Run On Yuan (RMB)?

by: The Nattering Naybob


Discussion of the potential effects on equity, bond, commodity, capital and asset markets regarding:

Offshore Hibor; PBOC RMB Intervention.

Forward Dollar Swaps; Eurodollars.

The Dollar Short; But It's Different This Time?

Offshore Hibor

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Above note, Chinese offshore HIBOR rates exploded from 4% last Friday to 13% on Monday, to 66.8% on 01/12/16, (NOT A TYPO. that is sixty six percent) then fell back to 8.31% on 01/13/2016. A dealer at a European bank in Shanghai told Reuters...

"The market suspects that the PBOC is possibly using major state banks to directly drain yuan liquidity in offshore markets," a dealer at a European bank in Shanghai told Reuters. The dealer described the strength of the central bank's actions as being of "nuclear-weapon" level strength. "Its actions are comparable to steps taken by other central banks when they previously fought against international speculators, such as George Soros"

AND THE FLAG IS UP!!! And SOROS isn't whom you need to be afraid of, it's the KING, as in KING DOLLAR whom we have Nattered about at length. The PBOC intervened to discourage speculators from shorting the RMB and close the nearly 2% gap between onshore CNY and offshore CNH.

PBOC RMB Intervention

The PBOC (through their proxies) have been selling dollars into the spot market, (dollar float up, dollar down) and they have been buying RMB with the proceeds (RMB float down, RMB up) and that is what is keeping KING DOLLAR trapped in his cage, temporarily as he is banging loudly on the cage door.

This propping up of the RMB makes their currency harder to short, by reducing the supply and increasing the cost to borrow it. Devalue? Hell no, the PBOC is struggling to maintain their currency at all costs. However, since Nov 1st, in doing so, the PBOC reduced the RMB float causing local lending rates to jump as reflected in onshore SHIBOR rates: overnight 1.75 to 1.95% and 30-day from 2.7 to 3%.

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Above note, the PBOC intervention or defense was very similar to Russia 2014, Brazil 1999, South Korea 1998 and Mexico 1995.

Forward Dollar Swaps

The Catch 22, higher local borrowing costs can hurt a contracting economy and spot interventions burn FX reserves. So in order to minimize the burn rate on those dollar FX reserves, and give temporary relief to fund short-term markets through lower interest rates, the PBOC has also been trading forward dollar swaps. These derivatives, which are off the books, give the appearance that dollars are being supplied while keeping the RMB selling from hitting market, driving the RMB and local borrowing costs lower.

Since early November, the PBOC has been dealing with the maturation of their forward dollar swaps, which were written in August. Remember the massive RMB devaluation Aug 11th and the global repercussions on Aug 24th? Those forward dollar swaps are the forward selling of dollar reserves and give temporary relief, but at the expense of future pain.

That future pain being, forward dollar swaps are nothing more than kicking the can. Last round of rolling Chinese dollar forwards was in August with 30-90 day maturation. Those forwards started maturing Nov 1st, and to confirm this, just look at an onshore RMB or CNY chart for the period.

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Above note, the stability and appreciation after Aug until Nov 1st, bought through spot intervention, then a ramp up of devaluation as USD forward swap contracts got rolled. For an excellent missive regarding China's use of forward dollar swaps and nature of eurodollars, see Jeffrey P. Snider's Forward China.

When those forward dollar swaps contracts mature, if the RMB currency situation has not settled down or corrected (i.e. against a rising dollar), the PBOC either has to come up with the (now more expensive) dollars to settle the contract differential they owe or enough to pay the margin call and roll the contract forward.

Thus forcing another massive sale of FX reserve assets, be it dollars or otherwise, to come up with those dollars due. Which means more PBOC liquidation of "dollar" assets and positions they hold in global markets, affecting any arb or carry i.e. yield related investments exposed to rising dollar reversal, or currency hedged positions, CNY/CNH, USD, JPY, as in potential margin call and unwind.


The problem isn't the onshore/offshore RMB or US dollar, it's ED or eurodollars, a credit based currency which took the place of bankers' acceptance years ago. As the ED market (whom we have Nattered about at length) has been in contraction since the crisis, there are not enough "dollars" to go around, concomitant a contracting global economy and less petrodollars, less dollars circulating means a lower float and those eurodollars and the USD both increase in value, driving down the cost of commodities and oil in a self reinforcing manner. Given the above, not many will create those "dollars" by taking on a dollar based liability, unless the price is right, which is dear indeed.

As credit based ED (eurodollar) "dollars" accommodate funding activities, any CNY/CNH arb moves much needed dollars and "dollar" liquidity offshore, creating instability onshore. This is why the PBOC are trying to contain both CNY and CNH, but with little success as they appear to be losing control of their currency and capital outflows. Hence the wide spread or difference between onshore CNY and offshore CNH RMB; the artificially low onshore SHIBOR rate and the spikes in offshore HIBOR lending rates. Both of which seem to have corrected following their intervention. How long that holds, remains to be seen.

Note to self, by holding down short term interest rates with dollar forwards, the PBOC has given speculators an access point to short the RMB. Lower short term interest rates allow speculators to borrow your currency cheaply and effectively short it, like many have done post 1985 peak, with the US dollar.

The "Dollar" Short

With China and the global economy going in the tank, those who have dollar denominated debt (est. $9T) are short the dollar and feeling pain. As for the RMB, who wants to hold a currency or assets denominated in it that are rapidly devaluing?

If one is short the dollar (formerly cheap carry), they are in effect long China's economy. Neither is a good bet at this moment, how does one mitigate that? Short the RMB, especially if one does business or lives there. Think commodity exporters, EMs, NFCs (non-financial corps) and any banks that facilitate business, which was outsourced to China, read Asia (Japan, Korea, etc.), US and European.

As reflected in the aforementioned onshore HIBOR, offshore SHIBOR and FX rates, there appears to be an ongoing "run on yuan" or the RMB. With $1T capital outflows est. 2015; current FX reserves est. $3.3T and burn rates, 2015 est. $512B with $500B in volume during the last five months, the PBOC might be able to stave off this "run on yuan" for another two years?

Think currency crisis and the global credit based medium of exchange, the Eurodollar aka KING DOLLAR'S pet python ED. King Dollar is one thing, but the PBOC are in the grip of ED and the more they fight, the worse it will get, as in tighter. As long as the PBOC is pegged to the dollar, tighter "dollar," tighter RMB.

Go ahead PBOC, make ED's day, another massive devalue, de-peg from the dollar completely and stop spot intervention. Then stand back and watch that 800-pound gorilla known as King Dollar go berserk, as in bust out of his cage and go through the roof causing massive global dollar short pain.

But It's Different This Time?

Putting this time in perspective, top 4 players in nominal GDP, the US (24.5%), China (15.5%), Japan (5.6%), and Germany (4.4)% constituting 50% of global GDP.

From the Telegraph: Citi estimated that China is now growing at just 4%, well below the numbers issued by its government statisticians, and the country's official 7% growth target. Other large economies - Brazil, Russia, and South Africa - are already in trouble.

Just like Russia, Thailand, Brazil, Korea, Mexico and a litany before them, the PBOC are in the process of being asphyxiated and swallowed by ED. Symptoms? A 2% RMB devalue on Aug 11th caused some indigestion in global markets by Aug 24th. Since Nov 1st a 4% RMB devalue caused some IBS by year's end, to date lasting through this week.

Above note, China is "only" the 3rd largest debt bubble in the last 25 years. Think a la Thailand 1997 and Ireland 2007, not even carbuncles, but tiny pimples on the arse of global GDP. Both amounting to GDP appetizers for ED, what contagion ensued after those currencies collapsed? Perhaps global dysentery? As in, the Asian contagion (1997) leading up to (2000) and the recent real estate MBS crisis (2008).

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Oh yes, it is different this time, and how. This time out at the formerly "all you can eat" ED buffet, if the numbers are to be believed, what matters is China has the 2nd largest GDP globally at $11.3T and the largest GDP based on PPP valuation at $19.5T. Again, China has a 15.5% share of nominal global GDP and a 25% share of annual growth.

Be mindful, that aforementioned litany of hors-d'oeuvres were swallowed whole by ED when he was expanding and healthy. What will happen when ED, who is currently not so healthy and in full constriction (limited "dollar" buffet and smaller exit doors), attempts to swallow a pig the size of China? Global monetary projectile vomiting? At the moment, there would certainly seem to be a lot of belching and flatulence.

You can pay me now (all at once, large devaluations or depeg) or pay me later (in slow painful never-ending installments, with spot interventions and forward dollar swaps). As the "dollar" gets increasingly scarce, the level of pain for those short gets worse.

The banks engaged ($19T in ED) do not have enough requisite dollars (which have been rehypothecated) upon which the unregulated fractional "credit" ED lending is based. Spot intervention, forward swaps, FX reserves and the central bank doctors with all the open dollar and FX "liquidity" swap lines in the world can't save them. For those in the trap or death grip of ED, there is no way out.

USB said "a big tradable multi-week rally awaits, but requires catalysts, above all a stabilisation of the Chinese yuan and oil, better PMI data and a halt to the rising dollar.

Good luck on that, as the deflation of this global debt driven expansion through the credit based eurodollar and its ensuing asset bubbles could be as Billy Fucillo says… and King Dollar is, it's going to be HUGE!! I tell ya Caroline...

This is the ninth in a series of thematically related missives, which will attempt to identify the macroeconomic forces with potential to adversely affect capital, commodity, equity, bond and asset markets.

I wish to dedicate this missive, to one of my mentor's Salmo Trutta, who is a prolific commenter on SA. Without Salmo's tutelage, and insistence in not masticating and spoon-feeding the baby ducks, as in learning the hard way, by doing the legwork and earning it, this missive would not have been possible. To you "Proximo"... "win the crowd and win your freedom" - Spaniard

Since the market potential is broad in both scope and scale, our conclusion could not be more specific than the discussion already had. Again, more grief in the dollar "short" or squeeze and its associated liquidity issues, with the potential to adversely affect capital, commodity, equity, bond and asset markets. Will it happen? TBD, and forewarned is forearmed.

As for how all of the above ties into the potential and partial list of market plays below... the market as a whole could be influenced, and this would tie into any list of investments or assets. Those listed below happen to influence the indices more than most.

Would like to thank you folks fer kindly droppin in. You're all invited back again to this locality. To have a heapin helpin of Nattering hospitality. Naybob that is. Set a spell, take your shoes off. Y'all come back now, y'hear!

Investing is an inherently risky activity, and investors must always be prepared to potentially lose some or all of an investment's value. Past performance is, of course, no guarantee of future results.

Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of an investment vehicle. This and other important information is contained in the prospectus and summary prospectus, which can be obtained from the principal or a financial advisor. Prospective investors should read the prospectus carefully before investing.

Below, recommended reading for those invested in mutual and bond funds, ETFs, REITs, HY, leveraged, EM, oil, energy, bonds and the broader markets. Why? There are many macroeconomic cross sector and market asset correlations involved that affect your investments. Economic conditions, the eurodollar, global dollar debt and monetary policy all influence the valuation of the above and market plays below, via King Dollar's value, credit spreads, swap spread pricing, market making, liquidity, monetary supply and velocity, just to name a few.

Market Warning: Reading not only those listed below, but also every installment of these multi-part missives could lead to a better understanding of the market forces in play and how to profit from them.

For a complete missive series listing, click here.

These global economic developments could affect numerous capital and asset markets, sectors, indexes, commodities, forex, bonds, mutual funds, ETFs and stocks.

A List of Potential Market Plays (Long or Short?):

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  • SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) 49K
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  • The United States Oil ETF, LP (NYSEARCA:USO) 40K
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  • Berkshire Hathaway A (NYSE:BRK.A) 39K
  • Union Pacific Corporation (NYSE:UNP) 31K
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  • US Natural Gas ETF (NYSEARCA:UNG) 27K
  • Vanguard Total Stock Market ETF (NYSEARCA:VTI) 25K
  • iPath SP Crude Oil Total Return Index ETN (NYSEARCA:OIL) 25K
  • Energy Select Sector SPDR ETF (NYSEARCA:XLE) 25K
  • Baker Hughes (NYSE:BHI) 23K

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.