent months."

I was reading a Bloomberg article this morning and read an analyst's reaction to recent economic data and market action. Effectively he said:

"Markets are full risk-on mode."

I suppose we are. Three things to consider:

1) The view in China is a major impetus -- better-than-expected export and industrial production numbers yesterday and today, respectively, are helping to drive the rally in Chinese and emerging market equities. 

2) Russia apparently has a respectable proposal on the table that would see Syria give up its chemical weapons and bring an end to the face-off that's unnerving market players. I can't yet say with any confidence that Russia engineered this Syria fiasco, but I can say they seem to be coming away with increased global influence. Russia has been mocking the US by pointing out the insanity and inanity of America's social policy disputes. And now Russia is seen to be driving the dimplomatic efforts in the Middle East.

3) The Fed will always be in the picture. And it seems Friday's Nonfarm Payrolls report is being used as a rationale for why risk is on this week. It's not surprising.

The question, of course, is this: how long will risk appetite remain the impetus du jour?

As I said, I thought this reprieve rally might last a few weeks. But a look at several recently beaten down assets shows that the market has bounced back sharply and quickly. It will take persistent optimism to generate additional significant gains going forward.

Perhaps the September bears will emerge next week around triple-witching. But they have to get through the September 17th -18th FOMC meeting first.

S&P 500 chart setup -- finishing a B-wave corrective bounce?

The S&P 500 is testing a key Fibonacci retracement number that could mean the end of this corrective bounce is near.

-JR Crooks 




Setting up for a US growth disappointment

It seems the US trade deficit data released yesterday went largely unnoticed. And that's usually how it goes each month, probably because there tends not to be much, if any, knee-jerk market reaction to that report.

But considering how most markets have been moving this week (up), it got me thinking about how the trade numbers might influence markets over the next few weeks ...

To recap: the US trade deficit widened sharply in August. That followed the previous month's narrowing to a level not seen since October 2009.

I was particularly wondering how this might impact the US dollar. There is not a tight correlation between the US trade balance and the US dollar, especially over the shorter-term. But the widening trade deficit is a nod to the typical dynamic -- trade imbalances -- that's characterized global growth over the last decade.

Manufacturing PMIs in US, Europe and China are all higher in the most recent month, poking above the 50-level that delineates expansion and contraction.

Despite the recent scare over emerging markets, many are quick to notice a general stabilization in global growth expectations.The US economy has been the least of the concern for investors. But if the world is seen to be stepping back into what's been a typical growth pattern, then maybe Asia (namely China) gets cut some slack. 

In an environment where things seem to be "back to normal," then maybe we see capital exit the US in search of return. Maybe the US dollar loses any safe-haven appeal and is potentially looked at as a funding currency. And maybe most markets around the world feel a reprieve from recent selling pressure.

Obviously this is all speculation on my part. And it's all speculation that I imagine would run its course in a relatively short period of time, say three to six weeks.

So I may be stretching it to think the trade deficit could have such an influence on markets in that amount of time.

But one reason (among many) I tend to think such a "back to normal" growth mentality won't last too long: the recent US GDP beat was driven largely by a surge in exports.

As mentioned, the latest trade deficit number showed the surge in US exports reversed last month. In other words: come the end of September or early October, everyone may be rethinking their expectations for the US economy. And if they start rethinking the US, chances are they'll start rethinking global growth as well.

This chart is from Part 5 of a five-part series The Wall Street Journal put together on "China's Rising Risks." Click the image to access the article.

September is well known for being the worst month for US equity market performance. That may be reason enough to expect the opposite in the early going. After all, the catalysts for market weakness -- mainly concern for emerging markets and rising interest rates -- are probably overdone in the near-term.

I expect a reprieve from general selling pressure in global equity markets and other risk assets over the next few weeks. In that environment, the US dollar probably will be pressured lower. Once the US dollar is again looked at as a dog, it should be about time for it to head higher as many have been quick to forecast in recent months.

-JR Crooks



Currency Warriors WRONG; Now Emerging Markets are on the verge of crisis

Click here to read in PDF format ...

The emerging (developing) market [EM] currencies are getting clobbered.  It seems the idea of EM growth as far as the eye can see, as once heralded by the BRIC lovers, is fading fast.

Source: Financial Times 

The realization that EMs lack enough internal demand and depth of capital markets is coming home to roost.  They have not been able to sever their dependence (remember how we have been sold on the bill of goods called “decoupling” by many EM sponsors) on those dead old industrialized economy consumers.  And the demand from their new leader -- China, where much of its growth depends on those dead old industrialized economies -- is adding to EM woes ...

Interesting that not long ago all of those armchair currency warrior analysts were so worried about all that money pushing those EM currencies to the moon.  Now, EMs are doing all they can to prop up the value of their currencies.  Shouldn’t that be considered war against the United States dollar and other industrialized world currencies now?  Oh where have you gone currency warriors (sung to the tune of “Mrs. Robinson”) ...

I wonder if Jim Rickards’ book, Currency Wars, has hit the give-away bin at Barnes and Noble yet.  Jim seemed to tell us a lot about his resume in that book, and not much about currencies, in my humble opinion. 

Here is what I wrote about the fake currency wars back on February 8th, 2013…

Of course adding to the “Currency War” scare pieces of late you have probably seen the invocation of…wait for it….wait…be ready to be scared...“The 1930’s all over again!” Sorry Yogi.

Oh really. “The 1930’s again?” I like what Niall Ferguson wrote about the phony “Currency Wars” a couple of weeks ago in the Financial Times:

“Back in the 1930’s it was obvious who was waging a currency war. Before the Depression, most countries had been on the gold standard, which had fixed exchange rates in terms of the yellow metal. When Britain abandoned gold in September 1931, it unleashed a wave of competitive devaluations. As economist Barry Eichengreen argues, going off gold was the essential first step towards recovery in the Depression. Floating the pound not only cheapened British exports; more importantly, it allowed the Bank of England to pursue a monetary policy focused on domestic needs. Lower interest rates helped generate recovery via the housing market.

 “Today, however, we live in a world of fiat money and mostly floating rates. The last vestige of the gold standard was swept away in August 1971, when Richard Nixon suspended the convertibility of the dollar into gold. For one country to accuse another of waging a currency war in 2013 is therefore absurd. The war has been going on for more than 40 years and it is a war against all of us.”

Central banks (CBs) are delusional in their belief that they can wonder off into a fantasy land of monetary madness and it not lead to some type of blowback.  

The crush out of EM currencies on the back of a relatively small increase in market yields shows just how hooked on credit these countries must be and how desperate for more they must be in a world of tepid aggregate demand.  This has boom-bust written all over it.  We have seen it many times before.  Here is how George Soros defined it in Alchemy of Finance, circa 1987:

The connection between lending and economic activity is far from straightforward (that is, in fact, the best justification for the monetarists’ preoccupation with money supply, to the neglect of credit).  The major difficulty is that credit need not be involved in the physical production or consumption of goods and services; it may be used for purely financial purposes.  In this case, its influence on economic activity becomes problematic. For purposes of this discussion it may be helpful to distinguish between a ‘real’ economy and a ‘financial’ economy.  Economic activity takes place in the real economy, while the extension and repayment of credit occur in the financial economy.  The reflexive interaction between the act of lending and the value of the collateral may then connect the ‘real’ and the ‘financial’ economy or it may be confined to the ‘financial’ economy.  Here we shall focus on the first case.

A strong economy tends to enhance the asset values and income streams that serve to determine creditworthiness.  In the early stages of a reflexive process of credit expansion the amount of credit involved is relatively small so that its impact on collateral values is negligible.  That is why the expansionary phase is slow to start with and credit remains soundly based at first.  But as the amount of debt accumulates, total lending increases in importance and begins to have an appreciable effect on collateral values.  The process continues until a point is reached where total credit cannot increase fast enough to continue stimulating the economy [this may be precisely where the EM markets are now in this process as evidenced by the chart above showing the number of units of credit to produce a unit of gdp growth].  By the that time, collateral values have become greatly dependent on the stimulative effect of new lending and, as new lending fails to accelerate, collateral values begin to decline. The erosion of collateral values has a depressing effect on economic activity, which in turn reinforces the erosion of collateral values.  Since the collateral has been pretty fully utilized at that point, a decline may precipitate the liquidation of loans, which in turn may make the decline more precipitous.  That is the anatomy of typical boom and bust.

To taper or not to taper, that is the question. [My apologies to Bill…]


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Thank you.


-Jack Crooks


As usual, we're ahead of the curve: The China-Japan Parallel

[Click here to read the PDF]

John Ross (aka JR) sent me a piece of research this morning from Trading China, titled, "China risks following Japan into economic coma."  The first paragraph of the piece read:

After decades of emulating Japan's export-driven economic miracle, China appears in danger of following it into the same kind of economic coma that Japan is trying to wake up from 20 years later. 

Well, I couldn't agree more.  And in fact I would like to share with you more detail on the possibility China follows down the path of Japan by re-printing an article I wrote three years ago, titled, "The Japanese-China Parallel: Eerie and Scary Combined."  This piece was published in the Forex Journal in the August 2010 edition.  

Read on ...

Currency Currents 30 July 2013


Collision course: China and Japan...Starring the Eurozone, with US in a cameo

Countries have interests.  Most have allies.  All have enemies (real, perceived, and of the manufactured variety).  In times of economic turmoil enemies appear more menacing.  The normal jockeying for position by a country during the good times, may often be perceived as a threat (or opportunity to manufacture a threat) by another during the bad times.  It seems China and Japan, because of the inordinate impact of global rebalancing on current account surplus countries, may be locked into this game of "perceived or real" threat for some time.  Interestingly, the key global economic policy choice being made inside the Eurozone could grease the slides along a collision course for China and Japan.  The impact of such a collision would likely lead to an end of the euro currency regime as we know it, but the potential impact on the global economy would be even worse.  

Read on ...

Currency Currents 24 July 2013


Really? Should today's China news be reassuring?

It's the nature of financial news media -- they have to look for explanations; they have to find reasons; and they have to be first to break the news.

And that's some of why most of the news that moves markets does so in a short-term feedback loop sort of way. Take this top-of-the-page headline from Reuters this morning:

China moves send world shares higher, dollar softens

So what were China's moves that so convincingly impacted markets?

According to the article, "Local media in China reported the government was looking to increase investment in railway projects to reduce gluts in steel, cement and other materials as it aims to ensure annual economic growth does not sink below 7 percent."

Now actually take a moment to think about it, which Reuters obviously didn't do (or if they did they didn't care that their conclusion doesn't make a whole lot of sense.) But I suppose what matters is what traders and investors think about the news.

Here's what I think:

China is facing a very real credit market dilemma. And they openly recognize the growing risks of perpetuating their investment-led growth model of recent years. Yet they come out now and claim investment can further prop up economic growth and help China avoid a hard-landing.

Maybe in the short-term. Maybe if they create artificial demand for certain commodities and materials by promising railroad projects. Maybe if prices of these commodities and materials don't fall further, maybe China can convey a sense of economic recovery.

It's the same modus operandi. And maybe that way of operating still has some life left.

I tend to think it doesn't. The game is old hat now. And the global environment is clearly not in a position that will allow it to drive new, meaningful Chinese growth.

Finally, the comments in the Reuters article also imply that GDP could reasonably be expected to fall below 7% if China doesn't take some kind of action ... even if it is the kind of action they've become reluctant to take because the risks of investment bubbles and credit troubles is growing rapidly, right? 

Please excuse me if I'm completely missing something here. But as someone who follows the markets every day, I find nothing reassuring about China's talked-about "moves."

But then again, what I find only matters if most of everyone else in the market finds it too.

Perhaps if Reuters instead put this article at the top of their homepage (I found it in small print at the bottom!) the market would find little reason to cheer today. Here is an excerpt:

The bank measures come as China's cabinet said this month it would cut off credit to force consolidation in industries plagued with overcapacity. This was shortly after China Rongsheng Heavy Industries Group, the country's largest private shipbuilder, fell into financial turmoil.

Beijing did not specify then the industries it had in mind, though in 2009 it named nine, including shipbuilding. Industry sources said neither the banking regulator nor any central government agency had issued new rules on tightening lending to shipyards or other industries.

That's just one example of the changing credit and lending environment across China. Creating artificle demand in some industries (e.g. housing, railroads) can only compensate for lost growth in other areas for so long. 

Will the 7% threshhold be tested this year? Or will China be able to evade major risks even longer? 

The mood has generally improved recently. But that, of course, lays the groundwork for disappointment.

Stay tuned.


-JR Crooks