As Geopolitical Tensions between Trump and Xi Escalates, Will the Hong Kong-US Dollar Peg Suffer?

As Geopolitical Tensions between Trump and Xi Escalates, Will the Hong Kong-US Dollar Peg Suffer?

Due to the lingering uncertainties, and the ongoing downward pressure from the recent stringent political response to contain the COVID-19 pandemic, the Chinese government suspended its annual GDP target for the first time, last week.

China’s GDP shrank by 6.8% in the first quarter. The fact that China discarded its GDP target shows the prevailing frustrations of the Chinese government on its economy.

And Chinese woes don’t stop there. As a creditor and promoter of its Belt and Road project, many of its partner nations have sought debt relief.

Aside from its economic turmoil, perhaps the worst part is with its growing division with the US.

Since the US government has charged that the Xi administration hasn’t been transparent with the way it handled the Covid-19 pandemic and sought damages from it, aside from the trade war, tensions from the pandemic have aggravated this rift.

Last week, the Trump administration moved to cut off China’s major telecom supplier Huawei from the global chip supply.

Later, it slapped sanctions on 33 companies for “supporting procurement of items for military end-use in China”.

The US government also condemned Beijing’s proposed passage of a 'new security law' in Hong Kong that bans "treason, secession, sedition and subversion" as a ‘death knell’ for freedom. 

Many fretted that the friction between the superpowers over Hong Kong could spillover to Taiwan.

And the Xi administration further fanned this speculation. Last Friday, in a report to the parliament about China’s plan to reunify with Taiwan, Chinese Premier Li Keqiang dropped the word “peaceful”, signaling a downward spiral in geopolitical relations. Taiwan also requested a sale of torpedoes from the US, angering Beijing.

Will geopolitical tensions centered on Asia escalate further?

If so, will this compound on strains on the Hong Kong Dollar-US Dollar peg presently afflicted by Hong Kong protests and the COVID-19 induced economic downturn?

Hong Kong’s GDP shrank 8.9% in the 1Q.

Moreover, mainland Chinese have been putting off Hong Kong investments, which has contributed to the weakness of the island’s real estate prices.  Office prices have recently been down.

And the economic recession plus price declines in real estate must have some effects on Hong Kong’s $25.231 trillion banking system (as of March) signifying a whopping  880% of Hong Kong’s $2.866 trillion 2019 GDP!  

Against the USD, Hong Kong’s dollar and the Offshore Yuan have gone in opposing directions.

Will US President Trump use the popular domestic sentiment to push for more conflicting rhetoric and policies against the Middle Kingdom to get reelected?

And if Mr. Trump does, will the Hong Kong USD peg, which has a narrow trading band between HK$7.75 and HK$7.85, survive? The decline of the Hibor’s Overnight and other rates must have been from HKMA’s boosting of the island’s monetary base since May 2019. Aside from domestic troubles, will a surge in USD outflows rattle the banking system?

And should the pressure on the HKD peg emerge, would this not escalate the volatility in global financial markets, worsen the global recession and magnify the risks of the coronavirus, trade, and cold war into a kinetic war?

We truly live in interesting times.

China’s Government Launches Xi Jinping Put 2.0! How Strong Will Asia Be In the Face of a China epicenter Asian Crisis 2.0?

China’s Government Launches Xi Jinping Put 2.0! How Strong Will Asia Be In the Face of a China epicenter Asian Crisis 2.0?

The Xi Jinping Put is back!

From Reuters: China’s regulators lined up to rally market confidence on Friday with new rules, measures and words of comfort as shares brushed near four-year lows for the second straight day before surging. Vice Premier Liu He, who oversees the economy and the financial sector, supplemented regulators’ moves by saying the recent stock market slump “provides good investment opportunity” and that economic problems should be treated rationally… Earlier in the day, the securities regulator, central bank and banking and insurance regulator all pledged steps to bolster market sentiment as China reported its weakest pace of economic growth since the global financial crisis for the third quarter.

Figure 1

Last Friday, China’s main national equity benchmark, the Shanghai Composite (SSEC), opened the day’s session sharply lower (-1.25%) and had a short rally to almost close the deficit. The botched rally sent the index lurching back near the early morning lows.

By mid-morning, the rally found a second wind to send the index to neutral at the lunch break. When the afternoon session commenced, the index advanced mightily and never looked back.  In a wild roller-coaster session, the afternoon spike in theSSEC ended with a 2.58% advance, pruned the week’s losses to -2.17% (-22.88% year to date; -28.35% from January 24th high)

Unlike the Philippines where the bulk of price fixing manipulation comes with ‘tails’ at the closing bell, China’s National Team operates within the regular market session.

Intensive leveraging typically characterizes stock market bubbles. And the recent crash of the Chinese stock market exhibits such symptoms.

About 4.5 trillion yuan (US$648.6 billion), which amounts to an estimated 13 percent of the combined market capitalization of stocks on the Shanghai and Shenzhen exchanges, were pledged as collateral for loans, according to the South China Morning Post. In the face of falling share prices, creditors either demand additional collateral from debtors or were impelled to liquidate ‘pledged’ shares, thereby accelerating the stock market rout. China’s central bank, the People’s Bank of China (PBOC), assured the investing public that it would use various monetary tools such as re-lending and medium-term lending facilities to ease the liquidity crunch.

Liquidations based on collateral calls will most likely spread to the real economy. So based on path dependency, the proposed policy solutions to liquidity issues from systemic credit impairments by the PBOC is to extend more credit! Solve substance addiction by the provision of more of the same substance! Solve credit problems with more credit!

Liquidation has not just occurred in China’s stock market. China’s offshore yuan fell 2.1% this week and has been fast approaching its December 2016 USD-CNH high of 6.98!

When China’s stock market crashed in June 2015, the CNH was stable. In contrast, ongoing liquidations have now plagued both the CNH and the SSEC.

And more reports surfacing exposing China’s ‘skeleton in the closet’ debt in the real economy.

From the Financial Times: China could be facing a “debt iceberg with titanic credit risks” following a boom in infrastructure projects by local governments around the country, S&P Global has warned. Local governments may have accrued a debt pile hidden off their balance sheet as high as Rmb30tn to Rmb40tn ($4.3tn to $5.8tn) following “rampant” growth in borrowings, the rating agency estimated. The mounting debt in so-called local government financing vehicles, or LGFVs, hit an “alarming” 60 per cent of China’s gross domestic product at the end of last year and was expected to lead to increasing defaults at companies connected to regional authorities. The estimates come amid long-running concerns over debt levels in China, which has seen what some analysts regard as excessive bank lending in the wake of the financial crisis that has created unsustainable bubbles in property and other assets. (bold mine)

And the PBOC may have shifted its policies towards Hong Kong that might have caused liquidity squeezes (interest rate spikes) and sharp volatility in the USD-HKD last September. Of course, the FED’s policies had some influence too.

Figure 2

When China experienced a stock market crash in 2015, the Hong Kong stock market plunged too (-35% peak-to-trough). A short bout of volatility hounded the Hong Kong dollar in early 2016. Nevertheless, HIBOR rates were benign and unaffected by the events in the stock markets.

As an aside, as of Friday, the Hang Seng Index was down 14.6% year-to-date and down 22.9% from the record high in January 26.

Today, turmoil affects both Hong Kong and China.

In piecing together the current events, the PBOC’s whack-a-mole strategy hasn’t been working.  China's manifold bubbles have been in search of an outlet valve.  And the PBOC appears to have run out of tools to buy it time from a major eruption.

And further interventions to cosmetically boost asset prices will lead to more intense instability within its financial system.  And when the cracks spread and become too large contain, everything will unravel.

And here’s a symptom. From the Financial Times (October 16, 2018): A wave of protests by Chinese homeowners against falling property prices in several cities has raised fears of a downturn in the country’s real estate market, adding to pressure on Beijing to stimulate the economy. Homeowners in Shanghai and other large cities took to the streets this month to demand refunds on their homes after property developers cut prices on new properties to stimulate sales. In Shanghai, dozens of angry homeowners descended on the sales office of a complex that offered 25 per cent discounts to demand refunds, causing clashes that damaged the sales office, according to online reports that were quickly removed by censors. Similar protests have been reported in the large cities of Xiamen and Guiyang as well as several smaller cities. The property sector is estimated to account for 15 per cent of China’s gross domestic product, with the total rising closer to 30 per cent if related industries are included. A downturn would add to financial strains on China’s heavily indebted property developers which paid record sums for land during auctions last year but are now struggling to recoup their investment. Other evidence of a downturn is starting to emerge. Sales by floor area dropped 27 per cent year on year during the “golden week” national holiday earlier this month, a peak period for house buying in China, according to research house CRIC, which tracks 31 cities.

Just which of the region’s economies and financial markets will survive an Asian crisis 2.0 with the epicenter in China?

The coming crisis could make all other crises a walk in the park. Instead of one crisis, it may be a combination of multiple crises happening at once: 1997 (Asian crisis), 2000 (dotcom) 2007 (US crisis), 2011 (European debt crisis) and emerging market crisis.

 

Figure 3

Could this periphery to the core transmission serve as the nascent stage? (Pointer to Charlie Bilelio)

Will Financial Tremors in China and Hong Kong Lead to the Big One?

Bankruptcy comes in stages. In the early stages, it is barely visible. Income does not keep pace with expenditures. The spendthrift borrows. "No problem." This is seen as a temporary anomaly. Then the borrowing speeds up, but there is sufficient capital to justify the increased debt. The accountants warn of trouble ahead. The debtor responds: "So far, so good!" "There's more where that came from!" The process continues. Then the accountants say: "The future is now." The spendthrift responds: "Eat, drink, and be merry, for tomorrow we die." —Gary North

In this issue

Will Financial Tremors in China and Hong Kong Lead to the Big One?

-Mounting Stress on China Yuan and the Hong Kong Dollar; Will the Hong Kong’s USD Peg be Broken?

-From Convergence to Divergence: China’s Stocks Leads The Rest of the World Lower as US Tests Record High!

-Will China’s Government Launch Xi Jinping Put 2.0?

-Has Financial and Economic Rescues Reached its Natural Limits?

Will Financial Tremors in China and Hong Kong Lead to the Big One?

From Turkey back to China.

Mounting Stress on China Yuan and the Hong Kong Dollar; Will the Hong Kong’s USD Peg be Broken?

After hitting a 15-month low, the Chinese yuan rallied most since January by .79% last Thursday, on rumors that US-Chineseofficials reopened doors for trade discussions.  In spite of the rally, the USD yuan firmed by .45% this week. (see figure 1, upper pane)

 

Figure 1

Like the yuan, the Hong Kong dollar’s US dollar peg has been under pressure. Hong Kong's de facto central bank, the Hong Kong Monetary Authority (HKMA), reportedly bought more than $2 billion worth of local currency to maintain a long-held peg to the US dollar leaving just $12 billion in its reserves by the end of the week.

Tremors in the yuan appear to have diffused into Hong Kong. Should the USD-HKD peg break, not only will the yuan’s fall accelerate, tensions may intensify in Hong Kong and China’s financial markets that could prick both China and Hong Kong’s property bubbles.

From Convergence to Divergence: China’s Stocks Leads The Rest of the World Lower as US Tests Record High!

 

Figure 2

Strains in the currency markets have been reverberating on China and Hong Kong’s stock markets.

The national benchmark, the Shanghai Composite (SSEC), tumbled by a staggering 4.52% this week, to hit the lowest level of the 2015 crash in January 2016. Hong Kong’s HSI sank 4.07% to a one year low.

From its zenith in January, the SSEC has lost 24.99% and posted a year to date performance of -19.3%, Asia’s worst. Meanwhile, Hong Kong’s HSI which has been down 17.92% from the January peak may likely drop into the bear market’s lair.  

Pressures on the Chinese stock market appear to have truncated the recent rally of ASEAN stocks. Excluding the Vietnamese benchmark, which closed almost unchanged (+.04%), the national indices of Indonesia (-4.83%) and the Philippines (-2.84%) led ASEAN benchmarks down.  

Only six (31.6%) of the nineteen national bourses defied selling pressures in Asia. The region’s weekly performance had an average of -1.35%.

Bank Indonesia raised rates for the fourth time since mid-May this week to stanch the hemorrhaging rupiah (-.79% week on week, -7.66% in 2018). The Philippine peso slid .55% to 53.43.

Since the January acme, the complexion of the performance of global equities experienced a radical change.

While US stocks represented by the S&P 500 (+.59, week, +6.6% year to date) continues to climb to its January highs, the MSCI World ex-US (MSWORLD), China’s Shanghai Composite and the Emerging Market iShares ETF have fallen to reach more than a year’s depths.

Convergence in global equity market performance has morphed into a divergence. Yet how sustainable can this seminal divergence be?

Have global investors been rotating into the US? If world national benchmarks have been signaling an economic downshift, will US stocks follow suit? Or will the US power the global economy higher? But how can the latter be if the trade war will remain in place or if it will intensify?

Such divergent dynamic has also emerged in parts of Asia.

With most of the region’s markets under pressure, the Pacific benchmarks of Australia and New Zealand ironically hit milestone highs.

Bifurcating markets have also appeared in India. While the Indian rupee’s free fall plumbed a fresh low, its equity benchmarks raced to landmark heights!

Will China’s Government Launch Xi Jinping Put 2.0?

The plunge in China’s stock markets should be a concern to Asia. The Middle Kingdom has significant links with latter which functions primarily as its supply chain network. China has likewise been a significant source of Asia’s financing, fund flows, and a market for tourism

In 2015, a slew of draconian measures had been implemented by the Xi administration to arrest the stock market crash.

Aside from imposing assorted bans and limits on equity sales, the government infused cash to brokers and state-owned enterprises to put a floor on the stock market. 197 people, including journalists, were reportedly incarcerated for spreading rumors. “Spreading rumors” carries a three-year jail sentence after its introduction in 2013

The Xi administration’s stock market rescue efforts had been known as the Xi Jinping Put.

Nevertheless, the SSEC still crashed by 48% in 6 months.

The crash exposes how meddling and manipulating the markets will fail to attain its intended objectives. Though perhaps China’s markets could have gone lower, the present stress highlights the fact that kick the can down the road may have reached its end.

China’s stock markets may likely bear the brunt of the accrued imbalances caused by the 2015-2016 Xi Jinping Put.

All actions have consequences.

 

Figure 3

That episode caused the Chinese government to panic!

It launched a considerable amount of fiscal stimulus (see above), accelerate interest rate cuts and infused massive amounts of credit to stabilize and insulate the economy from the aftermath of the stock market crash. According to Federal Bank of New York’s Liberty Street Economics, “In 2016 alone, credit outstanding increased by more than $3 trillion, with the pace of growth still roughly twice that of nominal GDP” (bold and italics mine)

Since the stock market crash, the bank loan share of M2 continues to bulge.

Some of the global central banks responded by implementing negative interest rates in 2016 (e.g. ECB, Bank of Japan, Denmark and Sweden).

Under introduction of the corridor system, the Philippine Bangko Sentral ng Pilipinas slashed rates to a historic low in June 2016(also partly in response to domestic downside price pressures or “disinflation”).  Remember the erstwhile BSP chief Amado Tetangco Jr’s spiel on deflation or disinflation?

If stocks continue to crumble, will the Chinese government respond in the same way as they did in 2015?

Will interest rate cuts be the next move for global central banks?

Has Financial and Economic Rescues Reached its Natural Limits?

But here is the thing.

China’s property markets continue to burn the road.

New home prices and property investment growth have rocketed at the fastest pace in 2 years which had been financed by a rapid buildup in household debt which soared 15.14% in June month on month.

So rescue operations will only accelerate the meltup in the housing market which the Chinese government has been attempting to control, although at local levels.

Figure 4

And weakness in stocks or properties may aggravate its fragile offshore dollar/eurodollar conditions in part by rekindling capital flight and mainly from growing scarcity of access to US liquidity and collateral. China’s international reserves have begun to fall again last July. [upper window]

China’s monetary system, like the Philippines, is built upon mainly forex or international assets (mostly US dollars). [lower window]

China has been experiencing tremendous economic and financial tensions. The snowballing strains appear to be spreading. It has been ventilated on the currency markets (the yuan and Hong Kong dollar) first and then has spread to the stock market. Will credit be next? Then housing?

Unless Chinese authorities will be able to pull a rabbit out of a hat soon, a major financial and economic tremblor may be upon us, with the epicenter in China.