Asian markets are mostly weaker as concerns about China keep some investors at bay, with the PBoC halting open market operations for a third straight day. Losses for Asian equities have come despite US futures actually improving from the close of US trade. Concerns about liquidity tightening have seen investors on seven-day repo watch yet again, with some fearing we will see a repeat of the June squeeze. China’s seven-day repo rates are at around 4.6% (from 4.04%), but we feel the PBoC is merely taking measures to manage liquidity and we won’t see a repeat of the squeeze we saw in June.
Today’s Asian session has also brought another positive economic reading in the form of a better-than-expected HSBC flash manufacturing PMI (50.9 versus 50.5) reading. However, it seems this figure has been largely ignored given the current liquidity concerns. The PMI reading is a backward number and liquidity issues could potentially impact future growth, particularly in the small business arena. The Hang Seng, Shanghai Composite and the Nikkei are all around half a per cent weaker. Meanwhile the ASX 200 finished in positive territory with a surge in the banks underpinning the price action.
AUD finds support off the lows
We have been watching the AUD closely today after a sharp slide yesterday as the China issues surfaced. The AUD tends to be a good indicator of sentiment around China being a prime commodity currency. Just the fact that the AUD has actually managed to recover in Asia today suggests the China concerns were perhaps overdone. RBA Deputy Governor Philip Lowe is also speaking today and traders will be keen to hear more on interest rates and the local currency. While it looks like AUD/USD is in for a bearish turn, I’m more inclined to look at buying the dips, particularly, heading into uptrend support at 0.96. There is also the 200-day moving average, which is likely to support the price action in that region.
Europe pointing higher
European markets are eyeing a modestly firmer open after having struggled yesterday with the banks being the main culprits. Talk of an asset quality review (AQR) for euro area banks also did the rounds and affected sentiment. The AQR will require banks to set aside 8% of risk-adjusted capital as a buffer against losses and is due to be completed in October. While this seems negative in the short term, we feel ultimately it will be a confidence booster.
While the AUD struggled, the euro actually held up fairly well against the greenback. EUR/USD momentarily dipped to 1.374 and swiftly recovered to knock on 1.38 again. Perhaps news that Spain has emerged from a recession with a 0.1% q/q rise in Q3 GDP gave the single currency a kicker.
It’s a big day of trading ahead with a raft of PMIs set to hit the wires, with manufacturing PMIs for Germany and France being the highlights. Both data points are expected to be revised up slightly and this could support the EUR and finally see it convincingly trade through 1.38 for the first time since November last year. Over in the UK, central banker Mark Carney will be on the wires and a much less dovish tone is expected after yesterday’s BoE minutes. In the US we have trade balance, flash manufacturing PMI and new home sales data due out.
Local banks rally
The local markets has enjoyed a steady recovery today after having experienced a nasty reversal lower yesterday. The main story is around the banks with our largest company by market capitalisation trading at a fresh record high. Commonwealth Bank just continues to defy gravity and lead the big banks higher today. All four banks were firing on all cylinders heading into their reports.
Next week we have ANZ and NAB getting the ball rolling with their FY results and expectations are always high heading into bank earnings. With risk on edge, most flows have been into the defensive names with the healthcare sector in favour. Resmed climbed 1% heading into its results which will be released in the US. RMD’s locally-listed stock is right near its record high of $5.94. Iron ore miners have tapered off a bit today with some mild profit taking on the back of China concerns.
Chinese tightening
China money market rates have come firmly back onto the markets radar, with the seven-day interbank repo hitting the highest level since July at 5.00% (now at 4.73%). The overnight repo rate has also moved higher in the last few days, although is not threatening to replicate the same sort of moves we saw in June when we saw liquidity really dry up between the banks and huge bouts of volatility were seen in the JPY, Nikkei, and Chinese bourses.
Back in June we saw the seven-day repo spike to 12.44%, as the PBOC refrained from adding to its usual liquidity operations; once again we are hearing increased talk from traders and clients that China’s money market rates are back on their radars. We need to be cognisant that the PBOC has the tools and motivation to keep liquidity stable; authorities in China would be fully aware of lessons learnt in June, while of course they would want a stable and confident platform going into its November Third Plenary meeting.
It’s also worth pointing out that while the seven-day repo rate is trading 137 basis points higher than where it was on October 16, many believe we may not see the PBOC come back until the rate trades over 5%.
So, why is the PBOC standing aside and letting lending in the interbank market dry up? Well there are a number of reasons behind this, however it seems logical to me that at 7.8% we have seen the peak in Chinese growth, although I am not predicting significant downside either and would expect Q4 to print around 7.7%. In 2014 we should see annual growth between 7.4% and 7.5%. Taking a step back, it must be said that the Chinese authorities have done an excellent job in keeping its economy supported and promoting growth at a time when other emerging markets were seeing significant outflows, however that time has come to an end and the PBOC is keen to limit further upside.
Its wasn’t just the September house prices (+9.1% nationwide) that can be attributed to the tightening in financial conditions; we have witnessed a record level of hot money flowing into Chinese banks and this was seen front and centre in the latest FX positions, which gained by just over RMB120 billion ($20 billion). We have seen a natural reaction to the inflows, with USD/CNY hitting a new twenty-year low. On the housing front there is talk that we will hear new government initiatives, which will involve property curbs in the fourth quarter, and again this seems to be weighing – another reason why the PBOC is staying put and not adding to its traditional liquidity operations.
When you are seeing a headline inflation rate above 3%, while drilling down property inflation is running at 20% in Beijing, Shanghai, Shenzhen and Guangzhou, you can why the PBOC is happy to let liquidity naturally drained out of the system. Further down the line we are likely to hear of changes to the requirements to second home purchases and there is talk that supply could be increased.
It is also worth pointing out that higher repo rates (generally a function of banks showing a reluctance to lend to each other) are quite thematic of this time of year, and from a seasonality point of view there is a tendency for rates to spike, predominantly down to companies raising funds to pay tax payments this week.
From a trading perceptive, the market has already seen a knee-jerk reaction on Wednesday to the spike in financial conditions, with big moves in the Nikkei, JPY, AUD and the variety of Chinese equity markets. More sanguine conditions have been seen today, with the market feeling that the moves in the repo market won’t be sustained. However, a move (in the seven-day repo) above 7% could change this, especially if the PBOC doesn’t make the right noises about coming back into the market.
China does need to reform and perhaps more colour around that will be announced in its November Plenary meeting. However, I feel this event has marked a symbolic turning point in China, where it is now managing the liquidity issues in a more prudent manor; the PBOC made mention of this on Sunday and perhaps this is the dawn of more prudent, if not tighter policy settings. The upside in AUD should be harder to come by, while Chinese markets could find renewed headwinds.