Monday, November 28, 2016

USDCNY 6.91 and climbing

The higher they go, the hard they fall.  There hasn't been such heavy inflows over a two week period since late 2014.  That led to choppy and toppy markets in 2015 which led to moments like lock limit down in S&P 500 futures on Monday, August 24, going from 2100 to 1840 over a span of just one week.  How soon we forget that the reason for that big drop was because of fears of the deflationary effects of a Chinese yuan devaluation and Chinese financial stability.  The USD-CNY exchange rate rose to 6.38 that day.  Today we are at 6.91.   And yet not a peep.  The situation in China has gotten worse, and the Chinese are selling Treasuries to defend the yuan to prevent it from falling even more.  When the yuan is in a controlled descent, it makes it obvious for those with yuan to get the hell out of that currency and convert it into dollars, euros, yen, whatever.  But now there is news of the Chinese government trying to crack down on capital outflows by making it difficult or illegal for Chinese companies to do foreign mergers and acquisitions.  Many of these acquisitions are a way for the Chinese to convert their yuan into dollars.

If the CNY was a free floating currency, it would be at 10 right now.  There has been so much money printing by the PBOC to keep their debt pyramid from collapsing that you now have more M2 money supply in CNY (dollar converted) than in USD.  How can the US with a GDP almost twice that of China and with the world's reserve currency have a smaller M2 than China?  It makes no sense, and it points to a massively overvalued yuan which has kept its value because of capital controls.

The most interesting thing to watch in 2017 is not what Trump will do, but what happens in China.  We are getting really close to that Minsky moment where faith in the Chinese government and the PBOC causes a panic out of the yuan and into foreign currency based assets.  In China, there are very few choices.  The only thing I can think of that the Chinese investor can buy to protect against a yuan devaluation is gold or other hard assets denominated in dollars.  Perhaps they will go back to hoarding copper or oil.  A yuan devaluation would export some deflation into the global economy but I don't see it as trigger for a global financial panic.  But I do see it as a trigger for a panic out of yuan based assets, mainly the one that the Chinese have been hiding out in the most:  Chinese real estate.

The smart ones in China already have transferred most of their yuan assets into USD or other foreign assets to convert their vastly overvalued currency into something more accurately valued.  Even if that means overpaying for luxury condos in Manhattan or London.

This bull market in the S&P is getting very old, and I will be actively looking for signs of a major top in 2017.  The optimism over Trump's tax cuts and infrastructure spending is way overdone, and a disappointment over its economic effects could trigger the downside of the slope.  We are getting close to the peak of the mountain.

I don't see any good trades in the near term, the S&P should continue to grind higher, and I won't actively look to short until we get into 2017 and closer to 2300 level.

No comments: