While the bear's away, the bulls will play.

While the bear's away, the bulls will play.   Such, it seems, is the lesson from yesterday, when a poor Japanese GDP figure and an unchanged RMB fix versus its basket prompted an orgiastic response across risk assets, including oil.  Notably, US markets were closed for President's Day, though of course they return today to bask in the warm glow of Goldilocks' smile.

Although the enthusiasm over the RMB fix was probably misplaced, it does seem as if something likely has changed in China.   PBOC governor Zhou's comments over the weekend about maintaining yuan stability and defeating speculators were unusually forthright, though unsurprising to anyone with much experience of watching them over the years.  It seems likely that China will try to maintain at least the illusion of stability in the currency, at least against the USD, particularly if they can simultaneously weaken in against a broader basket of currencies.  The real notable news, however, was the explosion of credit growth in January to levels that blow away anything observed in history.

Now clearly this will be meat and drink to a number of prominent China bears, who are calling for an implosion of the financial system any day now.  While it's true that China cannot continue to sustain credit growth like this ad infinitum, the latest data serves as a telling reminder that if many if not most cases in China, credit is administered via administrative diktat rather than any price mechanism.   Clearly the word has come down from on high to get credit flowing again to juice the economy; while China, like most places on Earth, is seeing a lower payoff in growth per unit of credit issued, a rise in this magnitude may well generate a boost to activity, particularly if sustained over the next few months.   We saw a similar step-jump during the great stimulus program of 2009; while many of those loans have subsequently gone bad, the time frame of the final reckoning is somewhat different when it's a government-owned or sponsored entity doing the lending.

In any event, it is perhaps an ominous sign for RMB bears that when Macro Man checked the CFETS website last night, this is what he saw:

Switching gears, the SPX looks set for a nice rally based on current futures pricing (up 175 bps at the time of writing.)  What's interesting, however, is that fixed income, while, lower, doesn't really seem to buy it.  Macro Man ran a little scatter plot study to get a sense of how extreme rates pricing is given the sell-off if equities.  The chart below plots the 2nd vs 6th eurodollar calendar spread versus the drawdown in the SPX from its highs since the beginning of last year.

As of last Friday, it's difficult to argue that the current reading (marked in red) is terribly mis-priced.  That being said, the relationship is a fairly linear one, with every percent of drawdown worth 4-5 ticks on the spread.  Obviously, there are other factors at work driving ED pricing than just the stock market, but it's pretty evident which factor was driving the bus when it came to pricing the Fed out of the equation for March.

Anyhow, if we do see the equity correction broaden out endure for more than a few hours, then segments of the fixed income market look like a chip-short short.   Of course, some people (including your author) have said that before, and been dead wrong.  Still, it's hard to argue a) that it isn't an asymmetric trade in your favour, and b) that most if not all longs have perished in a similar manner to Edward II.  If the bulls are going to play for a while, this looks like a much safer game than buying the Nikkei 1000 points off the low or anything like that....