China Crashing: Shanghai Composite Tumbles Most Since 2009

by Tyler Durden

Those who have been holding their breath until China joins the overnight market fireworks can finally exhale.

Following yesterday's unprecedented formal announcement of epic capital misallocation, the PBOC tried to continue the damage control when a few hours ago it announced that Chinese banking system liquidity "is at a reasonable level", but that banks must control liquidity risks from fast capital expansion, especially credit expansion, according to a statement on management of banks’ liquidity on website. The implication: no easing any time soon, and sure enough no repo or reverse repo activity was logged in the overnight session meaning Chinese banks, for the time being, continue to be on their own, without any hope of the central bank stepping in to bail them out.

The PBOC announcement appears to have restored some stability in the interbank market if only for a very brief amount of time: the 1 Month SHIBOR drops 234 bps, most since Oct. 2007, 7.3550%, with the one-day repo rate falling 204 bps to 6.6540%. Longer-term liquidity also improved modestly, with the seven-day repo rate drops 159 bps after sliding 237 bps on June 21. However, as Market News reported , the PBOC won’t cut reserve ratio, interest rates in near term, and if anything will just use more open-market operations. The problem with this kind of opaque intervention is that it once again raises the specter tha behind the scenes one or more banks are getting direct bailouts. In other words, look for real interbank liquidity to be abysmal at best.

Not helping the PBOC's credibility was the news that China Development Bank canceled a bond sale up to CNY20 billion planned for tomorrow for "reasons."

Certainly not helping China was that late on Sunday Goldman cut its China growth forecasts for 2013 and 2014, "on the account of soft cyclical signals and recent tightening of financial conditions. We now expect real GDP growth to be at 7.5% yoy in Q2 2013 (from 7.8% previously), and 7.4% and 7.7% for 2013 and 2014 respectively (from 7.8% and 8.4% previously)."

End result: the Shanghai Composite, which had largely been able to weather the recent dramatic shocks to both liquidity and the economy, finally threw in the towel and crashed. Moments ago the Shanghai Composite fell 5.5%, the biggest intraday slide since August 2009, and dropping below 2,000 for first time since December.

The brodest China index is now down 14% year to date, with the Property Index leads slump with 7.7% drop to lowest since November.

Needless to say the world's second largest economy imploding, and its stock market crashing were enough to send all of Asia lower, with the Nikkei225 unable to sustain gains on a weaker Yen, and swining from up over 1% to down 1.3%. As for that China derivative, Australia and specifically its currency the AUD, it just hit a fresh 52 week low against the USD at 0.9155.

Of course, if the BIS's warning about what is coming to the "developed markets" is accurate, this is nothing but a pleasant rehearsal of what one can expect in the US and in other G-7 places.

As for China, if Goldman is correct, look for much more pain below. Here is the summary of the firm's downgrade of the Chinese economy:

We are cutting our China growth forecasts for 2013 and 2014, on the account of soft cyclical signals and recent tightening of financial conditions. We now expect real GDP growth to be at 7.5% yoy in Q2 2013 (from 7.8% previously), and 7.4% and 7.7% for 2013 and 2014 respectively (from 7.8% and 8.4% previously).

The recent tightening of the interbank market has sent a strong policy signal that the strong credit growth earlier in the year will likely not continue. We estimate this to tighten the FCI by another 30-40 basis points (bp) in the coming months, in addition to the FCI tightening of 100 bp so far this year driven by the rapid CNY appreciation on a trade-weighted basis.

The liquidity tightening is another indication that the new government has put priorities on tackling the structural problems. These policies help to foster more sustainable medium-term growth, but will test the government’s tolerance for a cyclical downturn. A reversal of the recent tightening is the main upside risk to our new forecast. Continued DM stagnation or spreading overcapacity problems will imply downside risks.

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US Traders Walk In To Another Bloodbath

by Tyler Durden

Lots of sellside squeals this morning following the epic bloodbath in China, where in addition to what we already covered hours ago, has seen at least five companies (China Development Bank, Shanghai ShenTong Metro, China Three Gorges Corp., Doosan Infracore China Co. and Chongqing Shipping Construction Development) delay or cancel bond offerings as the PBOC's admission of capital "misallocation" is slowly but surely freezing both bond and stock markets. And while the plunge was contained first to China, then to Asia, then to Europe (where the Spanish 10 Year once again surpassed 5% as expected following the carry trade unwind), with the arrival of bleary-eyed US traders the contagion is finally coming home.

In a redux of last week, 10 Year yields are shooting up, hitting as high as 2.63% a few hours ago, while equity futures are now at the lows of the session. It could turn very ugly, very fast, especially if the Hamptons crowd were to actually read the stunning BIS annual report released on Sunday, which not even Hilsenrath explaining "what the BIS really meant" will do much to change the fact that the days of monetary Koolaid are ending.

DB's Jim Reid summarized the angst among Wall Street quite well earlier:

There was plenty of weekend news to digest but most of it seemed to circle around three main themes: China, the implications of June’s FOMC and the situation in EM. Starting with China, domestic financial stocks (-4.0%) are seeing sharp losses this morning amid ongoing news flow around liquidity tightness in the interbank market.

In terms of the latest on bank liquidity, the PBoC posted a statement on its website today that said banking system liquidity remains at a “reasonable level”, but warned that Chinese banks must control liquidity risks from credit expansion. This came after China Development Bank, the country’s policy bank became the latest institution to cancel a bond sale (originally scheduled for tomorrow). The official state news agency, Xinhua, wrote over the weekend that "it is not that there is no money, but that the money has not reached the right places". The article suggested that a misallocation of funds into wealth management products had caused the tightness in liquidity in some banks. Indeed, Fitch noted last Friday that more than CNY1.5 trillion in WMPs - substitutes for time deposits - will mature in the last 10 days of June. Issuance of new products, and borrowing from the interbank market, are among the most common sources of repayment for maturing WMPs, and the recent interbank liquidity shortage complicates both.

China's mid-tier banks, are likely to face the most difficulty says Fitch, with an average of 20%-30% of total deposits in WMPs. This compares with 10%-20% for state-owned and city/rural banks. Fitch also noted that the PBOC’s hands-off response in easing the recent tight monetary conditions reflects in part a new strategy to rein in the growth of shadow finance by constraining the liquidity available to fund new credit extension.

Elsewhere in the region, we are seeing a continuation of the weakening trend in EM bonds and local currencies. Asian EM sovereign bonds and CDS are about 5-10bp wider to start the week. China CDS has given back more than what it gained on Friday and is 10bp wider overnight. Most currencies continue to weaken against the USD and the dollar index is 0.4% higher this morning. The Nikkei (-1.2%) is outperforming on a relative basis, helped by a 0.5% rise in USDJPY, after PM Abe's Liberal Democratic Party won a sweeping election victory on Sunday.

The LDP secured an overall majority in the 127-seat Tokyo metropolitan assembly with its coalition partner the New Komeito party. The victory is seen as a good sign for Abe’s government as it heads into upper house elections next month.

Returning to Friday’s session, for much of the day we had a continuation of the momentum that has gripped markets since last Wednesday’s FOMC. Indeed, the S&P500 was languishing at a low of -0.68% early in Friday’s session and was
poised to close weaker for the third straight session, before staging a comeback on the back of a couple of Fed headlines. The first set of headlines suggested that the Fed could delay QE tapering if worsening financial conditions, in the form of rising bond yields and lower stock prices, hurt the economy. There wasn’t much detail behind the headlines though, and the Fed sources were unnamed. As we discussed in our EMR on Friday, volatile markets could keep the Fed on hold for longer than they and the market now think. We continue to expect a difficult few weeks for risk followed by a realisation that the pace of tapering will actually be slower than flagged on Wednesday which in turn will eventually provide some good buying opportunities before the summer is out.

Several minutes after the first Fed headlines hit screens, the WSJ’s Hilsenrath was on the newswires again suggesting that the market had overlooked a number of dovish signals in Bernanke’s post-FOMC press conference. These signals included the Chairman hinting that rate rises would be gradual, and that “a strong majority” of Fed officials had concluded the Fed won’t ever sell its growing portfolio of mortgage-backed securities. This was followed by dovish comments from the Fed's Bullard who said on Friday that the decision to taper was “inappropriately timed” because inflation and economic output has been soft. Interestingly, 10yr yields continued to push higher despite the headlines, and managed to cross the 2.5% mark in the final minutes of Friday’s trading (closing 11bp higher at 2.53%). Selling pressure continued in EM equities despite the better tone in US equities. The MSCI EM index closed 0.88% weaker for its 4th straight loss. Across the EM world, bonds and currencies were generally weaker amid negative reports of outflows. Mexican and Turkish 10yr yields added 11bp and 32bp respectively.

Turning to the day ahead, we have little on the radar today outside of the latest monthly German IFO survey. Indeed, we have a relatively quiet week ahead of us compared with the events which have transpired over the course of the past seven days. Tomorrow, the data flow begins to pick up with US durable goods orders, new homes sales and consumer confidence in the US. On Wednesday, the third and final estimate of US Q1 GDP is scheduled. On Thursday, the UK’s Office for National Statistics will release its annual revisions of past data alongside its third estimate of first-quarter GDP. Other data on Thursday include US personal income /consumption and jobless claims together with an update on German employment. The 2-day European Council/EU Leader's summit starts on Thu with the agenda to consider country specific recommendations on economic policy + bank supervision. To round out the week, Japanese CPI, industrial production, unemployment and retail trade for the month of May is due out on Friday. In the US, the Chicago PMI will also be released on Friday. With the focus on yields, and the patchy demand in recent auctions, it worth keeping an eye on the UST auctions this week: We have US$35bn in 2-year notes on Tues, $35b of 5-year notes on Wed and $29bn in 7-year bonds on Thu. In addition, we get another round of post-FOMC Fedspeak with Fed Governor Powell and Atlanta FedPresident Lockhart speaking on Thursday, followed by regional Fed presidents Lacker, Pianalto and Williams on Friday.

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The Last Time the Feds Devalued the Dollar To Save the Banks

byJesse

Here is a reprise of an article in which I take a closer look at the Gold Act of 1933 and the devaluation of the dollar against gold to recapitalize the banks.
As you may recall at the time the government withdrew gold from circulation it was the sovereign currency, and essentially 'owned' by the state, even while it was used by individuals as money.
This time gold has no official standing as money, and is considered private property, except perhaps for gold and silver Eagles which is a tenuous claim at best.
Therefore the government might be forced to use extraordinary and deceptive means to keep gold out of the hands of the people, and prepare the way for a revaluation of global currencies against gold is other ways.
Not all countries are on board with this, most notably China and India, although the RBI has been urging its people to substitute paper claims for actual bullion of late.
I do not think the US will go back to a gold standard. However, I do think that there will be some inclusion of gold in the emerging replacement for the US dollar as the reserve currency for global trade. I think it will be a basket of currencies and gold, perhaps silver.
The revaluation of gold to the dollar would boost sovereign reserves significantly. And I suspect that this move is being delayed while some countries are allowed to 'catch up' in their accumulation.

The Last Time the Feds Devalued the Dollar to Save the Banks
14 January 2009
We dipped once again into the Federal Reserve Bulletin Publication from June, 1934 to take a closer look at the growth of the monetary base, and found an interesting graphic that shows the accounting for the January 1934 devaluation of the dollar and the subsequent result on Bank Reserves in the Federal Reserve System.
As you will recall, the Gold Act, or more properly Executive Order 6102 of April 5, 1933, required Americans to surrender their gold coinage and certificates to the Federal Reserve Banks by May 1, 1933. There were no prosecutions for non-compliance except one benchmark case which was brought voluntarily by a person who wished to challenge the act in court.
After a substantial portion of the gold was turned in by US citizens and taken from their bank based safe deposit boxes, the government officially devalued the dollar from 20.67 to 35.00 per ounce in the Gold Reserve Act of January 31, 1934.
The proceeds from this devaluation were used to provide a significant boost to the Federal Reserve member bank positions as shown in the first chart below.
The inflation visited on the American people because of this action helped to take the CPI as it was then measured up 1200 basis points from about -8% to +4% by the end of 1933. To somewhat offset the monetary inflation the Fed also contracted the Monetary Base which served the nascent recovery in the real economy rather poorly and is viewed widely as one of a series of policy errors.
Considering that the actions did little for the employment situation this was painful medicine indeed to those who were dependent on wages.

Fortunately at the same time FDR was initiating the New Deal programs which, despite continual opposition from a Republican minority in Congress, managed to provide a small measure of relief for the 20+% public that was suffering from unemployment and wage stagnation.
People ask frequently "Will the government seize gold again?"
While there is no certainty involved in anything if a government begins to overturn the law and seize private property, one has to ask for the context and details first to understand what happened and why, to understand the precedent.
Technically, the government did not engage in a pure seize of private property, since at that time the US was on the gold standard, and much of the gold holdings of US citizens were in the form of gold coinage and certificates.
Governments always make the case that the currency is their property and that the user is merely holding it as a medium of exchange. The foundation of the argument was that the government required to recall its gold to strengthen the backing of the US dollar against the net outflows of gold for international trade. The devaluation helped with this as well, since dollars brought less gold for trade balances.
People also ask, "Why didn't the government just revalue the dollar without trying to recall all the gold from the American public?"
The answer would seem to be that this would have been more just, more equitable recompense for the public. The Treasury could have purchased gold from the public to support its foreign trade needs.
But it would have left much less liquidity for the banks.
One can make a better case that the recall of the gold, with the subsequent revaluation to benefit a small segment of the population in the Banks, was a form of seizure of wealth without due compensation. Hence the lack of active prosecutions.
So, will the government take back gold again to save the banks by devaluing the dollar?
Highly unlikely, because they not only do not need to this, since the dollar is no longer backed by gold, and is a form of secular property except perhaps for gold eagles, but they do not have to, because they are devaluing the dollar already to save the banks.
This time the confiscation of wealth to save the banks is called TARP. (and subsequently QE - Jesse)
If one thinks about it, US Dollars are being created and provided directly to the banks to boost their free reserves significantly, at a scale comparable and beyond to 1933-34.
The confiscation of wealth is being spread among all holders of US dollars and dollar assets, foreign and domestic, in the more subtle form of monetary inflation.
Granted, the government must be more opaque to mask their actions in order to sustain confidence in the dollar while the devaluation occurs, but this is exactly what is happening, and all that is required to happen in a fiat regime.
There is no need to seize widely held exogenous commodities like gold and oil, but merely dampen any bellwether signals that a significant devaluation of the dollar is once gain being perpetrated on the American people in order to save the banks.
Its fascinating to look carefully at this next chart below.

First, notice the big drop in gold in circulation of 9.8 million ounces, or roughly 36% of the measured inventory at the end of 1932. Think someone was front-running the dollar devaluation? We suspect that the order went out to start pulling in the gold stock to the banks.
The reduction in gold in circulation AFTER the announcement of the Gold Act in April would be about 3.9 million ounces, or roughly 22% of the gold remaining in circulation in March 1933.
Considering that all gold coinage held by banks in the vaults was automatically seized, the voluntary compliance rate is not all that impressive. We are not sure how much of this was being held in overseas hands by non-US entities.
But beyond a doubt, there was a unjust, if not illegal, seizure of wealth by requiring citizen to turn in their gold to the banks, which was then revalued at the beginning of 1934 by 69% from 20.67 to 35 dollars.
It would have been much more equitable to devalue the dollar and to change the basis for dollar/gold first, before requiring private citizens to surrender their holdings. But of course, this would have lessened the liquidity available for direct infusion into the Federal Reserve banks.

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Steepening yield curve benefits banks, but major headwinds remain

by SoberLook

The treasury curve has steepened materially over the past few weeks, driven by Bernanke's seemingly hawkish statements. One group of companies that will benefit from this adjustment is the banking sector.

In fact bank shares have been outperforming the broader market by a significant margin - over 6% in the past couple of months.

The reason is simple. Given the short end of the curve has not budged, banks will continue to pay next to nothing on deposits. But they can now charge much higher rates on new term loans they make. That spread increase (net interest income) will flow right into equity and juice up bank dividends. Bank shareholders and executives should thank Bernanke for this "gift".
But there are headwinds appearing on the horizon for the banking sector that may negate some of these gains. Here are a few examples:
1. A portion of bank revenue has been generated from mortgage refinancing in the past couple of years. But that game is over (see post) and the refi fee revenue will no longer be there. We'll let our friends who analyze bank shares quantify that number, but it can't be immaterial.
2. With rates rising, loan demand in the corporate sector may in fact decline. We are already seeing evidence of that.

On top of reducing origination fees and asset growth for banks, this trend could easily result in slower economic growth, which has been quite fragile to begin with.
3. Treasury and agency securities make up about 10% of bank assets. Even though not all of these securities will get marked to market, the recent bond correction can't be good for the old P&L. Customer flows in fixed income departments of banks will also decline materially.
4. New regulatory pressures could create tremendous headwinds for the larger banks and could even result in dividends being shut off for years to come as banks are forced to build up capital.

Bloomberg: - U.S. regulators are considering doubling a minimum capital requirement for the largest banks, which could force some of them to halt dividend payments.
The standard would increase the amount of capital the lenders must hold to 6 percent of total assets, regardless of their risk, according to four people with knowledge of the talks. That’s twice the level set by global banking supervisors.

For those who think banks haven't been lending enough, just wait till such rules go into effect. We will see an outright credit contraction in the US.
Given these headwinds in the banking sector, one should be careful jumping on the bank shares bandwagon. There may be some nasty earnings surprises along the way. And with banks under pressure, those who are predicting the US GDP to grow at 2.5% or higher should go back to the drawing board.

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Emerging markets for sale

by SoberLook

Floating emerging markets currencies have been under tremendous pressure over the past month, as active investors move out. Slowing growth, political instability, and weaker demand for natural resources have all contributed to the sharp declines. Rising rates in the US have not helped the situation either, making the dollar more attractive on a relative basis.

Not to be outdone, the Australian dollar - which is sometimes used as a proxy currency for China - is also down 6.4% over the same period. Many Emerging markets currencies have not seen these levels since the financial crisis. The Indian rupee touched another all-time low of 59.57 to the dollar. As discussed earlier, Brazil has been hit the hardest. The situation would have been considerably worse if the governments didn't actively intervene in the currency markets.
Nations with pegged currencies are also not immune to flight of capital. Argentina for example is experiencing tremendous pressure on foreign reserves.

Credit Suisse: - [Argentina's] central bank’s reserves remain under pressure. Gross foreign reserves have declined $5.0bn ytd to $38.3bn, compared to a $0.1bn increase over the same period in 2012. ... Reserves could fall by nearly $8.0bn this year. ... Any additional increase in reserves related to the tax amnesty program carried out in 3Q (perhaps $2.0-3.0bn) will likely be temporary and counterbalanced by external debt payments. Overall, we expect more controls to target deteriorating external imbalances, but reserves could still fall to $35.5bn by year-end and by another $5.0bn in 2014.

Anecdotal evidence suggests that China is also becoming concerned about capital flight. As a data point, the stock market is down some 10% over the past month. Some have even proposed that the high short-term rates in China (see post) is an attempt to "punish" those trying to short the currency (high rates and difficulties borrowing would make it hard to stay short the yuan).
Whatever the case, active investors are dumping emerging markets equities and bonds with the intensity not seen since the financial crisis.

JPMorgan: - EM bonds have been at the center of the flight from carry and illiquidity. EM local markets lost 1.5% FX-hedged, and almost 4% in USD terms Thursday, the former a record, the latter the worst day since October 2008. EM bond funds continue to see outflows, if more from hard currency than local currency funds. FX weakness is tilting risks toward tighter monetary policy to support the currency is some markets, and this week we penciled in another 50bp of hikes in Brazil. We maintain a short duration stance in EM, with position squaring likely still not done.

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Percent Change Week over Wheek