Friday, June 29, 2007

10 ways to dispose of RMB 1.55 trillion worth of bonds

Well, the initial market reaction has been to conclude that this is, after all, just another dip that we're meant to buy. While the SPX has stabilized, many other risky assets have roared higher, including the dreaded FX carry trade. Macro Man is among those who've been sucked back in, as his carry model filter is now flashing bright green. The P/L has been updated accordingly.

While it's tough from an intellectual point of view to get back in to an overvalued trade at a level above the recent exit point, at the same time it is strangely liberating to do so when instructed by a 'higher authority', e.g. a mechanistic model. As far as Macro Man can make out, those gaijin who do have the yen carry trade on in any meaningful size are those that follow a similar quantitative process. Those managers who engage in qualitative assessments, among whom number the legendary cabal of secretive macro hedge funds who rule the world in conjunction with the Pentavirate, the Illuminati, Opus Dei, the Rosicrucians, and Hermes Trismegistus, are relatively unexposed or even long yen, or so Macro Man believes from his conversations with a number of these types of players.

One topic of discussion and speculation today has been the news that China's yet-unnamed soverign wealth fund will be selling $200 billion worth of RMB bonds to pay for its initial assets from SAFE. Contrary to the general expectation, they will not be able to jam these bonds down PBOC's throat because it's against the rules. Of course, so is industrial espionage and copyright infringement, but that hasn't stopped those sorts of activities in China. Nevertheless, one should probably respect the fact that "no" in this case does appear to mean "no".

In which case, CIC and the authorities will need to find a home for these new bonds. A swift look at China's yield curve will reveal that the market probably isn't priced to receive $200 billion worth of bonds, particularly given the level of nominal GDP growth in China:

Macro Man has read one analyst's note that suggested that a drip feed issuance will ensue that will replicate the impact of a 0.5% hike in the reserve requirement every month for the next year or so. Given the general view that further hikes in the RRR might actually alter banks' behaviour, this is clearly an undesirable outocme. Where, oh where, therefore, to dipose of these bonds?

Macro Man has some ideas. Herewith, and with apologies to Cassandra, is Macro Man's Top 10 ways of disposing of RMB 1.55 trillion worth of debt:

1) Include RMB 1 billion worth of bonds with every DVD player sold in America and the EU.

2) Call the new debt, pretend it's a stock, and let Chinese equity punters have at it.

3) Strip out the interest payments from the principal, and back each one with the production output of a different non-existent factory. Securitize each cash flow into an "asset"-backed CDO, and bribe the agencies to provide a favourable rating. Sell it all to Western hedge and pension funds at $10,000 on the dollar. Laugh.

4) Call your new best mate Steve Schwarzman and "suggest" that Blackstone buy a few.

5) Tell Senator Herb Kohl that if he wants to sign Yi Jianlian, he'll need to buy your bonds, too.

6) Pay the Pentavirate, the Illuminati, Opus Dei, the Rosicrucians, and Hermes Trismegistus to dispose of them for you.

7) Use diplomatic contacts to construct an "oil for bonds" transaction with regimes deemed unsavory by the West.

8) Default on the first interest payment, and then issue government-guaranteed debt to buy back the 'reserve issue' at half price.

9) Get Jim Cramer to pimp it for you on CNBC: Boo-yah! Back up the truck, baby!

9a) Trade the bonds to the Duke of Westminster for a small portion of his property portfolio. After all, London property is the fashionable investment of choice for kleptocrats the world over...

and finally, the least likely of the bunch....

10) Open your capital account and allow foreigners to have access to onshore rates and currency risk


Anonymous said...

Hi, what's your take on the announcement by China that the new bonds will be parked at PBoC allowing them the freedom to slowly distribute the bonds? Would think this move significantly reduces the market impact of the issue and, knowing how China works, could mean that the paper stays at PBoC indefinitely.

Macro Man said...

Well, there has been some talk that it is actually against the law for PBOC to hold the debt, hence the list.

However, it wouldn't surprise me if the bonds find their way to PBOC and then, as you suggest, never see the light of day again. The biggest assurance you can get that nothing is changing is an announcement rfom the authorities that they intend to change something.

Anonymous said...

Great post! :)

"Cassandra" said...

MM - I am honoured you consider my drivel worthy.

BTW, did you see my follow-up to your post over at Once in a Lifetime??

Econocator said...

All credit to submitting to the higher power of the mechanistic model when it comes to re-entering the carry trade. I can understand why the systems have been firing off buy signals, and unless we see a sudden rush for the doors, you have a nice yield cushion to protect against directional moves.
That said, my rational side just can't stomach getting back in at these levels, and my pockets can take the burning sensation of paying the hefty charges to be long (unless JPY is traded against CHF and other low yielding currencies). Wishing you a profitable journey, Econocator.

Econocator said...

typo: 'pockets can take' should read 'can't take'

Macro Man said...

C- I don't break out a word like proskynesis for "drivel". I did see your reply on OIAL, but got tied up with some month and quarter end drivel and forgot to respond.

I think your stance is a fair and indeed admirable one. The only thing worse than losing money on a position you wholeheartedly agree with (and thus are liable to hang onto too long) is losing money on a position that is fundamentally abhorrent to you.

Indeed, it is my custom, when "on song", to exit long-profitable and cherished positions when doubters finally get sucked in by price action. Easier said than done, of course, but I generally try and have an idea of what portion of the market is "renting" a position rather than "owning" it.

As noted in the main body of the post, I have found delegating authority over market timing to an "intelligent" machine, and formally segmenting positioning and performance attribution into alpha and beta components, to be strangely liberating.

I've been running a soft version of the same idea in the real job, but the hard and fast segregation seems to work better.

Anonymous said...

macroman -- i too was a bit surprised that you had total confidence that the PBoC wouldn't be buying the paper, and was hoping for a link (especially on the against the law point -- that seems strange, as gov bonds = the normal asset for central banks). the idea that the PBoC might take a whole lot of bonds and then sell them off to sterilize ongoing inflows always made sense to me -- basically, the pboc rebuilds its inventory of gov. bonds in one big swooop(avoiding the need to sell a lot of bonds into the market) and then slowly sells them off as it needs to withdraw liquidity from ongoing reserve growth.

incidentally, jon anderson thinks Chinese reserve growth slowed in May and June (based on some domestic indicators he looks at). Are you hearing similar things?


Macro Man said...

Brad, see email re: PBOC participation.

Anonymous said...

MM and C - it feels like you guys are already ahead some of us experiencing the Summer doldrums -- even I now am seeing both the yen/yuan blog mirages (enough already!) -- and just in the naked time that I'm taking a couple days to relax and cool off with 4th of July 4th to refocus.

Taking a breather!
Asian Man

dryfly said...