Professional Documents
Culture Documents
Matthew
Garrett
@MattGarrett3
11/13/14
China
has
begun
to
liberalize
its
financial
system
and
Yuan
policy.
One
major
step
was
greatly
relaxing
restrictions
on
the
Hong
Kong
based
offshore
Yuan
(CNH).
While
this
currency
is
somewhat
tethered
to
the
onshore
Chinese
Yuan
(CNY),
it
is
at
the
end
of
the
day
a
market
driven
currency.
The
CNH
became
the
funnel
for
foreign
money
to
participate
in
the
carry
and
for
onshore
entities
to
borrow
in
foreign
currency.
CNY-CNH
Spread
The
Currency
War
Stresses
- As
the
PBOC
pursues
internationalization
of
the
CNY
the
currency
has
been
freed
to
appreciate
in
increasingly
looser
trading
bands,
currently
2%
from
the
fix.
This
has
occurred
while
the
Chinese
economy
attempts
to
pivot
from
largely
being
export
and
investment
driven
to
more
consumption
and
services
driven.
- Currently
Chinas
export
sector
is
under
significant
pressure
from
some
of
its
largest
trading
partners
via
the
BOJ
and
ECBs
forward
balance
sheet
expansion,
driving
down
their
currencies.
Exacerbating
this
move
is
the
FED
ending
QE
and
speaking
to
further
policy
normalization
putting
upward
pressure
on
the
USD
and
by
extension
CNY.
The
chart
below
shows
CNYs
spot
return
(%)
against
major
trading
partners
The
stresses
from
exchange
rates
are
likely
not
in
synch
with
the
PBOCs
timeframes
for
allowing
services
and
consumerism
to
fill
the
gap
left
by
exports.
This
puts
direct
pressure
on
Chinas
exports
during
a
time
when
aggregate
demand
out
of
EU
is
weak
and
Japan
is
very
shaky.
That
said,
Chinas
pivot
in
trade
and
economic
ties
is
directed
at
AXJ
(Asia
ex-Japan).
Internal
Credit
Market
Stresses
- The
PBOC
has
gone
to
great
lengths
to
provide
funding
facilities
to
the
overextended
and
cycling
down
credit
markets
while
avoiding
a
wholesale
policy
cut
(Benchmark
rates
and
required
reserve
ratio).
The
latest
iteration,
the
Medium-Term
Lending
Facility,
provided
3-month
liquidity
at
350bps
to
the
tune
of
769.5B
Yuan
in
Sept
and
Oct.
- The
heavily
levered
Chinese
corporates
(w/
debit-GDP
levels
of
124%,
as
noted
by
BAML)
have
increasingly
turned
to
USD
bond
issues.
Positioning
and
Market
Structure
Risks.
- Given
the
long
running,
strong
performance
of
the
CNY
and
CNH
carry
trades
over
the
past
few
years
and
the
rapid
growth
in
the
offshore
currency
market,
it
reasonable
to
expect
net
exposure
is
large
and
leveraged
with
investors
and
financial
institutions.
Furthermore,
the
size
of
cross
border
trade
with
China
has
led
RMB
to
be
the
2nd
largest
trade
finance
currency.
This
leads
me
to
believe
that
foreign
corporates
may
have
large
expsure
to
the
carry
via
RMB
trade
finance
arrangements
and
evidenced
by
over-
invoicing.
Furthermore,
this
could
be
resulting
in
a
favorable
and
potentially
fleeting
skew
to
the
underlying
economics
of
trade
with
China.
-
Anecdotally,
having
spoken
with
a
businessman
who
imports
from
China,
I
sensed
more
excitement
about
his
exposure
to
the
currency
than
the
underlying
business.
Summing
it
up
- As
described
above,
a
confluence
of
events
and
circumstances
exist
that
cause
me
to
be
weary
of
the
engrained
(but
increasingly
questioned)
assumption
of
a
one-way
path
(and
trade)
for
the
Chinese
currency.
In
fact,
I
would
put
a
far
better
than
50/50
chance
that
the
CNY
and
CNH
will
experience
a
period
of
unprecedented
depreciation
and
volatility
over
the
next
12
months.
Future
volatility
will
likely
exceed
the
bout
of
volatility
experienced
in
1Q2014
brought
on
by
the
PBOC
to
shake
out
one-sided
bets.
The
implications
would
be
hugely
disruptive
to
global
markets.
Implied
vol
rerated
higher
with
the
PBOC
doubling
of
the
USDCNY
trading
band
to
2%
on
March
17,
2014.
Possible
Triggering
Scenarios
for
Disruptions
1. An
external
market
shock-
This
could
be
broad
market
volatility
brought
on
by
the
FEDs
positioning
away
from
ZIRP
that
will
have
spillover
on
the
EMEs
and
carry
trades.
Market
volatility
(risk-off
environment)
could
also
come
in
the
form
of
credit
market
contagion
stemming
from
the
energy
space
(which
makes
up
~18%
of
N.A.
HY).
2. PBOC
broad
based
monetary
policy
loosening
(this
includes
changes
to
FX
trading
bands
and/or
new
cheap
money
lending
programs)-
This
can
come
in
response
to;
(a)
further
credit
market
deterioration;
(b)
weak
economic
and
inflation
prints;
and
(c)
pressures
exerted
by
the
current
round
of
currency
devaluation
by
other
central
banks.
3. Emergence
of
an
alternative
regional
or
global
currency
scheme,
outside
of
the
existing
system.
Potential
Mitigants
1. Large
pools
of
incremental
foreign
capital
that
would
find
local
currency
products
attractive
if
a
risk-on
environment
firmly
takes
hold.
2. Strong
growth
in
Chinese
consumption
and
services
sector
offsetting
export
weakness.
3. Remaining
policy
levers
at
the
PBOCs
disposal.