Daily Market Reports | Jun 25 2013
By Greg Peel
Yesterday the People’s Bank of China issued a statement suggesting “that overall banking conditions are at a reasonable level,” and that “banks should prudently manage liquidity risks that have resulted from rapid credit expansion”. On that note, the Shanghai stock index fell 5.3% to mark its worst one-day fall since 2009.
The ramifications were felt across the globe, with the Australian stock market falling 1.5%, Japan 1.3%, Germany 1.3%, London 2.1%, and the S&P 500 falling 2.0% by midday in New York (Dow down 248). The question was being asked around the world: is China having a Lehman?
The question relates to the sudden credit squeeze in China, which last week sent the Shibor interbank lending rate spiking catastrophically before the PBoC stepped in with a 50bn RMB injection. Despite that rescue, yesterday’s comments from the central bank seemed to suggest that no more injections will be forthcoming. Just as the Fed abandoned Lehman, Beijing is standing aside while the Chinese banking system collapses.
The less panicked view is, however, that China is not having a Lehman at all. First of all we need to appreciate that despite the label, Shibor is not as influential a rate as the Libor, the London equivalent from whence the name is derived. Most of the developed world’s banking system can trace rate-setting back to Libor, but as Forbes’ Nathan Vardi points out:
“Shibor is not as important as it might seem. It doesn’t impact as many short-term and long-term transactions as Libor. The China Development Bank, one of China’s big policy banks, may have cancelled a planned $3 billion bond sale this week, but Shibor is not used to price that issuance. It is used by smaller banks that do appear to have been excessively engaged in abusive behaviour and are now caught in a cash crunch.”
What’s more, Lehman’s collapse was caused by a general run on liquidity which caught the Fed by surprise. The Chinese credit squeeze, by contrast, is being orchestrated by the PBoC. There are some differing views on why such a tactic is being risked at a time when China’s economy is slowing.
It is well known that Beijing is trying to deflate China’s speculative property bubble. Part of the strategy is to restrict the flow of monetary stimulus to those who lend to property developers, but China’s smaller banks have been borrowing from the central bank at low rates and on-lending to non-bank financiers at higher rates, thus creating a bridge to the developers and making a tidy profit in between. It is this “shadow banking” system Beijing is trying to crush, just as the new regime has clamped down on pollution, corruption and currency speculation. These reforms are crimping China’s economic growth, but are seen as necessary evils if China is to become a legitimate global financial centre.
Another theory is that the squeeze is being orchestrated by the PBoC and China’s four big banks, which as noted above do not have much to do with Shibor, to illustrate to the government just what will happen if Beijing continues to free up China’s capital markets. It is a warning shot across the bow of the new regime not to move too fast, or in the case of the big banks who stand to lose from a free market, not to move at all.
Either way, it is believed by those outside China that the PBoC is fully in control. Such reforms are painful, but must be orchestrated. The credit squeeze actually began before the Dragon Boat holiday a few weeks ago, but has only caught the rest of the world’s attention over the past week. It is thus an unfortunate case of timing that credit tightening is now occurring simultaneously in the world’s two largest economies. There’s a squeeze on the short end in China, and US long bond rates are rising rapidly since the Fed declared its tapering timetable.
The US ten-year yield spiked again last night, hitting 2.66% before retreating to 2.55% by the close, up 3bps from Friday. The stock market now has a firm eye on the bond market, hence the peak in yields was matched by the trough in stocks. It was at that point the “Fedheads” came out to do their stuff once more – communicate their thoughts on QE.
New York Fed president William Dudley said the Fed has fallen short of its inflation and employment objectives and that current policy is not sufficiently accommodative. Notch one up for the doves. But it was longstanding ardent hawk Richard Fischer, the Dallas Fed president, who most surprised. He suggested the Fed fully expected the market to respond the way it has to the taper timetable, acting like “feral hogs” as he put it, but suggested that stimulus should not be withdrawn too quickly.
The result was a sharp turnaround on Wall Street, and a rally in Dow terms from down 248 to down 25 before the selling won out again in the end. We have to remember that this week represents the end of the June quarter, and fund managers do not like to get caught the wrong way. The last two quarters have seen last minute buying. This quarter is looking a bit different.
It doesn’t help in Australia that it’s also the end of the financial year.
Australia is certainly not being helped by what’s going on in China. Goldman Sachs yesterday downgraded its Chinese GDP growth forecast to 7.4% from 7.8% for 2013 and 7.7% from 8.4% for 2014. While not helpful sentiment-wise, the GS downgrades are no real shock given recent Chinese data such as the contracting manufacturing PMI. As we moved into 2013, the world was expecting the new regime in Beijing to turn on the stimulus pumps once more. The regime was not expected to suddenly introduce reforms which would stifle growth in the short term.
The US dollar was the safe haven of choice last night as bond yields rose and stocks fell on Wall Street, and experienced the same turnaround, to be only 0.1% higher at 82.44. Yesterday the Aussie copped a beating once more, trading well below 92, before last night rebounding to US$92.61, up 0.3% from Friday.
The signs are not good ahead of today’s open for the local materials sector, again. The China story sent base metals tumbling 1-3%, with copper down 2%. Gold fell US$13.40 to US$1282.30/oz and spot iron ore fell US$2.00 to US$116.60/t. Only the oils managed to hold up, with Brent up US25c to US$101.16/bbl and West Texas up US$1.28 to US$94.97/bbl after a wild ride.
The SPI Overnight was down 30 points or 0.7%.
There are a lot of US data out tonight – the real world stuff – which could well have an impact on Wall Street as long as nothing else blows up around the rest of the globe. We’ll see house price indices, new home sales, durable goods, consumer confidence and the Richmond Fed index.
As to the Fed, the sensible message is “don’t panic, the Fed will not withdraw QE unless the US economy is strengthening”. But the feral hogs will always panic anyway. As to China, the sensible message is “the PBoC is in control, we think”. As to Australia, well there’s going to be some pretty attractive valuations floating around soon, once the dust settles. Lost in the wash is the significant, positive impact a lower Aussie will end up having on ASX 200 forecast earnings, and on the economy in general, albeit with a fragile lag.
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