Chronicle Of A Tightening Foretold

Wednesday, January 20, 2010

Just when it looked like equities had finally shifted to "sell the rally" mode after ten months of "buy the dip", the SPX goes and rips 14 points to a new post-2008 closing high (cash basis.) While the rally came contrary to Macro Man's expectations, it was nice to be flat for once and thus avoid that sinking feeling that he experienced all too often last year.

In any event, while stocks closed on their highs yesterday, risk assets have beaten a bit of a retreat overnight courtesy of developments in China. Despite the PBOC claiming that the recent hike in the RRR wasn't actually a tightening, the news emerged this morning that the authorities have directed the big 4 banks to halt new lending for the time being. (As Macro Man types this, a PBOC source is on the tape suggesting that banks lent Y1.1 trillion in the first two weeks of January alone. Yowsah!) In an economy where loans and capital are largely directed by administrative diktat rather than prospective return/the price of money, that does in fact represent a tightening of policy.

Moreover, the rumour mill in China was cranking at full speed last night. Stories circulated of another hike in the RRR and, more intriguingly, sharp upside surprises to forthcoming CPI and PPI data. While the y/y change in CPI has thus far been muted, the rumoured print (marked by the star on the chart below) represents a pretty sharp bump and an uncomfortable trend.

That the authorities are finally starting to adjust policy is the clearest signal of all that they are becoming concerned about the trajectory of inflation. It appears, therefore, that we are entering a new phase in China-watching, where inflation may trump growth as the primary determinant of policy change. Will it be enough to prompt a CNY move? Probably not. But as noted a few days ago, the impact on Chinese equities could be substantial; the Shanghai Comp was slightly down on the year even with 1.1 trillion RMB of lending in the first half of January; how should we expect it to fare with the liquidity taps turned off? "Not well" is the obvious answer, at least judging from the market reaction today.

The dollar has performed pretty well overnight, perhaps driven by hints of tightening in the "Chimerica" complex. EUR/USD has broken the 200 day moving average, which could prove significant given the performance of the eur following the break of the 55 day. As you can see, the latter supported EUR/USD for much of the past six months, and the euro shanked when it finally broke, only finding support at the 200d. Might the break of the 200d herald a similar collapse? Inquiring minds want to know. Certainly the performance of many "risk on" currencies over the past 24 hours does little to suggest that the dollar will slow down any time soon.
Finally, Macro Man had to laugh at Merv the Swerve's Exeter speech last night. Look up "dovish" in the dictionary and you might find a verbatim transcript. Particularly amusing were his comments that the inflationary episode will prove temporary and that CPI will soon move back towards target.

Macro Man had to shake his head. Courtesy of the VAT-hike base efffect come January, it will be almost inconceivable that Merv does not have to write a letter to his Darling to explain why he's let CPI drift so much above the target. Merv would do well to save the letter onto his hard drive, for he may be needing it again. The BOE's own track record of projecting inflation has been dismal to say the least, as a perusal of recent inflation report fan charts will confirm. They have used the old forecasters' trick of moving their near-term projections of inflation in line with the market while leaving their longer-term forecasts unchanged.

How dramatic has this shift been? In May, assuming "just" £125 bio of QE, it was literally inconceivable to the BOE that inflation could rise to more than 2.7%-2.8% by year end; that was the very top of the fan chart. In fact, even with an extra £75 bio of QE, December CPI came in at 2.9%. Ouch!

Not that private-sector forecasters have exactly covered themselves in glory, of course. The cumulative consensus forecasting miss on CPI in 2009 (measured by subtracting the consensus m/m CPI forecast from the actual outturn, and summing the differences for the 12 months of 2009) was a whopping 1.6%!

It would be an interesting subject for an academic study as to why UK inflation has been so sticky; regardless, it certainly feels as if "Rip-off Britain" rides again. And the stickiness of inflation also raises the question of what will happen to prices if Macro Man is wrong and the UK ever does manage a period of strong self-sustaining growth.

And so your author cannot help but think that at some point, the Guv'nor will be for swerving once again. Whether that happens in 2010 is of course a matter for debate, and Macro Man doesn't have a strong view on the timing. Merv has, after all, demonstrated in the past that he can remain irrational longer than "haters" can remain solvent. But with inflation set to exceed 3% and the Bank not particularly interested in lifting a finger, Macro Man cannot help but think that Gilts make an attractive short here, especially as a spread trade against something like Bunds.

Posted by Macro Man at 8:50 AM  

38 comments:

1y fwd 2-10 steepeners also make sense, outright or vs eur.

Anonymous said...
10:21 AM  

Speakng of shanks, anyone catch the fifty dollar shank on pre expiration of Bidu, followed by a thirty dollar shank back yesterday. Some marketmaker should have gone BK or deeb in det on that one. It goes without saying that the Dept of State should encourage investment in companies that render political activists unto Chinese state police at the expense of Goog making a stand for political freedom of expression. Made me feel proud.

Anonymous said...
10:23 AM  

Impl vol of CLo1 fell below 30 for 1st time in at least 2 years.This am at 29. Dec10 < 32 now. Crude vols have followed VIX vols down to pretty low levels,taking last 3 yrs or so. If WTI vols drift down further, there will be some great opportunities to pick up low cost calls further down the curve. Unless you believe in OGDF, then u can long cheap puts.

Anonymous said...
11:19 AM  

gilts-bunds... a no brainer to me but apparrently a very crowded trade. even so, yield spread dropped 6+ beeps right after CPI

melki

Anonymous said...
11:19 AM  

MM, I'm a bit surprised at your logic (especially since usually it's impecable) around the inflation outrun and extra QE.
The point of QE was, after all, to increase inflation (whatever BoE may say officially) thus reducing the debt cost (both future and net debt by increasing asset prices).

So saying that with more than 50% increase in QE the inflation went over the top range of the previous forecast just doesn't make sense to me. If you put the pedal closer to the flor, you're likely to go faster, yes?

Of course, should you wish to question the BoE's seeming assumption of lack of inflation stickiness, it's an entirely different story.

vlade said...
1:05 PM  

My logic is, of course, illogical. Good catch, vlade. Still, I don't think the huge miss versus the May forecast can hardly be attributed to an extra 75 squid of gilt buying...

Macro Man said...
1:22 PM  

How much higher do rates have to go in China before "investors" there start to question whether their capital would earn a higher return in an interest bearing investment, vs. the few tons of copper sitting in the back yard? Not good for the commodities complex, and maybe that is a purer play than Chinese equities because of the opacity of Chinese government involvement in their equity market.

PPM said...
1:27 PM  

Did me get this straight, (the completely unexpected) increase in (consumer priced) inflation in China does not effect RERs, spells commodities & chinese equities meltdown and rallies the (pegged onto Yuan) USD, yes?

Anonymous said...
2:01 PM  

equity melt up yesterday was pure insanity... buy programs caught short sellers and market never once pulled back after 8:30am US time.. classic sign of a short squeeze, especially after a down day on friday. Just proves how utterly un profitable it is to play the short side in equities.. but the market is giving hints of weakness

abee crombie said...
2:08 PM  

The 1.1 trillion lending in the first 2 weeks in China is clearly the sign that people widely expected that the money would be tight in the future, then tried to get hold of credits as soon as possible.

zjin said...
2:16 PM  

MM: indeed, especially since most of it will circularly just go back to the reserves held with BoE (by a quick look the reserves grew by about 50b since May).

It was just that the logic of your argument seemed strange :)

vlade said...
2:18 PM  

The rapid loan growth early in January in China probably does reflect commercial banks anticipating the introduction of quotas. However, the big picture problem for China is that the rapid loan and money growth over the last 12 months suggests that inflation is already likely to rise rapidly over the next 6 months. Have a look at a chart of the CPI and M2 lagged by 12 months.

The comfortable consensus is that inflation will gradually rise toward 3% year-on-year in 2010.

That is probably optimistic, in my view. Historically, 4% inflation is when the panic button has been hit.

However, monthly annualised inflation is already running at a double digit pace over the past couple of months.

The bottom line is to expect more aggressive policy tightening in China as inflation accelerates. Short commodity-linked stocks and currencies.

Skippy said...
2:55 PM  

So Voldy can stop printing and continue to peg all at the same time?

Anonymous said...
3:13 PM  

Governments around the world announce openly that they are printing money as fast as they can. Investment banks and central bankers forecasted **deflation**??

The old adage in the US is "Don't fight the Fed" (one could substitute any other central bank).

If the guy running the central bank promises to hurl money out of helicopters, you have to be an insolvent investment bank to believe deflation is going to happen. Then the Fed announces -- in public -- they are going to monetize debt by buying Treasuries, and somehow Wall Street still forecasts deflation?

Don't fight the Fed -- the Fed says they are going to trash the currency.

The beggar thy neighbor policies will continue all over the world, with central bankers hurling cash out of helicopters and into worthless banks, car companies, mortgage securities, and (mostly) government securities.

The Fed buying overpriced Treasuries (and thus artificially driving down yields) is not evidence of deflation, not even if every investment bank claims it. It is evidence of a non economically motivated player buying recklessly, and that's it.

The world will pay dearly for what the central bankers have done in the last couple years -- especially England and the USA.

Gary said...
3:13 PM  

Idly wonders if yesterday's vote will lead to end of Stimulus II talk, some minor measure of forced austerity, Helicopter Ben's scope for printing money being reduced and the second downward leg of the W...

Our Man in NYC said...
3:34 PM  

Some print faster than others, some print under the table, one prints the reserve while others devalue outright (first IMFs “reserve reserves” followed by the Upper Korea and Venezuela).

Anonymous said...
3:50 PM  

@Our Man NYC - I have been wondering the same things.

Continued inflation is basically a sure thing IMHO. Existing debts are not payable in real terms.

As for more pointless spending (stimulus by whatever name) -- Washington DC (both parties) have demonstrated a stunning disconnect from the rest of the country.

They should slow spending, if they followed common sense. But there is a high risk that they will continue to delude themselves that every event outside the beltway is just a fluke.

That's what King George did 200+ years ago, and it worked great for him. It marked the beginning of a long slow decline in the then world super power.

As you have been wondering too ... what are your thoughts?

Gary said...
4:15 PM  

@Gary: They're still formative but...

i). Obama
MA wasn't that bad for him despite attempts to portray it as a referendum, a majority in MA still approved of his performance!

ii). Healthcare:
I thinks something gets passed, Obama's come too far down the road to walkaway. I don't know whether it's Congress approving the Senate bill (meaning it doesn't have to go back to the Senate) or Snowe getting persuaded to flip (I don't think her and Nelson are far away).
Also, Brown's from MA...and (afaik from my brief readings) isn't against their single-payer plan!

iii). Stimulus 2
DOA -- I think that's the first chip the White House gives up. However, I'm sure chunks of small stuff that's politically useful for both sides (Unemployment insurance extension, etc) goes through.

iv). Budget Deficit/Spending Cuts
The Independent/Youth nos were terrible -- also from the exit polls, deficit reduction was everywhere. I think given it's an election year, we hear lots of talk/leaks over the summer about Rahm clamping down on spending...proposing cuts to budget, etc. but see no real action. I suppose that's an incremental positive on the deficit side.

v). Bailouts/FED/Geithner
The wild card -- it's clear people hate the Banks (rightly or wrongly) and blame them, and also seem to realize the FED's printing press is working (I'm surprised by non-financial friends who say this!). I don't know if it has any impact, perhaps QE end will actually happen in March/April. I do think Geithner goes (to be replaced by Bair) as the fall guy, in Q2 (so it doesn't look knee jerk).

That said; I worry all of the above is far more what I'd like to see happen...than what will actually happen (no changes!)

Our Man in NYC said...
4:59 PM  

".. if yesterday's vote will lead to end of Stimulus II talk, some minor measure of forced austerity, Helicopter Ben's scope for printing money being reduced and the second downward leg of the W..."

You've got my vote. Also my money. The stronger dollar trades are going to be successful before long. I like shorting the metals, the miners and the commodity currencies here.

leftback said...
4:59 PM  

@LB

I'm 100% with you on the dollar and metals comment there...

One thing I'm thinking tho... I wouldn't be surprised to see a wee waiting period until Bernanke actually gets his ass in the seat...

The Senate has not done the final formal vote yet, as they were on holiday...

The docket is pressing with other issues at the moment, and so the final vote may not come until very late this month...

I'm wondering how many will want to make HUGE moves before they're 100% sure Bernanke is officially confirmed...

Just thinking...

CV said...
5:12 PM  

@OMNYC - Every single member of Congress is doing some hard thinking today. If Ted Kennedy's seat is vulnerable, no one is really safe.

Obama needs to pass something, anything, with the words "Health Care Reform" in the title. It doesn't need to have any teeth or any substance, but he must have something to save face. He pretty much bet the farm and his career on it, no one will take him seriously if he doesn't pass something, however lame.

Having said that, its become pretty clear that Nancy Pelosi has become a major liability for Obama and Democrats in general -- and not without good cause.

Forcing through the Senate version is political suicide for every member of the House -- and they know it. They won't hesitate to tell Obama so if he is dumb enough to ask.

Snowe may be close to Nelson in willingness to accept bribes, but few people missed the fact that Nelson got booed out of a pizza shop in his home state.

Obama couldn't save Corzine in NJ. He couldn't help Chris Dodd. And he couldn't help Coaxly win/save a practically locked seat. If Obama goes to a House member and promises to campaign for them, he will be lucky if they don't laugh in his face.

So Obama needs to pass something, anything. Congress needs to avoid a slaughter in November. Obama is weak and vulnerable, and for career politicians (Congress) he is expendable.

Members of Congress will dump Obama even faster than he dumped Coaxly. Its not personal, its politics. They all know that a slaughter in November will result in a repeal of whatever is passed now, so its not worth risking their careers.

Obama has to decide if he wants the 2nd half of his Presidency to be with a mixed Congress, or an extremely hostile Republican one.


Geithner brings up an interesting variable (for politicians anyway). It seems like they have been stalling on investigating Geithner and Paulson for the Goldman/AIG fiasco -- almost like they want the "trial" to be in an election year...

You have evil bankers, evil Bush-era officials, corruption, accounting fraud. All the stuff of a good conspiracy theory -- except an employed electorate. I doubt anyone is going to be surprised that the bailout was not kosher, so the trial will be rather anti-climatic. And convicting Geithner is as bad for Obama as convicting Paulson is for Bush -- except Bush isn't up for election.

In the end, the "trial" will just make government look really inept, which will just feed into the general anti big government / big business feeling that is already deciding elections.

I still can't decide if that means the beltway gang will clamp down on spending. History suggests they will be clueless and spend like drunken sailors until China can't take it anymore.

The collapse of Bretton Woods II (when China cries "uncle") is the thing to watch for...

Gary said...
5:35 PM  

"Obama couldn't save Corzine in NJ. He couldn't help Chris Dodd."

It's hard to save Democrats with a series of policies that have made this essentially George Bush's 3rd term. Obama is going to have to take some risks.

leftback said...
5:49 PM  

Its not about democrats or republicans -- its both. Its not about Bush or Clinton or Obama, or even Pelosi -- its about widespread bad leadership in big business and in big government.

Obama will now be a casualty of the system. If Obama was smart enough to fix things, he also would have been smart enough to stay out of Washington.

People are known by the company they chose to keep. Keeping company with Congress, Geithner/Paulson, Blankfein, etc will now define who Obama is.

Gary said...
5:59 PM  

Gary: You're correct, Obama will be best advised to go solo here and dissociate himself from the Congress. There are some tough choices to be made and it is time for independent leadership. He has the intellect to do this, but does he have the fortitude to clean house? Geithner, Summers, etc.. will all have to go.

leftback said...
6:02 PM  

Perversely, I think Obama will come out of this ok -- he's almost as teflon as Reagan/Blair/Clinton -- who knows, maybe LB's right and it'll give him the kick to actually go it solo rather than leaning on congress.

Also, the underlying poll nos for Obama in VA, NJ and MA weren't bad (though nobody could call them good/great)-- i think it's an anti-incumbent (irrespective of whether its R or D) sentiment more than an anti-Obama sentiment.

Our Man in NYC said...
6:19 PM  

Americans discover the "by-election" protest vote, MM? Mister Brown will be tossed out next time.

Good to actually make money for a change, eh, MM? LB is just charting the DXY from here on out, with half an eye on Greece and the other on US employment. Both situations seem to be dollar positive for a while.

Leftback said...
6:28 PM  

In Massachusetts:

The DEMOCRATIC PARTY didn't win...
The REPUBLICAN PARTY didn't win...

The TEA PARTY won...

CV2

CV said...
6:42 PM  

Havent posted on macro mans blog in a while, but couldnt resist after readings Garys posts. Anyone who is looking at the the numbers on the computer screen right now might as well be living in the Matrix. No one has ever seen anything like what the governments of the world are doing right now. The solution should have been take the losses last march, but because a bunch of arrogant formal thinking retards at the Fed along with a bunch of desperate fools at the big banks everyone is still walking around in circles.
There is no way to tell what is going to happen because we are in a situation will zero predictability.

James said...
6:48 PM  

Is 1.40 the floor for the € for the near future, absent more Hellenic unrest?

leftback said...
7:21 PM  

Leftback and Our Man in NYC are showing their partisanship when they confuse what they would LIKE to have happen with what MIGHT happen.

I have a crushing reality check for you both: Obama, Bush and Clinton all put their pants on one leg at a time. Like his predecessors, Obama is not able to walk on water

Obama can't fix the country going solo -- leaders have to LEAD

Anonymous said...
8:08 PM  

So Obama is now saying that Congress should not jam through a health care bill before Brown is seated.

He then said there are elements of the House and Senate proposals that democrats and republicans agree on (uncontroversial stuff) -- and Congress should pass that. Essentially, Obama just wants something / anything so he can save face and move on to another issue

Obama also said people are as angry as they were in 2008 -- the same problems that swept Obama into office had swept Brown into office.

Just in case anyone needed reminding on those issues: the justice department reported that the FBI improperly accessed thousands of telephone records between 2003 and 2006. Same people who want to strip search your grandmother at the airport and access your credit history at the airport -- but they didn't want to offend an extremist from Nigeria with a similar search.

Only honest tax paying citizens need be harassed.

Makes you want to put them in charge of your health care, doesn't it?

Gary said...
8:22 PM  

I may be in Peru but i've got to say that this whole China credit tightening thing is going to be sweet. Expect some serious widening in Asian credit - as soon as the onshore taps get turned off the likes of Agile etc hit the high yield market in a big way.

Viz the US, I am sincerely hoping that there is a significant reality check on how to keep the population happy: reduced payroll taxes or other incentives to hire and throwing a few elbows on the protectionism side so Voldy gets his skates on. Healthcare is all well and good but the job creation is the sure fire winner. This insansity in Kabul really should make the US reconsider whether they really give a toss about the middle east now that a certain little lithium company I've been holding for a while (ORE AU) is getting funded by TM's trading co arm.

Nemo Incognito said...
11:02 PM  

China + Greece + A Few US Jobs = Big Dollar Squeeze.

The Clavadista d'Oro* is almost upon us.

*A sudden and precipitous decline in the price of a certain instrument favored by inflationists.

leftback said...
12:15 AM  

Further to your Long Bunds:Short Gilts trade, how about Long USTs:Short JGBs?

Time is running out for Japan. Those who have been calling for a sovereign debt crisis in the US are looking for a bond crash in the wrong place. With a net decrease in savings and a national debt primarily owned domestically, Japan is in big trouble.

<a href="http://globaleconomicanalysis.blogspot.com/2010/01/no-way-out-for-japan.html> Crisis in Japan? <a/>

leftback said...
12:33 AM  

Leftback, having dropped, oh, 3% of NAV on Yen shorts that are only partly compensated by JGB shorts I can wholeheartedly agree but it appears the zombie army of the Wantanabes and whatnot are against all good sense on this matter. Sadly the Chinese don't own much of their debt, otherwise they'd be offer only and have "Remember Nanjing" on their bloomberg headers.

Nemo Incognito said...
2:50 AM  

Macro Man,

I love this blog but feel you sometimes mix up concepts with TA.
The "sell the rally" is a tecnical concept which does not stop there, but goes on like " in the downtrend".

Where is the downtrend?

Who cares what one belives? The charts say it all.....(to me)

With all my respect,
fxpanther

Anonymous said...
9:09 AM  

With the Chinese sentiment, sloppy HSI close , commodities starting to whiff it seems to this punter that the AUD trades remarkably well .... given its leverage to all things above ? ... Maybe it is just an S&P proxy and thats the end of the story

Rossco said...
9:31 AM  

fxpanther, I know exactly what I was saying. There are some markets where the weight of money flow (i.e., the most likely marginal trade) is to buy weakness, which explains SPX performance since March. At other times, the weight of money flow will morph to sell strength...a development that often PRECEDES a technical breakdown (and in many cases, can be the cause of one.) The hypothesis that I expressed (reflecting the views of a number of peopls with whom I correspond) was simply that we have moved from the former to the latter.

Rossoco: see today's post.

Macro Man said...
9:48 AM  

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