With Dennis Gartman seemingly correct this time, and the market not only melting up, but in full “blow off top” mode, traders can only sit back and watch in quiet amazement how nothing can lead to even the most nominal of downticks. So in hopes of bringing some daily clarity, here is RBC’s cross-asset head Charlie McElligott with his daily dose of market zen, focusing not only on the key events of the day, namely China’s record credit injection and Yellen’s more hawkish than expected Congressional testimony, but with an observation of what “continues to be the chief concern of clients on recent marketing swings”, namely “The TRILLION dollar question: when does all of this “inflation as a good thing” tip over into “inflation with no growth”—aka STAGFLATION?”
From McElligott’s “Big Picture”:
CHINA CREDIT-PUMPING=HIGHER GLOBAL INFLATION
Today’s newest pain-trade? Very popular Yuan shorts, who bet on the currency’s depreciation (long CNY, CNH, or SGD as ‘cheap’ proxy) and are being squeezed sharply today off the back of some big overnight Chinese inflation and financing data. In the larger-sense though, the real takeaway here is that a stronger Yuan could very much alter the current macro regime landscape, as it could represent further tailwind to the +++ “global reflation” story.
It all starts with the Chinese economy–already YTD we’ve seen very firm Mainland data (manu and service PMIs for example), but last night’s data dump took it a step further. China inflation data went ‘full mongo,’ with PPI YoY printing at 5.5 year highs (6.9% YoY), and it was driven by record PBoC credit pumping—with new monthly loans coming in at the second highest reading on record, and china all-system financing aggregate data coming in at the highest ever recorded (see chart below).
WHEN CHINA PUMPS FINANCING / CREDIT –GLOBAL INFLATION SPIKES
So with Chinese data surprising even the most bullish of folks to the upside; with inflation running hot; with record credit cram-down; all against a PBoC which has actually been incrementally tightening in short-term rates markets—you’ve really set the stage for a “(Yuan) short gone bad.”
Frankly too, you could separately ‘add-in’ fixed-asset investing (FAI) as a another China ‘stimulus driver’ that has ‘surprised to the upside’ and boosted the economy, as many had expected a slowdown of -1 to -2% YoY following last year’s record CNY59.6T print. Instead, with approx. 2/3 of Chinese provinces having reports their plans, FAI investment is already north of CNY40T YTD, run-rating at another new record ~64T.
The ‘knock-ons’ are potentially quite significant:
- In a larger macro-sense, Chinese inflation is set to ripple through the global supply chain—i.e. CHINA IS EXPORTING INFLATION…and not ‘deflation’ as many anticipated in ’17 with further Yuan depreciation bets.
- In the micro, a stronger Yuan should inherently sees a weaker Dollar on the other side. For this reason, along with significant trade relationship btwn China and Japan, a lower CNH (cleaner read than onshore CNY) too is highly correlated with lower JPY (correlation btwn CNH and JPY ~57%), with lower US 10Y rates (40% corr) and higher gold (-40% corr).
CNH / UST 10Y YIELDS / JPY:
CNH AND GOLD:
This final point on correlation with US rates may seem incoherent, as we’re saying ‘stronger Yuan’ is REFLATIONARY…so why could US rates then potentially head near-term lower? Well, I have two potential thoughts here:
- The current macro regime is currently one where a ‘higher USD’ has been an expression of the “US reflation trade,” as it’s been representative of US domestic growth expectations (better data) and with it, higher nominal rates. As noted yesterday though when discussing the near-term resumption of the “USD / crude” traditional negative correlation, it seems we could be transitioning in the regime to where a stronger USD will NOT help further the “GLOBAL reflation” theme, especially with regards to global trade and negative impact on commodities. As a stronger Yuan is an input (marginal, but directional) to a weaker Dollar, this could of course drag rates lower…until the negative correlation with commodities and USD again ‘kicks in’ which eventually will drive rates higher (fits with my final long-term point on ‘higher inflation, higher rates’).
- The other very rational thought on “how a stronger Yuan could drive lower US rates?” Because a stronger domestic currency in China will help reverse the capital outflows which have been driving the PBoC’s need to sell USTs. Perhaps this too is why Treasuries haven’t been able to get that ‘flush out sell-off’?!
So I think the takeaway here is that in the near-term, the correlations between stronger Yuan / weaker USD / lower US rates can persist for awhile. In the long-term though, this Chinese credit pumping trickle-down into better data–which is sending the Yuan appreciating–will eventually flow-through the global supply chain and ‘bleed’ inflation into the R.O.W., and as such help keep pressuring US rates higher.
The TRILLION dollar question is then reiterated: when does all of this “inflation as a good thing” tip over into “inflation with no growth”—aka STAGFLATION? This continues to be the chief concern of clients on recent marketing swings.
So perhaps THIS point is why we are seeing so much “reflation joy” within equities (cyclicals, banks, value)…but still seeing very little follow-through within the fixed-income complex.
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