China drops bank reserve rate. USD swap rates buckled down on by all six major central banks. Liquidity restored, all is well, sing along. Risk on, squeeze those shorts, and we can go party on the weekend (if we’re not registered for CFA I’s, at least), right? Not so much.
I guess it really is really bad. Again, follow Form 1A in crisis fighting and dump liquidity in the markets to get people out that were previously long and couldn’t exit in those conditions, wait a few weeks and voila! some real, actual problems (instead of the backyard, backdoor-settled variety that existed at least in the US and Asia). Now, following this alone, it will have a few rather strange short-term effects. In order of punditry coverage:
China’s PBOC drops reserve rate by 50 bps.
If any of the other central banks had done this, it would be a pretty rad thing to do, you know, like actually flushing some liquidity into the system. Running through the numbers of approximate numbers on the quick-and-dirty 1/RRR multiplier, China dropped, in percentage points, 0.5 / 21 = 0.0238, or 2.38% relative change. I use 21 flat over 21.5 for the larger banks as the PBOC is slightly less stringent to other banks While on the matter for adjustments, the next calculation is done in the q-a-d way because I don’t have access to reliable M1 and M2 separate multipliers in China. Money supply growth comes in at a whopping 2.44% increase. Look at PMI numbers, housing cooling off, and you still expect this to have any significant impact on lending to households?
For the punditry worried about Chinese inflation, there is one more challenge I’d love to post. Answer, in turn, the following questions. Who really runs China: engineers or lawyers? What does the below equation describe and why is this important to China?
And that’s it. Combine with the above discussion on lending rate effects, and we’re there. You can deduce the rest yourself. To those of you not well versed in mathematics, or that have forgotten about the equation, it is a differential equation, and solving of these things is pretty much exactly what underlies policy in China. (I won’t spoil what this describes though, look it up yourself, you’ll be pleasantly surprised.) The solutions to these things are not fixed levels in most cases, as differentials most often describe rate of change. Thus China pretty much plots out policy paths for important factors, look when they get close and ahead of time attempt to dampen the effects to land near, and then applies a policy mix of stabilizing features. They were aggressive to curb lending before – 21% RRR, compare that to anywhere else! – stopped it and now they observe the eurozone debacle pretty much coming down on them like a ton of bricks, so they adjust preemptively.
Consider, in this context, a 2.44% money supply growth rate change. It’s a little bit like when Huijin went in and bought token amounts of the domestic banks. “We’re here, don’t worry, here’s a sugar cube and a penny for the candy shop. Don’t fall over going there though, we really don’t want you to get hurt.” For those saying inflation/hard landing/housing bubble/tin foil hat scheme 1 or 11 will take China down? Not yet.
Still, Cheng Yu-Tung, owner of Chow Tai Fook which is heading for IPO, must be kicking his own teeth in at the moment. Equities higher, gold higher, and it’s all out on a written tender right now? Anyone guessing that the issue is underwritten and will fail to sell out on IPO day?
6 central banks run out to save world liquidity:
Oh my god. Nothing is solved. We’re at zero bounds in pretty much every market for lending known in the industrial world, and this happens? The solvency problems, where occurring, are none the closer to being solved, and the eurozone still has fundamental problems which are unrelated to liquidity. Lets break this down into a few subsectors.
Squeeze some shorts out, and get some dry powder in rotation. Nothing spectacularly different from 2008, unless you actually start seeing the short interest data, add two and two together, and realize that short interest really isn’t all that high. People are just out of the market, but you just made it much more safe to trade. Up? Down? Don’t flip that coin to call it.
Lets see how this works. You’re stuck with a horrible position in peripheral euro issues, or you did actually take that one bet long Bunds at around 1.7% yield sometime this summer, and you’re just waiting for the realization of everyone that Germany would still be the main exporting economy of the world on a per capita basis if they had a strong, truly competitive currency. Keep dreaming. Super currency speculation? Breakup worries? First they effectively devalued their currency versus the periphery to fill it with German engineering, and then sold them the proceeds back at interest. Then because the union wasn’t as strong as the rest of the world, they could pretty much sell at effective discount to the emerging world, or anyone outside of the printing-happy US, because of the effective currency devaluation in numbers. Lets see what happens when they are alone.
So, back to our unhappy investor. BTPs? OATs? Bunds? Ouch. And worse yet, no one wanted to buy yesterday. (Maybe the ECB, but they couldn’t.) Now, we have liquidity, so we can actually be incentivized to sell, because at least the spreads are tight and for a while our counterparties are more liquid. The quicker we are, the less losses we take as long as we enjoy this one-time offer before the equity markets and retail investors figured out what happened, so lets dump while there is still time. Result: the institutionals that got unfairly stuck with a position get another week or so to offload it to some other sucker at firesale prices. Person number 2 who is currently kicking his teeth: Jon Corzine.
Risk on! EURSEK is touching the 9.1 bound again (meaning liquidity is restored in the slightly less dysfunctional links to euroland). EURUSD at 1.35, guess pretty much anyone that can at the moment is enjoying the extra liquidity of their counterparties to sell non-performing assets and trade it back home, 1.35 is still pretty good for anyonein europe, so why not go at it while printing isn’t further ahead? Aussie up! Guessing some people just buying the inflation story there, and the China influence isn’t small either. And my little darling, the USDJPY ran higher. Wait, in a risk-on world where bonds are falling, a quick interlude to the threat of everyone else becoming like Japan? Apparently… Guessing the talkdown the last few days with the downgrade chatter, manufacturing, unemployment, trade surplus, and the discussions of volatility from Jun Azumi – I have never heard of something more ridiculous – just wasn’t enough to prevent yen going higher on safe haven (read: speculation of no total collapse or imminent printing) demand. Pushing 75 by year end? Or unilateral BOJ intervention off the liquidity-induced mayhem to get another opportunity to go long?
Well, risk on, print baby print, and more liquidity from central banks that realize the need to facilitate sponsored SPE’s (read: “independent banks”) moving out of the junk they speculated in into something safe. Commodities it is! That, and options. Looks like some of those banks just might have gotten shaken out pretty badly at the moment in the commodity space, with gold shooting higher like everything else, but what is miraculous is the tighter range after mid-October (to regain composure after the margin hikes) and indications of strong interests holding it back. 1750 in sight, which is ‘just’ a 1.75% up-print on new monetary debasing, but do take what you get. Target 1800, but things on a momentum view are looking pretty grim from there on out, and therefore silver or platinum look better on a short term view (and definitely if you are on physicals markets).
Oil looks a little too dear, copper could likely see a jump off the economic shot in the arm, especially if the yen is held down somewhat, but my main bet at the moment would be to reinstate the equity link to gold and invest heavily/leveraged in gold-sensitive equities, emerging markets if possible.
And with that, it’s pretty much all of my estimates at the moment, it will be interesting to see how this plays out. One thing I do expect is for volatility to skyrocket, especially after we turn the leaf to 2012, and if I could I’d be running Monte Carlo on rather insane scenarios and play volatility on options. Model upshot to risk-compensating return and look at where that DCF will take equity valuations, wait until a steep fall and get some good puts out? Calculate some good places to sell short (dated) calls? Anyway, buying short term straddles never looked more attractive!