Thursday, June 02, 2011
There, that's more like it. We had our fingers crossed as we waited for the ISM and were rather chuffed that it came out pretty much where our model had called it. Good Model, pat on the head and an extra bowl of electrons for you.
TMM have only one more thing to say on the matter. Only two things come out of ISM.... and that's Fears and QE3ers. And this doesn't look much like Fear to us, so that kinda narrows it down.
The QE3ers are certainly rampant this morning but, even though TMM are thinking this looks like a repeat of 2010, it probably won't (probably due to observation affecting the outcome). So we would demur from joining the QE3ers just yet. In fact we are more interested in cutting our long held long UST positions, even though Equities look as though they have more downside to go.
More on the QE3ers at some other point, but before we move on, we have recently observed this headline hit the wires (yes, really).
*SPAIN TO ASK FOR EXTRAORDINARY EU AID OVER CUCUMBER CRISIS
€400bn, perhaps? That woud be a very European solution to the bailout problem. We look forward to the Greek, Portuguese and Irish cucumber crisis payments.
And now for something completely different: the HKD peg.
While a seemingly obscure point, TMM have been watching some action in Asian fixed income markets that has them very amused. But first a few charts:
1) Loan to deposit ratio of HK banks, per the Hong Kong Monetary Authority and the Hong Kong property price index. As you can see, property prices are on a tear and if you look at a few major banks, HKD deposits are beating a retreat.
2) Yuan deposits in Hong Kong (yes, that is a long scale). This is where the deposits seem to be going in Hong Kong - punters in HK see the rise of the Yuan as utterly inevitable and see putting money on deposit in Yuan as the only sure thing around. Now, TMM will be first to say that this is beyond stupid - you have low caps of how much you can convert in a day (~$3k USD), there are plenty of better options for Asian FX carry out there (Indo govvies / Singapore REITs, HK REITs, etc) that do not have liquidity problems and which actually pay positive real rates. Nonetheless, punters are punters and when it comes to deposits in HK they are driving the bus.
3) HK mortgage rates... vs Yuan mortgage rates: Here it is clear that while HKD mortgage rates are rising due to this funding squeeze for banks it is nothing compared to that experienced on the mainland, where the rate hike cycle is truly underway.
So here are the two salient problems here:
HK Commercial Bank: you only make loans on HK property in HKD - unfortunately, your deposits are running away. So what do you do? Make loans in CNY, basically accepting that HK is going to creep towards a CNY peg? Beg and plead with the HKMA to arrange some currency swaps? Or just keep on ratcheting up mortgage rates as your funding runs away to cause rates to level peg with yuan rates? In the meantime, your funding still keeps walking out the door.
HKMA: You are worried about a bubble as real activity is in Yuan but you have a USD monetary policy due to the peg. Do you repeg? Or do you just pester your banks about their loan to value ratios and force them into stress tests without doing anything at all to solve the root of the problem? To date, the latter appears to be the HKMA's attitude.
The sensible answer is to repeg and basically follow CNY monetary policy for better or for worse, because, lets face it, the HKD peg is an anachronism from when HK was a light manufacturing hub that exported most of its products to the US and Europe. It is of course now a financial services hub that is leveraged beta on China and Chinese capital markets activity.
So what is the trade? There is of course the old HKDUSD cross which is one of the more asymmetric trades out there, sadly you pay for it on risk reversals. Another trade though might be Hong Kong banks as distinct from mainland Chinese banks. If HK banks were to become organizations that got deposits, made loans and generally operated in Yuan they would no doubt be as hitched to monetary policy on the mainland as Chinese State Owned Banks and be the recipients of those sweet, sweet 3% Net Interest Margins that Chinese bank analysts know and love. They would also, however, not be natural lenders into all the dumb infrastructure and business lending that Chinese bank analysts know and hate.
Now, TMM may be crazy but if you are making 3% NIMs, not lending to fundamentally uneconomic policy projects and are reasonably well run, you can expect to get a 2-2.5x Price to Book multiple much like higher quality Indonesian banks. As a thought exercise, TMM have seen what the valuation uplift could be for a few HK banks.
In the interim, TMM expect some choppiness in these names as the HKMA girds them for the big inevitable change, but the asset risk is manageable here: HK property may be a bubble but these guys lend to 60% LTV and do not have the type of stuff on balance sheet that Chinese banks do. Going long HK banks and short Chinese ones might not be a bad way to play the HK peg, not to mention a China credit blowup, if you get bored of waiting for what feels like forever for something to happen in the FX market.