Cross-posted from Investing in Chinese Stocks.
As the yuan falls, here we go again…
As if overnight, Mainland dollar liquidity is suddenly scare. The large banks previously providing dollar liquidity began buying dollars, a number of commercial banks also have bought dollars in the interbank market and the swaps markets.
Within a few days, the dollar / renminbi swaps rapidly declined, with one week and one-month swaps on Tuesday hitting a new two year low.
The big banks may be soaking up dollars now to smooth the pain of yuan depreciation later:
Many analysts said that this is the result of multiple factors, combined to create pressure, and the Federal Reserve to raise interest rates expected to heat up not unrelated, but also within the tight dollar liquidity factors; they also do not rule out large banks “ordered settlement,” in order to smooth future RMB devaluation pressure.
The dollar is the hot trade:
“After the Fed rate hike expected to heat up, the dollar to appreciate nature, the dollar enchants everyone.” A stock line trader said.
A Fed rate hike in June is a shock event, as is a potential Brexit:
Also head of foreign exchange trading firm, said there are two black swan event in June will affect the devaluation expectations: the Federal Reserve to raise interest rates in Europe and the British retreat. If, unfortunately, these two things have happened, and that will bring a great impact to the renminbi expected, the central bank should be prepared in advance ready ammunition.
With the market already on edge about a possible rate hike, a switch in central bank actions triggered a sea change:
And perhaps this is expected to manage the central bank to make its usual supply of dollar liquidity in the market, large banks reverse and repurchase dollars, but the market touched the nerve, triggering market dollar liquidity shortage anxiety.
“The first day (the dollar) is tight I thought it was random, doesn’t matter, so the next day like this, three straight days, the psychological endurance is limited, anxiety rises, so we can only … buy (foreign exchange) as much as possible.” one commercial bank trader said.
The PBoC is also suspected of moving ahead of a potential depreciation:
However, the above trading company trading executives pointed out that the central bank intervention in the swap market has powerful chain of effects, use a small amount of capital to achieve a large result; on the other hand can stabilize market sentiment. In addition, the central bank also made a gesture, that it would not wait for devaluation
The reason that the interventions are short and long-term is the central bank’s trading strategy is to use the least amount of ammunition to achieve the best results. Because once the black swan happens, devaluation expectations will be significantly enhanced, which leads to delayed settlement of foreign trade enterprises, foreign exchange deficit will widen further bank, which will further increase the expected devaluation, creating a vicious cycle.
Earlier, SAFE has repeatedly said at a news conference that there is sufficient policy instruments to deal with the normalization of the Fed’s monetary policy.
The end of June is also a potential time for tight liquidity in China, and the news of a possible Fed rate hike reignited those fears:
Although the distance between the end of the second quarter June 30 liquidity assessment more than a month’s time, but if you take into account the mid-June Fed rate hike expectations, as this assessment from the point in time may be about 10 days, then the banks in advance hands-on management of liquidity and may not too late.
“Six months is a seasonal factor factor (purchase of foreign exchange) demand is there, because the feeling is June 15th FED may raise interest rates, the market is expected to stir someone to advance hands.” Another listed bank head trader said.
He laments that the rapid rise in US interest rates in China recently, swaps declined rapidly in China showed that the Mainland reaction to the Fed rate hike is even more sensitive than the United States, but now look at the market reaction, “a bit exaggerated.”
iFeng: 外媒：中国境内突现美元荒 大行意外回笼美元
How big is the hunger? A Discrete Look At What Is Bigger Than All The World’s QE’s Combined
In October 2014, Bank of China issued its first AT1 (coco) piece at a whopping $6.5 billion, more than three times subscribed with $21.8 billion in orders. Though the deal flow skewed Asian, meaning Asian demand, that only reinforces what the eurodollar actually represents. A little over a month later, Commercial Bank of China funded a large triple currency AT1 starting with a RMB 12 billion (about $2 billion equivalent) piece, $2.95 billion in eurodollars, and a final, marginal €600 million piece. According to Moody’s, the biggest issuers of cocos since 2009 have been the Swiss, including, not surprisingly, Credit Suisse #1 at $19.5 billion (not all in dollars) and UBS ($18.5 billion), and the Chinese; Bank of China ($18.9 billion very likely mostly in “dollars”) and Agricultural Bank of China ($17.8 billion).
When the coco market fell apart in early 2016, with no issuance at all for nearly the whole of the first quarter, that disrupted intended funding not just for Deutsche Bank and European firms expecting to raise that €40 billion on the year, but also the Swiss and Chinese heavily in terms of their intended “dollar” flow. I haven’t found any published expectation for what Chinese banks, in particular, were planning on funding via this market in 2016 but it is quite reasonable to assume it was significantly more than zero. Where might they have gone instead to replace those expected “dollars?”
Chinese banks were likely moved into shakier short-term “dollar” funding arrangements or to be put upon the PBOC’s rolling crisis management. From this perspective you can appreciate the Chinese central bank’s increasingly impossible tradeoff between “selling dollars” and internal RMB liquidity, and why it swings so assuredly from one to the other at these regular intervals. Unfortunately, there is very little information about cocos in the months since the Deutsche Bank-led scare of the January/February liquidations. While UBS was the first to open up the coco market back in March, there isn’t much to indicate that banks are back to sourcing “dollars”, euros, or anything else at even close to the same pace as last year’s level (which was already, again, less than 2014). In other words, just another tightening of the systemic ratchet.
Related: December, 2015 Bloomberg: The New Love for Chinese Yield Chasers: Leveraged Coco Bonds
The Chinese yuan’s declines and lower local rates have encouraged the nation’s investors to go offshore in their quest for yield. That’s fueling more interest in leveraged notes linked to contingent convertible bonds issued by Chinese banks.
“In recent months, we have seen growing interest from onshore Chinese clients in offshore U.S. dollar-denominated assets,” said Deng Xixi, head of the financial products department at Haitong International Securities Group Ltd. “A lot more Chinese clients are shifting their focus from the Chinese stock market to cross asset solutions, especially China bank preferred share products with leverage features to enhance yield.”
Chinese lenders are the biggest issuers of such capital used to meet rules for lenders to have sufficient buffers to cover losses. The convertible preferred shares are sometimes called coco bonds. Leverage features allow investors to gain more exposure to the underlying assets, or coco note in this case, than they had paid for.
…“Leverage is the theme for clients in the Greater China region and we have seen a lot of leverage requests on coco bonds,” Hong Kong-based Chan said. “The leverage can go from a bit more than one to up to three times.”
FT: Chinese banks issue most coco bonds
Faced with increasing demands from regulators for capital that can absorb losses, Chinese banks collectively issued $59bn of contingent convertible, or coco, bonds in 2014, equivalent to a third of all global volumes according to research by Moody’s.Most coco bonds sit above equity holders in a bank’s capital hierarchy, meaning they are exposed to losses before senior creditors.
Big.
