Collision Course
Doug Nolan
The Shanghai Composite sank 5.1% Monday, fell another 1.4% Tuesday, rallied 2.5% Wednesday, increased 0.6% Thursday, and then rose 2.4% Friday – with the wild week’s 1.3% decline boosting y-t-d losses to 16.3%.
If that wasn’t enough volatility, China’s growth-oriented ChiNext Index sank 5.6%, declined 0.9%, rallied 5.5%, fell 1.8%, and jumped 4.1% (up 1% for the week).
Beijing to the rescue.
And Friday from Bloomberg’s April Ma:
“The Politburo readout comes right in the nick of time, and is itself a meaningful signal of market support.
The statement came during the market mid-day break, just as rumors of more support for tech and the economy started to brew.
This was an exception to the norm of the release after market hours, closer to 6pm or 7pm.
It wouldn’t have taken much for authorities to hold the statement for the evening.
But then that would be missing the opportunity to spur afternoon gains just ahead of a five-day break from trading.”
Beijing prodding may have reversed much of the week’s equities market pain, though I doubt positive sentiment will return anytime soon.
Beijing crisis steps were less impactful elsewhere – notably with bank CDS and the renminbi.
Things are “breaking” in China – deflating Bubbles, “Covid zero,” faith, confidence and even mental health.
China Construction Bank CDS surged 12 this week to 92.5 bps, approaching the 2020 spike level (began 2022 at 57 bps).
China Development Bank CDS jumped 12.5 to 91.5 bps, surpassing the March 2020 crisis spike to a five-year high (began the year at 55bps).
Industrial & Commercial Bank of China CDS rose 12 to 94 bps, almost matching the March 2020 spike high (began the year at 57bps).
And Bank of China CDS closed Thursday’s session at 91 bps, up 12 w-t-d to surpass March 2020 highs (began 2022 at 56bps).
China Bank Assets have surpassed $55 TN this year, having doubled in only seven years.
Bank Assets have inflated five-fold since the 2008 crisis.
One would have to be a wild optimist to assume satisfactory asset quality.
At more than 300%, China dwarfs the U.S. Bank Assets ratio of just over 100% of GDP.
It’s rational for markets to begin pricing in massive stimulus and bank recapitalizations.
China sovereign CDS traded to 81.9 bps during Wednesday’s session, up nine for the week to the high since the March 2020 spike to 90 bps.
April 28 – Financial Times (Hudson Lockett):
“The renminbi is set to close out its steepest monthly fall on record as China’s economy reels from severe Covid-19 lockdowns and the US Federal Reserve prepares to raise interest rates, driving global investors to ditch Chinese assets.
The Chinese currency has fallen 4.2% this month to about Rmb6.6 per dollar, the biggest drop since the end of its US dollar peg, which was in place from 1994 to 2005.
The fall is greater than a one-off devaluation by the Chinese central bank in 2015 that rattled global markets and a tumble in 2018 during the US-China trade war under the Trump administration.
The pace of selling intensified after Chinese president Xi Jinping announced an ‘all out’ infrastructure spending package intended to help mitigate the damage from lockdowns in Shanghai and other cities.”
The renminbi declined 1.62% this week (offshore renminbi down 1.76%), with a stunning two-week drop of 3.59% (offshore renminbi down 3.94%) – trading this week to the low since November 2020.
Beijing is on a Collision Course.
“Covid zero” is significantly accelerating the deflation of its historic Bubble.
Meanwhile, global inflation continues to surge.
Global central banks have commenced what is expected to be aggressive tightening cycles, with the market now seeing about a 50% probability of a 75 bps hike at next Wednesday’s FOMC meeting.
April 28 – Bloomberg (Daniel Moss and Gearoid Reidy):
“Any doubt that the Bank of Japan is comfortable with a weak yen should now be eliminated.
The central bank is effectively doubling down on the trademark super-easy monetary stance it began developing decades ago — just as the Federal Reserve and its peers become more aggressive in raising rates.
In a statement after its policy meeting Thursday, the BOJ defended its efforts to keep the yield on 10-year government bonds near zero, and said it will buy a limitless amount of debt at fixed rates every business day to hold the line.
The bank kept its guidance that rates will stay low or go south…
Anyone looking for even a hint that Japan was prepared to crab-walk away from emergency settings would have been sorely disappointed. Traders, justifiably, hammered the yen.”
The yen declined another 0.9% this week, boosting April losses to 6.13% - and the 2022 drop to 11.22% - trading this week to the low versus the dollar back to 2002.
Yen weakness places Chinese manufactures at a competitive disadvantage, only emboldening Beijing to play the currency devaluation card in an attempt to mitigate mounting economic woes.
International investors have already been dumping Chinese assets.
Higher-yielding Chinese debt securities are losing their relative appeal (in a rising yield world), and now even the perceived stability of the Chinese currency is in question.
I have suspected that speculative leverage has expanded tremendously in China over recent years.
Enticing yields and a perceived stable (and appreciating) currency only ensured massive “carry trade” leverage.
There has been a proliferation of hedge funds in China and throughout Asia more generally.
Singapore, in particular, has become a major hub for leveraged speculation.
Now the region has become a hotbed of currency instability, raising the specter of de-risking/deleveraging-related market discontinuity.
Asian currencies were again under pressure this week, capping a dismal month.
April declines included the Japanese yen down 6.2%, the South Korean won 3.5%, the Malaysian ringgit 3.5%, the Thai baht 2.9%, the Taiwanese dollar 2.9% and the Singapore dollar 2.1%.
Asia Credit default swap (CDS) prices increased notably this week and during April.
For the month, Philippines CDS rose 32 bps (to 111bps), Vietnam 25 bps (137bps), Malaysia 25 bps (92 bps), India 22 bps (127bps), Indonesia 21 bps (106bps), and South Korea 12 bps (41bps).
Also factor in that Asia is the epicenter of technology manufacturing - with the global “tech” Bubble in grave jeopardy.
The confluence of China’s bursting Bubble, Japan’s foolhardy monetary policy gambit, and highly levered systems puts Asia today on a Collision Course with rapidly deteriorating macro and micro fundamentals.
I’ll assume mounting hedge fund and derivative issues.
“Amazon’s Biggest Drop Since 2006 Caps Miserable Month for Tech.”
“Top Five U.S. Stocks Lose $1.2 Trillion in Value in April.”
“Tech Stocks Sink Again, Nasdaq Has Worst Month Since 2008.”
The Nasdaq100 dropped 3.8% this week, boosting 2022 losses to 21.2%.
Technology dynamics are alarmingly reminiscent of the 2000 bursting Bubble episode.
The seemingly irrepressible massive flow of speculative finance has now reversed, triggering a destabilizing tightening of financial conditions for an inflated industry that has for years wallowed in extreme monetary overkill.
“Amazon.com Inc. acknowledged that a hiring and warehouse building binge during the pandemic is catching up with the company…”
Industry heavyweights such as Amazon and Netflix are only the most obvious companies that spent egregiously in industry Arms Race Dynamics (with little concern for profits).
Hiring and building excess are part of the story. Yet the overshadowing risk to the industry today is a drained money spigot, forcing a 2000-2002-style slashing of technology infrastructure and advertising spending.
The vulnerable technology/media/telecom (TMT) super-industry is today on a Collision Course with bursting speculative Bubbles and rapidly tightening financial conditions.
A dreadful amount of uneconomic chaff will be exposed.
Investment-grade CDS gained four this week to 84 bps, the high since May 2020 (began 2022 at 50bps).
It was curious to see a number of “TMT” companies high on the week’s CDS leaderboard – Dell (up 13bps), AMD (up 9bps), Disney (up 9bps), Verizon (up 7bps), Comcast (up 7bps), Cox Communications (up 6bps), HP (up 6 bps), AT&T (up 6bps) and Oracle (up 6bps).
High-yield CDS surged 27 bps this week to a 21-month high 467 bps (began the year at 292bps).
April 29 – Bloomberg (Michael Gambale):
“No companies are looking to issue fresh debt on Friday, according to an informal survey of debt underwriters, after a bunch of issuers shelved bond sale plans this week amid financial markets volatility.
Weekly volume is likely to finish at $8.6 billion, well below consensus estimates calling for as much as $25 billion.
This was the second biggest miss this year…”
The resilience of investment-grade bond issuance appeared to have finally succumbed this week.
Bank stocks were hammered 5.2%, and the Broker/Dealers sank 4.7%.
Also supporting the Destabilizing Financial Conditions Tightening Thesis, Bank CDS prices jumped to at least 2022 highs.
JPMorgan CDS rose seven this week to 87.5 bps – the high since April 2020.
Citigroup CDS jumped nine to 110.5 bps, and BofA CDS rose seven to 92 bps – both highs since April 2020.
Morgan Stanley CDS jumped nine to 105.5 bps (high since April 2020), and Goldman Sachs gained five to 107 bps (high since May 2020).
Market consensus has the FOMC hiking rates 50 bps next week, as “Traders Price Near-Even Odds of 75-Basis-Point Fed Hike in June.”
Breaking with the consensus, I see next week’s 50 bps hike as likely one and done with aggressive (50bps or higher) rate increases.
The Fed, after all, is on a Collision Course with a market De-risking/Deleveraging Dynamic and precarious market liquidity crisis.
Personal Spending jumped a stronger-than-expected 1.1% in March.
Rising 0.9% in March, the PCE Deflator was up 6.6% y-o-y – with the (Fed’s favored inflation indicator) Core PCE Deflator up 0.3% for the month and 5.2% y-o-y.
The Q1 GDP Price Index was revised up to 8.0% annualized.
The March Goods Trade Balance was reported at $125.3 billion – about 18% ahead of January’s record.
The S&P CoreLogic 20-City Home Price Index had prices up a blistering 2.39% for February, boosting y-o-y housing inflation to 20.2%.
Everything points to powerful inflationary dynamics and a Federal Reserve hopelessly “behind the curve.”
The market is now pricing in a 2.86% Fed funds rate at the Fed’s December 14th meeting.
Moreover, the Fed is expected to soon commence its $95 billion monthly balance sheet reduction (“QT”).
Aggressive tightening measures are now on a Collision Course, with the market’s faith in the hallowed “Fed put.” This is a huge unfolding issue.
The Fed is embarking on the first real tightening campaign since 1994, with securities markets already at the brink of illiquidity and dislocation.
Markets could soon be clamoring for assurances of the Fed’s “buyer of last resort” liquidity backstop, while our central bank is preparing to begin withdrawing liquidity by selling Treasuries and MBS.
Amazingly, the ECB is even further behind the curve than the Fed.
Annual euro zone consumer inflation reached a record 7.5% in April, with German inflation at a multi-decade high 7.8%.
European periphery bond markets (and the bank/bond “doom loop”) are on a Collision Course with “risk off” and tightened conditions.
Greek 10-year yields surged 35 bps this week (up 201bps y-t-d) to the high since the March 2020 crisis spike.
Italian yields rose 10 bps (up 160bps y-t-d) to the high (2.77%) since February 2019.
European bank stocks dropped 3.6%, as bank CDS surged.
Credit Suisse CDS jumped 15 to 135 bps (began ’22 at 57bps) – the high since the pandemic spike.
Deutsche Bank CDS rose 10 to an almost one-year high 94.5 bps, and SocGen gained 9 to 67 bps.
European high-yield (“Crossover”) CDS surged 40 this week (up 56 bps in seven sessions) to 428 bps – the high since May 2020.
And while on the subject of Collision Courses…
April 25 – Bloomberg:
“Russian Foreign Minister Sergei Lavrov warned there’s a ‘serious’ risk of nuclear war over Ukraine in a statement the U.S. blasted as the ‘height of irresponsibility.’
‘The danger is serious, real.
It can’t be underestimated,’ Lavrov said in a state TV interview broadcast...
Invoking the Cuban missile crisis of 1962, when the U.S. and the Soviet Union came close to nuclear war, he said that Moscow and Washington had understood the rules of conduct between the superpowers but ‘now there are few rules left…’
U.S. State Department spokesman Ned Price said Lavrov’s comments were part of a ‘pattern of bellicose statements’ from Russia, which he branded ‘irresponsible’ and ‘a clear attempt to distract from its failure in Ukraine.’
‘Loose talk of nuclear weapons, nuclear escalation is especially irresponsible, it is the height of irresponsibility,’ Price told reporters…”
April 28 – The Hill (Maureen Breslin):
“Russian President Vladimir Putin… warned of a ‘lightning fast’ response if any nation interferes in its war in Ukraine, according to multiple reports.
Putin made the threat against any country that creates ‘strategic threats for Russia,’ CNBC reports.
‘If someone intends to intervene on what is happening from the outside and creates unacceptable strategic threats for us, then they should know that our response to oncoming strikes will be swift, lightning fast,’ Putin added…
‘We have all the tools for this, ones that no one can brag about, and we won’t brag — we will use them if needed — and I want everyone to know this.
All the decisions have been made in this regard,’ said Putin.
A mention in his remarks of ‘instruments [to respond] that no one can brag about’ is reportedly speculated to be a reference to the Russia’s supply of intercontinental ballistic missiles and nuclear weapons.”
Powerful and sophisticated munitions now flood in to support Ukraine’s Herculean war effort.
The Ukrainians say Russia is suffering “colossal” losses in fierce fighting on multiple fronts.
Russia appears resolved to wreak only more horrific destruction.
The U.S. and NATO are determined to see a defeated Putin.
The conflict now has all the elements of a high-stakes “proxy war.”
And I understand that the West cannot be blackmailed or even appear intimidated by Russia’s references to nuclear war.
And while each passing threat becomes only easier to dismiss, the risks are of such an extreme nature that they cannot be ignored.
This has developed into the most perilous geopolitical flashpoint since the Cuban missile crisis.
April 28 – Wall Street Journal (Peggy Noonan):
“Sometimes a thing keeps nagging around your brain and though you’ve said it before you have to say it again.
We factor in but do not sufficiently appreciate the real possibility of nuclear-weapon use by Russia in Ukraine.
This is the key and crucial historic possibility in the drama, and it really could come to pass.
And once it starts, it doesn’t stop.
Once the taboo that has held since 1945 is broken, it’s broken.
The door has been pushed open and we step through to the new age.
We don’t want to step into that age.”
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