Monday, 16 July 2018

A free-float beckons...

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Anthony Peters sees more de-pegging in China’s interventions.

After the second renminbi devaluation – but before the third one, which took place today – markets had another day of merry mayhem. Is what we are seeing, one must ask oneself, the result of the dance of the headless chickens or is there something more fundamental afoot which is leading to a fundamental repricing of all asset classes?

I too have done some thinking about the actions of the Chinese government and have concluded that, although the timing of its move might appear to be spurious, it does have some justification in what it is doing. It has tried to maintain stability by more or less pegging the currency to the dollar. The rise in the greenback has dragged it higher and higher which has hurt its relative value to all non-dollar currencies.

The current action could therefore be seen as a managed de-pegging and thus, in some respects, bringing it rather closer to a free-float than further away. One way or the other, the third devaluation of today confirms suggestions that they might not yet be over and that the end-game has to kick in somewhere between 6¼% and 10%.

But does all this justify the DAX taking at 3.27% bath or the CAC cacking 3.4%? All the while, the 10-year Bund yield dropped below 0.59% which took the current 10-year, the 1% of Aug 15 2025, to a new high price of 104.00. I would be careful in determining that equities are being routed, especially German ones. The market has been hugely volatile in the six or eight weeks where the low as 200 points below where we are now. Obviously the Greek thing hasn’t helped investors determine what a fair price is for German equities, although one would do well to bear in mind that stock markets are even worse than bond markets in correctly pricing macro-economic trends and political events.

So let us assume for a moment that China is entirely justified in realigning the yuan’s value vis a vis the rising dollar, does the timing tell us anything? There are two answers to this. The first is the obvious one which is driven by the poor trade figures for July. I’m not so sure. Beijing has the ability to hold its breath for a very long time and the decision to realign the external value of the currency will barely have been taken in two days off the back of a single release. This move was surely longer in the planning. The second is that August is proving to be a great time for currency related market intervention. Markets are at their thinnest at this time of the year and if a central bank wants to make a point, it’s good to do it when there aren’t too many people around in the markets to fight back. I will be interested to hear what is said about it in Jackson Hole at the end of the month.

Summer dry spell

In the mean time, though, we who are here have to survive the slings and arrows in a market which is even less liquid than normal. To come back to my original theme, are we just being whipsawed in the summer lull or is a fundamental re-pricing taking place? The big question is of course whether the Fed can afford to tighten at a time when the greenback is already threatening to strangle exports and to suck in ever cheaper looking imports, both of which could bring an early end to the recovery. If it opts to hold back and wait – which seems to be in Janet Yellen’s DNA – then a re-pricing is not unreasonable. At 2.16%, the US 10 year note is in no-man’s land although I’m not sure that this is the time to be taking a strong view, one way or the other. For choice I’d be short on an intra-day basis as I suspect Western equities will stage a rebound and that is never a good time to be trading from a long position.

In Europe things are still far more complicated as the Greek bail-out package rumbles on. There are rumours around that it has already hit the buffers within the German government and that’s before its even been put to parliament. It might well have done but “Realpolitik” will no doubt prevail and it will end up being passed. None of this will dispel the doubts as it is quite clear that unless some serious write-downs are taken by creditors on outstanding debt, Athens will be back in a year, cap in hand. It’s all such a poorly-staged pantomime. Yet, with fears that the Chinese devaluations are harbingers of doom in the Middle Kingdom in their own rights, Greece fades into insignificance. Just vote “Yes” and move on….. We know it’s not the right thing to do but sometimes needs must.

My conclusion has to be, as things stand this morning, that we are not in repricing mode and that we are still just panicking around although I cannot exclude the possibility of a repricing being ahead of us. I do not, however, believe that the seismic crash is around the corner. Keep your eye on the horizon and a steady hand on the tiller…..

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