Category: Europe

Global asset deflation: nowhere to run, nowhere to hide

Over the past several months global stocks, bonds and currency markets have hit a wall.  Just 6-8 months earlier the central banks of Europe, Japan and the US were signaling endless monetary accommodation which initially emboldened global speculators and their reach-for-yield mantra.  Now we look around for evidence or confirmation that the four year stimulus experiment is DOA.

First, emerging market stocks, bonds and currencies have all dropped somewhere between 7% and 12% the last few months as the carry trade (borrowing in low cost currencies in order to buy higher returning risk assets, thus capturing the spread) comes off the boil.  Second, political commentary out of China confirms our earlier thoughts that a credit bubble for the ages has begun to burst.  Since the central banking talking heads opened their mouths last month, Shibor rates (Chinese overnight unsecured lending rate amongst 16 largest banks)  have spiked to levels not seen since 2004:

Shibor-overview

Here is the latest on the Chinese banking system from Bloomberg:

Policy makers could be taking advantage of tight funding to “punish” some small banks, which previously used low interbank rates to finance purchases of higher-yielding bonds, Bank of America Merrill economists led by Lu Ting wrote in a report. Tight interbank liquidity could last until early July, according to the report.

‘Warning Shot’

“The PBOC [People’s Bank of China] clearly has an agenda here,” said Patrick Perret-Green, a former head of Citigroup Inc.’s Asian rates and foreign exchange who works at Mint Partners in London. “To fire a massive warning shot across the banks’ bows and to see who is swimming naked. Moreover, it fits in well with the new disciplinarian approach” adopted by the government, he said.

Chinese regulators are forcing trust funds and wealth managers to shift assets into publicly traded securities as they seek to curb lending that doesn’t involve local banks, so-called shadow banking, according to Fitch Ratings.

The tightening is “emblematic of some of the shadow banking issues coming to the fore as well as some of the tight liquidity associated with wealth management product issuance, and the crackdown on some shadow channels,” Charlene Chu, Fitch’s head of China financial institutions, said in a June 18 interview. She earlier estimated China’s total credit, including off-balance-sheet loans, swelled to 198 percent of gross domestic product in 2012 from 125 percent four years earlier, exceeding increases in the ratio before banking crises in Japan and South Korea. In Japan, the measure surged 45 percentage points from 1985 to 1990, and in South Korea, it gained 47 percentage points from 1994 to 1998, Fitch said in July 2011. [Emphasis mine.  Japan and South Korea experienced bubble economies during these periods which both burst.]

Look at the massive growth in nonbank (shadow) lending in China post 2008 credit crisis while keeping in mind most of this was indirectly backed by the largest banks under the “wealth management” label:

Chinese shadow banking

Maybe this is why China made the news last week when a proposed 15.5 billion renminbi bond offering failed (for the first time in nearly 2 years), receiving only 9.5 billion renminbi.

Over in Russia and Korea we see even more instability permeating the credit landscape.

Romania’s Finance Ministry rejected all bids at a seven-year bond sale yesterday because of market volatility, while South Korea raised less than 10 percent of the amount planned in an auction of inflation-linked bonds. Russia scrapped a sale of 15-year ruble-denominated bonds June 19, the second time it canceled an auction this month, and Colombia pared an offering of 20-year peso debt by 40 percent. A cash shortage led to failures last week of China Ministry of Finance debt sales.

More than $6.9 billion left funds investing in developing-nation debt in the four weeks to June 19, the most since 2011, according to Morgan Stanley, citing EPFR Global data. The exodus is reversing the $3.9 trillion of cash that flowed into emerging markets the past four years as China’s annual economic growth averaged 9.2 percent and spurred demand for Brazilian iron ore, Russian oil and gas and Chilean copper.

Romania rejected all 688 million lei ($200 million) of bids at a bond sale yesterday because of “unacceptable price offers,” according to an e-mailed statement from the central bank. It was the first failure since August.

South Korea sold just 9 percent of the 600 billion won ($524 million) it targeted from 10-year inflation-linked bonds this week. Colombia’s government pared an auction on June 19 of 20-year inflation-linked peso bonds by 40 percent, to 150 billion pesos ($77 million).

Russia canceled planned sales of 10 billion rubles ($311 million) of notes this week, citing a lack of demand within an acceptable yield range of 7.70 percent to 7.75 percent. Yields on ruble bonds due in 2028 jumped 30 basis points, or 0.30 percentage point, yesterday to 8.1 percent, the highest level since the debt was sold in January.

After endless monetary interventions the prior 3-4 years governments around the world temporarily created the illusion that interest rates would stay below nominal GDP growth targets.  The sleight of hand only lasted this long because so many of the “professional money managers” never questioned the actions of central bankers (a.k.a. asset inflationistas) .  As currencies, bonds and stock markets decline in unison around the world, one might pose the question “Have central bankers lost control of their monetary experiment?”  Or better yet, why would so many “investors” believe that a group of central banks with combined reserves of $11.5 trillion could levitate with over $240 trillion in global assets?   Which then begs the question,  where does one hide?

Can Cyprus create a contagion within the EU?

Over the last week Cyprus has made front page news as the country teeters on the brink of insolvency.  Knowing the powers at be have stricken the word from their playbook, or replaced it with “liquidity issue”, one must now consider the fate of the EU.   How can this be when Cyprus is a tiny .2% of eurozone GDP?   Consider this, according to the latest bank figures from the BIS, European banks had $38 billion of exposure to Cyprus!   In addition, last week the ECB threatened to withdraw emergency lending access (ELA) to the Central Bank of Cyprus unless they move forward with the proposed bank bail-in restructuring.

Cyprus has proposed the idea of a bail in as a way to recapitalize their insolvent banking system whereby depositors above and below 100,000 euros will be given haircuts of 9.9% and 6.75% respectively.

Of course, this completely violates traditional bank restructuring laws where depositors are the last party in line to incur any losses.  Which then begs the question, “why is the ECB trying to protect bondholders”?

Lets take a step back and review the moving parts in this game.  First, Cyprus is a low tax haven for Russian oligarchs while total deposits from Russia are somewhere near $26 billion or 130% of Cypriot GDP.  Total bank deposits are approximately $140 billion.

Over the last week the Central Bank of Cyprus has been posting sovereign debt at the ECB window, with undisclosed haircuts, in order to keep a lifeline open for the banks (which have been closed over this period of time).  During the Greek crisis haircuts ranged from initial 25% to 50% as the situation worsened due to strings attached by the ECB.

Final comments:  Why all of a sudden are the Cypriots being threatened by a complete removal of ELA by the ECB unless a bail-in is imposed on depositors?  Could one reason be the $9.7 billion in German bank exposure to Cypriot banks?  Or is there really no collateral, unlike Greece, so the ECB has no choice but to go after Russian oligarchs with a 10% money laundering fee?  Either way, the tiny country of Cyprus has already set off Spanish and Italian bank runs as the EU periphery prepares for possible bail-in aka ECB theft operations.  Now all we need to see is Mario Draghi making a statement, a la Ben Bernanke at the outset of the subprime bubble bursting, “Cyprus is only .2% of ECB and remains contained”.

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