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The dollar under Chinese pressure

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Thale_98-tumb(Sept. 8, 2009) While I was looking forward to writing about the latest, rather mediocre, macroeconomic statistics from Europe, Asia has once again provided the bulk of today’s news flow, with the Chinese government’s announcement that it will issue 6bn renminbi worth of Renminbi (RMB) treasury bonds in Hong Kong on 28 September.

This move should please those who are betting heavily on a financial revolution in Mainland China via the move to the productivity of capital improvement stage, following that in agriculture, industry and technology.


Indeed, by creating an international benchmark for yuan-denominated treasury bonds, accessible to investors throughout the world, the government aims to facilitate the creation of a genuine corporate credit market, whose spread will be pegged to this benchmark. For the time being, only (5) banks have been able to issue RMB treasury bonds in Hong Kong totalling 30bn yuan since 2007.

With this new move, non-financial firms will now be able to participate in this market.

Moreover, this will reinforces Hong Kong’s position as a major financial centre.

This also dovetails with Chinese officials’ calls for supplanting the dollar as the world’s benchmark reserve currency.

Some may object that issuing debt in RMB while maintaining their dollar reserves is a funny way for the Chinese to try to slip their heads out of their massive exposure to the greenback, but what counts are the long-term implications of a shift to an economy benefiting from financial tools worthy of the name.

It will also enable them to skip the CPDO and other twaddle.

In any case, the consequences on financial markets became apparent immediately, as the dollar fell sharply throughout the morning (and the ensuing hike on stock markets).  It is now trading at 1.4480 against the euro, which is the lowest since 17 December, as it hovered near its support point of 92 against the yen.

But, it was gold which caught people’s attention, as it climbed above its peak of February to $1, 010 !

The Japanese currency already benefited from statements from the G20 vowing the continuation of the Keynesian stimulus measures (‘No early exit’), as well as promises by central bankers to let money flow freely. All that was needed was another alert on the dollar to…

Among the gold bugs clan, we can now include those who are intent on betting on inflation, those are looking for a weakening of the US currency and those who are betting on the deflation bust with a systemic crisis and then there are those who don’t know what to do and just following the momentu.

And then, there are mumblings by the Chinese themselves, including one official who complained last week to one of my “informers” that they wanted to continue to diversify in the yellow metal, but that each time they bought into it, the price increased.

This sort of price behaviour is something I still have a hard time fathoming in that it is based solely on flows and market mood. Luckily, other asset classes, such as European government bonds, conform a bit more to macroeconomic fundamentals.

Given the above-mentioned underlyings, we continue to advise investors to favour European government debt over US debt instruments.

Some macroeconomic data were released this morning for Europe, which continue to argue for overexposure to government fixed rate debt instruments.

In Finland, Q2 GDP plunged 9.4% y-o-y, vs an expected -7.3%.

In Spain, industrial production fell 17.4%, vs an expected -16%.

In Slovakia we see the same thing : -21.6% vs an expected -16.5%,

And especially, Primus Inter Pares, Germany.

Industrial production, which the consensus expected to climb 1.6% in July, from -0.1% in June, given good orientation of the IFO and other sentiment indicators, contracted 0.9%, bringing the annual decline to 17% !

The main culprit behind this unpleasant surprise was the capital goods sector, which fell 3.9% in July, bringing the y-o-y plunge to 24.4%.

You can see for yourself in the following graph why the sector has been hit so hard, and why this is consistent with benchmark or market interest rates being so low.

Indeed, while German industrial production of consumer goods (in graph) has fallen more steeply in the past -- for example, the 30% contraction between 1991 and 1997, as opposed to -15% since year-end 2007 – our German neighbours today are no longer dealing with a reunification-generated recession but a steep fall-off in global demand.

The direct consequence of this situation is the sharp contraction in capacity utilisation rates, which is all the harder to absorb for an export-driven economy.

This rate has shrunk from 88.20% in 2008 to 71.80%, pushing overcapacity to an historic high, the previous record being 78.30% in 1993 !

This situation guarantees (with the published hike in unemployment) that any worldwide economic recovery, thus including Germany, will not be accompanied by inflationary pressures. We still have a long way to go before businesses begin reinvesting in capital goods.

In this light, it is easier to understand the current serenity of the ECB’s hawks with respect to their “exit plans” and the warnings of various officials against “excessive optimism” (Gonzalez-Paramo, Trichet), King, Brown, Merkel).

Germany: Industrial production of consumer goods – utilisation capacity rates –Schatz rate (2 years).

Zero pressure on prices: quite the contrary…

Thale_98

Advised positions:

Bund

Call Ratio 123 / 124 October: 6, delta 3%, long theta 0.05 (P&L +8)

Bobl

Call Ladder 116.00/116.50/117.00 October: 7.5, delta 8%, theta 0.22 (P&L +1)

Eurostoxx :

Put Ladder 2700/ 2500/2350 Sep09: 12 delta -17%, theta 0.75 (P&L -14)

11 days left; think about the roll on October!

Euribor:

Midcurve Dec10 Call Fly 98.25/98.50/98.75: 4.5


Erwan Mahé - OTCexGroup

Asset allocation and option strategy

 



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