Monday, February 04, 2008

Snowed Under

Freak events and acts of nature are generally among the more difficult things to game from a financial market perspective. Even if you know that the long-term impact of event x is zero, if a sufficient number of people believe that event x will meaningfully alter the course of events, financial market prices will move. And as Lord Keynes famously remarked, "The market can stay irrational longer than you can remain solvent."

Prior to the last few weeks, the most recent example of a broad market-moving acto of nature was Hurricane Katrina. And what we observed with that undoubtedly tragic event was a short-term impact on activity, energy prices, and consumer confidence, but relatively little long term alteration of the course of financial asset prices. Stocks, bond yields, and the dollar all dipped in August 2005....and then ended the year considerably higher.

Now, of course, we have an unusually distorting, if no less tragic, force majeure hitting everyone's favourite engine of global growth, China. Not only is the lunar new year rapidly approaching, an annual even that severly distorts all manner of economic activity and data, but the counntry has been hit with the worst snowstorms in 50 years. This in turn has led to power cuts, fuel shortages, soaring food prices, and loss of life.

It's often difficult to know what exactly is going on in China at the best of times, but in a case like this it feels well-nigh impossible. Coming as it does at a time when the US economy seems to be on the ropes, could the snow be the tipping point for the global economic cycle? If so, why is a pro-cyclical currency like the AUD doing so well?

Judging by the Katrina experience, the long-term impact of the snowstorms will probably be relatively minimal. There may well be some short term distortions to the economic data, but heck- we were gonna get that anyway with the lunar new year. Michael Pettis had an interesting post over the weekend noting that the inflation prediction of the Director of the Office of the Central Leading Group on Rural Work (hint: you can tell that China is still Commuinist, because only Communists have job titles this long) is for January CPI to remain at 6.5%.

Now, such an outcome seems patently ludicrous, even if the government has released emergency stockpiles of food, etc. Moreover, we don't exactly have a long data series of this chap's inflation forecasting track record. Nevertheless, the authorities could easily conjure up an acceptable official figure, Argentina-style, and live with the family grumblings about the cost of living over the holidays.

Add in the fact that the G7 meeting is this weekend, wherein China will presumably be on the receiving end of a) commiseration over the snowstorms, and b) moans to keep going with the currency. China's usual response to b) is to stall the pace of acceleration. As the chart below indicates, the pace of the downtrend in USD/RMB appears to be slowing. Given the New Year, the snow, and the G7, it's not difficult to see a scenario wherein near-term downside virtually grounds to a halt. With NDFs pricing onshore rates at -6% at the front end, what odds that that market sees a short-covering rally? Macro Man is not brave (or, depending on your worldview, stupid) enough to go long USD/RMB, given the relatively modest upside and ever-present danger of the autorities "doing the right thing." But those who are short, particularly in long-term NDFs, could do worse than to partially hedge some of their exposure at the front end.

Elsewhere, cash rates are tightening again as the market anticipates the impact of massive rollovers. Certainly the last two quarterly refunding months, August and November, have seen significant distress in money markets while the prior one, May 2007, saw a rout in the govvy market. How much these concerns are justified remains to be seen, of course, but combined with events in China and US data, it would seem that volatility for the next few weeks is assured.

Not that Wall Street will care today, however. The Giants' shocking Super Bowl victory over the "Evil Empire" will probably leave the New York market with more than a few sore heads this morning. Macro Man is left to wonder: what did Vladimir Putin make of it?


Anonymous said...

Hi, Thanks for your ongoing commentary- it's educational and interesting...what is the significance in the wider scheme of things in the core capital markets of unch Chinese cpi? Are there capital flows which respond to this? thanks, E.L.

Macro Man said...

In terms of direct capital flows, probably relatively few. But insofar as a concern over CPI inflation has encouraged the Chinese authorities to tighten policy, and that that has a) helped lead top a stronger RMB, b) probably led to a weaker stock market, and c) possibly helped drive indistrial metals/infrastructure firm p[rices lower, one coul;d posit that an easing of inflation pressures might unwind some of these impacts.

Of course, if PBOC knows that a 6.5% reading is "really" 7.5%, they might keep the tightening policy in place.

Anonymous said...

Thanks, that makes sense. An easing of inflation concerns there may result at the margin in support for equities in the Asian space and hence in a minor way provide support- the issue is that if economic activity was negatively affected/suppressed from the weather which seems quite likely would that trump the easier inflation concerns? Of course assuming that either of these is taken out of context to have greater than short term considerations...