An Insiders View on China’s Policy Conundrums

Alpine Macro’s Chen Zhao is one of the more politically-connected China analysts. He recently published the transcript of his lengthy conversation with a recently retired senior Chinese bureaucrat, which we think adds some great context to the thinking inside China. Because lets admit it, we have no idea really when looking from the outside in. Chen’s source told him that monetary easing so far has been far too modest, and companies and consumers remain crippled by extraordinarily high borrowing costs. Interest rates (the rates applied to corporates and consumers) needs to drop much further so that liquidity injected into the banking system which will translate into credit creation that makes a difference, the source told Chen.  The former official said expects rate cuts this year, but not big ones, due to the constraint of a fear of a run on the yuan. Chinese policymakers, Alpine Macro were told, may have underestimated the downward momentum that has developed in the economy. The source expected that once the U.S. mid-term elections were over, Trump could be under less political pressure to attack China over trade. But nobody in Beijing knows how to deal with him. a fascinating discussion. Click below to request a copy of this interview from Alpine directly.

OIl; Price Targets on WTI and Brent

Worsening economic conditions, especially in emerging markets, are set to push Brent down to $65 next spring, Rapidan Energy argues in research published last week. The IMF’s cut to its global growth forecasts to 3.7% from 3.9% for 2018 and 2019 prompts Rapidan to lower its global demand growth projections down by 0.1 mb/d for both years. Rapidan have had a high-conviction bearish view for a while now, but last week they highlighted how this view is gaining much wider appeal with all three agencies materially loosening both 2018 and 2019 global oil balances.  As early as May of this year, Rapidan proved to be on the money in predicting that a market refocusing on fundamentals would drive prices down towards $65. Saudi threats to retaliate against possible US sanctions over the suspected murder of journalist Jamal Khashoggi in Istanbul on October 2 by causing an oil price spike can be disregarded, Rapidan argues in a separate report. The Saudis will stop short of antagonizing Trump and isolating themselves internationally. But the odds on NOPEC, or a No Oil Producing and Exporting Cartels Act, being passed in the US are increasing. NOPEC would also expose the 24 other members of the Vienna Group to antitrust lawsuits under the Sherman Antitrust Act. The implications are bullish for WTI versus Brent, as countries accounting for 43% of US crude imports would face fines. NOPEC would also jeopardize heavy crude imports from Mexico and Venezuela, benefiting Canadian crude. Click below to request sample any of the reports referenced above.

Time to Revisit JPY as a Safe Haven?

USDJPY has chopped a lot of wood between 112 and 113 in the past week and we’ve read of host of bearish pieces on USDJPY and reasons why the Yen should strengthen. It has yet to break down. Udith Sikand from Gavekal was one of those calling for lower USDJPY back in July. He was way too early he concedes, while foreign investors have failed to be lured back into Japanese equities, despite the most attractive valuations in years. In fact, Japan has actually seen outflows, Sikand, in the form of Japanese bond investors buying USTs, and probably unhedged, he says. It’s for this very reason that he remains optimistic that the bearish USDJPY view still has legs. a shift in sentiment as a safe haven could very well trigger a significant repatriation from Japanese bond investors and really set off a move lower. For access to this piece click below to contact Gavekal directly.

Finding a Rare China Bull

There’s no shortage of research that’s bearish on China, while the media have jumped on the bandwagon as China equity markets tank. Finding a bull among these bears is no easy task.  Veteran China analyst Simon Hunt is one of those rare bulls. He has published extensively in recent weeks, following multiple trips to the country and its industrial heartlands. Sure there have been some serious problems in credit transmission to the real economy, concedes Hunt, but many of these bottlenecks have been cleared and things are flowing again, he says. Hunt has also done his own research on the ground, and the evidence he sees is a high level of activity which suggests a broader based recovery is beginning to set in, with the negative sentiment due to the trade and credit issues acting as a cloud over the market. The foundations are being laid for a robust recovery in the fourth quarter and in 2019. Lastly, following Friday’s GDP print, Hunt provided  an update to his earlier reports, which was essentially was unchanged. He saw no surprises in the data issued for September. Growth has slowed but the economy is still growing, he says, with monetary aggregates recovering, bottlenecks within the credit transmission system easing and infrastructure spending recovering. Meantime, tax cuts for both households and businesses will come to the rescue of struggling consumers. If you’d like to discuss China with Hunt, feel free to reach out to his team arrange a call.

Saudis Oil Weapon has no Cutting Edge; No Shortage of Supply

It’s still unclear what measures will be taken by the international community against Saudi Arabia following the admission that Jamal Khashoggi was murdered in Istanbul on October 2. There’s also the question of how Saudi might retaliate via actions in the oil markets, and whether they might use oil as a weapon. Mehran Nakhjavani from MRB Partners addressed this question in a recent webcast, where he argued that use of any “oil weapon” will be either ineffective, or counterproductive, because raising prices would do nothing to hurt the US economy, a net oil exporter, but would damage demand in the Saudi Arabia’s most important markets in China and India. Oil prices are too high for reasons that cannot be justified by likely supply and demand outcomes. Only a major conflict in the Persian Gulf would be enough to trigger a fundamental shortage of supply. Demand remains in good enough shape to avoid a clearly bearish scenario, though demand forecasts will be reduced at the margin.  OECD demand is forecast to resume its gradual trend decline. Click below to request access to the webcast from MRB directly.

The Ties that Bond; The Pitfalls of Being Tethered to Big Central Bank Policy

Monetary policy in small, open economies must take into account the policy setting abroad as well as domestic economic conditions, writes Jan Hatzius,  Sven Jari Stehn and Nicholas Fawcett from Goldman Sachs. But, this constraint is not without trade-offs. In this note GS say that following the monetary policy of larger regional economies can insure against volatile capital flows and large exchange rate adjustments, but at the same time it might mean setting policy somewhat more accommodative or restrictive than domestic conditions would otherwise warrant. It is what they call ”The Ties That Bind.” This idea has important applications in the Nordic region, the report says, where central banks will likely raise rates sooner and more aggressively than their counterparts at the ECB. In this scenario, say Goldman, foreign exchange appreciation would not only be tolerated, but welcomed. GS clients can read the full note below.

USD/JPY Tipping Point

SG put out a note last week highlighting two important correlation shifts that support Yen strength; the breakdown in the positive correlations between US yields and the CNY. SG also note that this led ”USD/JPY to massively reject the 114.20/60 resistance area.”  In relation to the recent weakness in CNY, SG say that in a world of increased risk aversion, it makes JPY longs look very attractive. To express that view SG argue that an options strategy might be an efficient strategy. Furthermore, SG say there’s even a possibility of a BoJ repricing, that could mean higher domestic rates become a stronger driver of the currency. SG note that there’s a high vol risk premium (The 3m implied vol is trading at 7.1, whereas the 1m and 3m realised are about 5.5) , while on the other hand, the correlation between spot and volatility is low. This suggests to them that downside vega is unlikely to perform significantly if USD/JPY falls. One example is to buy USDJPY puts with a knock out option, which takes advantage of both the high volatility risk premium and the negative skew to cheapen a short vega option. SG client can read the full note by clicking below. To enquire about trialing the SG research product, click here.

What’s Correlating in FX?

Nomura put out a note yesterday updating their G10 FX correlations tables which we thought worth noting. They show that risk-off correlations continue to hold in EUR crosses as concerns over the Italian budget show no signs of respite, but what really caught their eye was changes in correlations between EURCAD and Bund-BTP spreads which have risen significantly. There have also been big moves in the correlations between commodity currency crosses and rate differentials are picking up across the board, e.g. AUDCAD. Nomura clients can access the note below. Interested in sampling Nomura’s FX research, click here.

Trump and Trade Unveiled

OM Research focuses on areas which are under-served and poorly represented in the sell side research space, yet are essential for a holistic and accurate understanding of present and future trends. One such strand of research is in the area of behavioural science at a geopolitical level. They’ve recently produced some interesting work looking at the high-level implications the US-China trade wars. On Oct 4th they published a behavioural report on the OODA (Observe, Orient, Decide then Act) loop that outlined how acting in an unusual manner has led to many successes for Trump – and they posed the question as to whether Trump would reach back for such psychological comfort in the event of bruising mid-terms? In their latest research they argue that the newsflow of recent weeks suggests a potential turning point on the trade and geopolitics front. This newsflow now provides a much better understanding of what the America First approach to international negotiations amounts to. OM Research argue that Canada and Mexico have effectively ceded sovereignty over trade talks with China in order to keep the economic gains of NAFTA. The scope of U.S. rivalry with the China is being deepened and widened in every official report. Click below to request trial access to OM Research’s reports.

Is the Phillips Curve Back From the Dead?

In the lexicon of most cited words on inflation, wage inflation might just top the list. Many analysts argue that tightening labour markets and wage inflation will be a key catalyst to the re emergence of inflation. Capital Economics think this is perhaps overstated. In a note: ”Is the Phillips Curve back from the dead?” published today,  economists Simon MacAdam and Franziska Palmas acknowledge that after years of falling unemployment, wage growth has finally been picking up in the major advanced economies this year. However, they argue that the forces that have kept a lid on pay growth over the past decade are likely to prevent it from rising sharply, even at historically-low rates of unemployment. Does this mean wage growth is about to shoot up? Capital don’t think that’s likely. The upshot is that we think wage growth is going to rise a bit in major advanced economies, but not take off. As a result, core inflation should also rise only gradually next year.