China's Big Bang?

Nigel Stephenson of Reuters reports, China's devaluation raises currency war fear as Greece strikes deal:
China's shock 2 percent devaluation of the yuan on Tuesday pushed the dollar higher and raised the prospect of a new round of currency wars, just as Greece reached a new deal to contain its debt crisis.

Stocks fell in Asia and Europe as investors worried about the implications of a move designed to support China's slowing economy and exports.

The stronger dollar hit commodity prices, driving crude oil down after Monday's hefty gains, though gold hit three-week highs as investors focussed on the risks to the global economy.

Weaker stocks lifted top-rated bonds, with yields on euro zone debt also falling on the Greek deal, struck nine days before Athens is due to repay 3.2 billion euros to the European Central Bank.

China's move, which the central bank described as a "one-off depreciation" based on a new way of managing the exchange rate that better reflected market forces, triggered the yuan's biggest fall since 1994, pushing it to its weakest against the dollar in almost three years.

The Australian dollar, often used as a liquid proxy for the yuan, fell 1.2 percent to $0.7322 as the U.S. dollar index, which measures the greenback against a basket of currencies, rose 0.4 percent before paring gains.

In Asia, the Singapore dollar hit a five-year low while the Malaysian ringgit and the Indonesian rupiah hit lows not seen since the Asian financial crisis 17 years ago. The Japanese yen hit a two-month low of 125.08 to the U.S. dollar.

Investors who had held euro-funded yuan positions bought back the single currency, pushing it up 0.2 percent to $1.1042 and weighing on the dollar index.

U.S. reaction will be crucial. Washington has for years pressed Beijing to free up the exchange rate to allow the yuan to strengthen, reflecting the growth in the world's second-largest economy.

Today, China's economy is slowing and the new exchange rate mechanism gives markets greater ability to push the yuan lower, just as the United States prepares to raise interest rates - a step that should add to dollar strength.

"It does look, however modest, like an attempt to recoup just a small amount of competitive edge lost in international markets," said Simon Derrick, head of currency research at BNY Mellon in London.

"What happens over the next few days matters. If we have a currency that moves much more freely, fine. If, however, we go back and it's just repegged ... that is currency war."

European shares fell. The pan-European FTSEurofirst 300 index was down 1 percent, led lower by car makers and luxury goods companies, whose products have just got more expensive for Chinese consumers.

"What is good for growth in China is unfortunately bad for everybody else," said Bill McQuaker, co-head of multi-asset at Henderson Global Investors.

Shares in Athens, however, gained 1.5 percent after the country secured a third bailout deal with creditors, making it the only European bourse to rise.

This followed falls in Asia. MSCI's broadest index of Asia-Pacific shares outside Japan gave up early gains and was down 1.4 percent at its lowest since February 2014. Japan's Nikkei slipped 0.4 percent.

On Chinese stock markets, airlines and importers fell, though exporters rose. The CSI300 index of the largest listed companies in Shanghai and Shenzhen lost 0.4 percent and the Shanghai Composite closed flat.


The weakness in stocks boosted top-rated bonds. German 10-year yields fell 4 basis points to 0.65 percent and U.S. equivalents dropped 6 bps to 2.16 percent.

The deal on another bailout for Greece also helped yields on lower-rated Spanish and Italian bonds drop 5 bps apiece while Greek two-year yields fell 4.8 percentage points to 14.67 percent, their lowest since March.

"The Chinese devaluation was taken as 'things are not going that well in China' and this is a risk-off move," said Martin van Vliet, senior rate strategist at ING, adding that "with the Greek deal secured and the ECB continuously buying bonds, peripheral spreads would have been much tighter (but for China)".

Oil prices fell as dollar-priced commodities became more expensive, weighing on demand. Brent crude was down 65 cents a barrel at $49.76.

Gold fell to as low as $1,093.25 before recovering to around $1,1109 an ounce as investors sought safety.

"Probably gold is benefiting from fears that this is a new round of 'currency war'," Macquarie analyst Matthew Turner said, adding that China's move had increased uncertainties about the global economy, which tends to be good for gold.
So, China "shocked" global markets by devaluing its currency. Ironically, anyone who saw China's latest trade report was bracing for such a move. A country that overwhelmingly relies on exports for growth can't afford to sustain a deep contraction in its exports. The bursting of the China bubble only exacerbated its economic woes, placing more pressure on its leaders to devalue.

A week ago, Sober Look published an excellent comment, Beijing may question the yuan peg as the Fed prepares for liftoff, explaining the pros and cons of pegging the yuan to the U.S. dollar.

On Friday, I wrote a long comment on the Fed's deflation problem where I noted that the strong U.S. dollar and global deflation are two big reasons why I don't see the Fed moving on rates in September. If it makes such a monumental mistake, it will all but ensure a prolonged period of debt deflation.

In fact, China's latest move will provide the Fed with enough reason to remain on the sidelines for a lot longer. Why? Go back to carefully read my comment on the mighty greenback which I wrote back in October, 2014:
Now, if you ask me, there is another reason why the USD is rallying strongly versus all other currencies and it has little to do with Fed rate hikes that might come sooner than the market anticipates. When global investors are worried about deflation and another crisis erupting, they seek refuge in good old U.S. bonds. This has the perverse effect of boosting the greenback (USD) and lowering bond yields, which is why I'm not in the camp that warns the bond market is more fragile than you think.

What does the strong USD mean for the U.S. economy? It means oil and import prices will drop and exports will get hurt. Ironically, lower oil and import prices will reinforce deflationary headwinds, which isn't exactly what the Fed wants. But the stronger USD might also give the Fed room to push back its anticipated rate hikes. Why? Because the rise in the USD tightens up financial conditions in the U.S. economy, acting as a rate increase.

In terms of stocks, the surging greenback may be a triple whammy for U.S. earnings. Multinationals which as a group derive almost half of their revenue from international markets, will see a hit on their earnings, especially if they didn't hedge accordingly. But you should see small caps (IWM), which have been beaten down hard in September and thus far in October, rally as they're more exposed to the domestic market.
The linkage between a stronger U.S. dollar, lower import prices and lower commodity prices cannot be overstated. If the U.S. dollar rises too fast relative to other currencies, it not only kills U.S. exports, it crushes commodity prices which are already reeling and it significantly lowers import prices, heightening global deflation risks which might even spread to the United States.

Of course, the green shoots on Wall Street will dismiss the risks of global deflation ever coming to America. They will tell you this latest move from China is "highly stimulative" for global growth and the U.S. consumer. 

And you know what? They are partially right. Cheap Chinese goods will flood the U.S., Europe and rest of the world. You can now buy an iPhone 6 for $150 (CAD) at Wal Mart (with a plan) and pretty soon they will be giving them away for peanuts. What's wrong with a little deflation in China spreading to the rest of the world?

Absolutely nothing. A little disinflation is fine. Some have even warned us to prepare for a deflationary boom as lower oil prices will spur the U.S. consumer to buy, buy , buy! The problem with these simplistic analyses is they don't take into account how levered most people are and how lower import prices can reinforce deflationary expectations

And once a deflationary mindset sets in,  the Fed and other central banks are cooked. We're going to head the way of Japan, namely, QE infinity with pockets of growth but mostly a moribund economy for a prolonged period. 

Now, let me expand your thinking a little more. I've repeatedly warned you of the following five factors which all but ensure a prolonged period of global deflation:
  • The global jobs crisis: Jobs are vanishing all around the world at an alarming rate. Worse still, full employment jobs with good wages and benefits are being replaced with partial employment jobs with low wages and no benefits.
  • Demographics: The aging of the population isn't pro-growth. As people get older, they live on a fixed income, consume less, and are generally more careful with their meager savings. The fact that the unemployment rate is soaring for younger workers just adds more fuel to the fire. Without a decent job, young people cannot afford to get married, buy a house and have children.
  • The global pension crisis: A common theme of this blog is how pension poverty is wreaking havoc on our economy. It's not just the demographic shift, as people retire with little or no savings, they consume less, governments collect less sales taxes and they pay out more in social welfare costs. This is why I'm such a stickler for enhanced CPP and Social Security, a universal pension which covers everyone (provided governments get the governance and risk-sharing right).
  • Rising inequality: The ultra wealthy keep getting richer and the poor keep getting poorer. Who cares? This is how it's always been and how it will always be. Unfortunately, as Warren Buffett and other enlightened billionaires have noted, the marginal utility of an extra billion to them isn't as useful as it can be to millions of others struggling under crushing poverty. Moreover, while Buffett and Gates talk up "The Giving Pledge", the truth is philanthropy won't make a dent in the trend of rising inequality which is extremely deflationary because it concentrates wealth in the hands of a few and does nothing to stimulate widespread consumption (I know, we can argue that last point but for the most part, you know I'm right).  
  • High and unsustainable debt in the developed world: Government and household debt levels are high and unsustainable in many developed nations. This too constrains government and personal spending and is very deflationary.
Keep these five factors in mind as you keep reading my blog to understand the "bigger picture" and why I think we're on a collision course with a major bout of global deflation. As policymakers all around the world, including China, struggle to stave off deflation, I'm afraid they're fighting a losing battle.

Having said this, there is plenty of stimulus and financial liquidity to propel all risk assets, including stocks, much higher. The reflationistas might be right, global growth might surprise to the upside in the months ahead, but this is only a temporary reprieve based on currency adjustments, not fundamental structural adjustments to the global economy. 

It is my contention that ultimately central banks and policymakers will lose the titanic battle against deflation. That's going to be one very scary moment for global markets and the global economy -- one that will usher in profound social changes, hopefully for the better.

But relax, this "great awakening" isn't going to happen anytime soon. Despite what blogs like Zero Edge think, the world isn't coming to an end. The electronically lobotomized masses will keep up with the Kardashians (lol) and the game will go on for a lot longer than doomsayers warn of as the power elite continue making off like bandits. 

That's why I keep trading these markets, focusing my attention on tech (QQQ) and especially biotech (IBB and XBI) where I use big dips to load up on companies I like going forward and continue to short the rips on energy (XLE) and mining and metal shares (XME), believing the leaders will surge higher and the laggards will continue hitting new lows.

But keep this in mind, it will be very volatile, all part of trading these Risk On/ Risk Off Markets.  If you can't handle the heat, don't play the game (especially in biotechs) or just stick to dividend plays like utilities (XLU), REITs (VNQ) and other solid dividend stocks (VIG) which should fare better in a deflationary environment as rates keep declining. (I like biotechs because they have pricing power, which is a must during a prolonged deflationary cycle).

Also, keep in mind there will be violent countertrend rallies in the weeks and months ahead, especially if global growth picks up steam and the U.S. dollar starts reversing course. Don't be surprised if you then see a snap-back rally in energy (XLE), mining and metal shares (XME) and oil service (OIH) and drilling shares which have been decimated in 2015. You can trade these sectors but be careful and take your profits or risk getting slaughtered (most have already gotten their head handed to trying to catch a falling knife in these sectors).

Below, Marc Faber, editor and publisher of the Gloom, Doom & Boom Report, explains why China's move to push its currency lower this week is “completely meaningless.” Not sure it's completely meaningless as it reinforces global deflation fears.

 Also, CNBC's Fast Money trader takes a look at the U.S. dollar vs. the Chinese Yuan, China's devaluation moving forward and the winners including Walmart and bonds.

Lastly, Boris Schlossberg, BK Asset Management, thinks the leadership in China is trying to "plug a hole in a leaky boat." He discusses when the Fed could raise rates.

Schlossberg also recently warned of a big correction in biotech stating these stocks are the "canary in the coal mine"and "a precursor of things to come." I agree with him on China and the Fed, totally disagree with his biotech call. Keep buying those big dips in biotech, it will be volatile but this long secular rally still has legs to run much higher.

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