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Uncertainty about the Chinese liquidity Pump

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question_2 January 20, 2010 (Erwan Mahe - OTCex Group)

China

Such is the today's topic, given recurring and increasingly precise rumours about the subject in the corridors of the Asian Financial Forum.

In his speech yesterday, Chinese Primer Minister Wen abandoned any mention of proactive fiscal policy or of accommodating monetary policy.

In the dialectic of Chinese officialdom, this may logically be interpreted as his way of saying the party's over, which would tally with the administered gradual hike in interest rates, as per the graph below, and lending restriction measures, which we will discuss below. 

1-year interest rates in China

So where is the next plateau?

TC_2010120

 

The question now is, given the exponential growth in credit seen in 2009 and in the first days of 2010, whether interest rates will remain at around 1.60% or return to around 2.25% (2006-2007) or 3.50% (2007-2008).

Given Chinese economic officials' habitual preference for "regulatory" or monetary" adjustments, they will start by restricting credit distribution which they will naturally direct, although interest rates will return to levels more consistent with business activity, money supply growth and credit volume. (Thaler's Corner 31-08-09: Still more on the Chinese Minksy ladder).

According to the China Securities Journal, the major Chinese commercial banks have been verbally ordered to stop lending for January.

The President of the China Banking Regulatory Commission, Liu Mingkang, declared in Hong Kong today that some banks were "instructed" to "limit lending".

He went so far as to say that some lenders were asked to rein in credit because they failed to meet regulatory requirements including those for capital.

He thus predicted that, following the boom of the first ten days of January (1.5 T yuan), loan growth will ease very soon.

The CBRC will impose new leverage and liquidity ratios on the nation’s banks, Liu said today, without providing details.

The central bank has ordered at least China Citic Bank Co.and China Everbright Bank Co. to lift their reserve ratios by 0.5% to slow their credit expansion, Reuters reported today, citing people it didn’t identify. These same ratios were already hiked last week, for the first time since June 2008 !

The 21st Century Business Herald also reported this measure this morning, which is meant to put a damper on overly aggressive lenders.

It will be set up for three months and ratios will be returned to "normal", once banks have demonstrated "moderation".

This needs to watched closely, because risky assets remain sensitive to this uncertainty, as seen by the nearly 3% decline on the Shanghai index this morning.


USA

American stock markets continue to fascinate, as they racked up a 1.80% rebound this afternoon in the wake of the Democrat's loss in the special Massachusetts Senate election. The results are said to freeze Obama's healthcare plan, which added new life into insurance (+1.90%) and pharmaceutical stocks (+2%).

If the stock market is going to rally because an American president, who came to office a year ago to the day, loses his filibuster-proof majority, financial markets look weirder and weirder…

I prefer citing yesterday evening's NAHB statement, relating to the deterioration in US home builders' confidence to the lows of June 2009:

"We stand poised and ready to deliver new homes as soon as our customers are ready to take advantage of the tax credit and other historically good buying conditions in terms of interest rates, selection, and prices. Yet builders also realize that factors beyond our control – including consumer concerns about job security and competition from foreclosed homes on the market – are still impeding demand for new homes at this time."

Since the FHA will soon toughen the terms of real estate lending insurance, with a hike in costs to 2.25% from 1.75% and more requiring credit scores...…

As such, few changes in our investment biases, favouring fixed interest rates on government debt (3-10 eurozone debt for the most part), and reticence toward risky assets.

As for the oil market, where $50 per barrel would be a much better reflection of "real" supply and demand than recent prices of around $80, ue les 80 $ recent, I believe that the recent price declines, following the announcement o the Japan Airlines bankruptcy, has a familiar flair to it.

Investment banks are indeed exposed to $441m (sell) in forward oil contract hedges by JAL from the days when the airliner still thought they had aircraft to put into the air.

If that does not amount to a reality check to demand, I don't know what is.

Have a good day.

Feel free to contact me at any time.

Erwan Mah Asset allocation and option strategy

22, rue des Capucines - 75002 Paris

TEL : + 33 1 53 05 57 20



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