Lots of sellside squeals this morning following the epic bloodbath in China, where in addition to what we already covered hours ago, has seen at least five companies (China Development Bank, Shanghai ShenTong Metro, China Three Gorges Corp., Doosan Infracore China Co. and Chongqing Shipping Construction Development) delay or cancel bond offerings as the PBOC's admission of capital "misallocation" is slowly but surely freezing both bond and stock markets. And while the plunge was contained first to China, then to Asia, then to Europe (where the Spanish 10 Year once again surpassed 5% as expected following the carry trade unwind), with the arrival of bleary-eyed US traders the contagion is finally coming home.

In a redux of last week, 10 Year yields are shooting up, hitting as high as 2.63% a few hours ago, while equity futures are now at the lows of the session. It could turn very ugly, very fast, especially if the Hamptons crowd were to actually read the stunning BIS annual reportreleased on Sunday, which not even Hilsenrath explaining "what the BIS really meant" will do much to change the fact that the days of monetary Koolaid are ending.

DB's Jim Reid summarized the angst among Wall Street quite well earlier:

There was plenty of weekend news to digest but most of it seemed to circle around three main themes: China, the implications of June’s FOMC and the situation in EM. Starting with China, domestic financial stocks (-4.0%) are seeing sharp losses this morning amid ongoing news flow around liquidity tightness in the interbank market.

In terms of the latest on bank liquidity, the PBoC posted a statement on its website today that said banking system liquidity remains at a “reasonable level”, but warned that Chinese banks must control liquidity risks from credit expansion. This came after China Development Bank, the country’s policy bank became the latest institution to cancel a bond sale (originally scheduled for tomorrow). The official state news agency, Xinhua, wrote over the weekend that "it is not that there is no money, but that the money has not reached the right places". The article suggested that a misallocation of funds into wealth management products had caused the tightness in liquidity in some banks. Indeed, Fitch noted last Friday that more than CNY1.5 trillion in WMPs - substitutes for time deposits - will mature in the last 10 days of June. Issuance of new products, and borrowing from the interbank market, are among the most common sources of repayment for maturing WMPs, and the recent interbank liquidity shortage complicates both.

China's mid-tier banks, are likely to face the most difficulty says Fitch, with an average of 20%-30% of total deposits in WMPs. This compares with 10%-20% for state-owned and city/rural banks. Fitch also noted that the PBOC’s hands-off response in easing the recent tight monetary conditions reflects in part a new strategy to rein in the growth of shadow finance by constraining the liquidity available to fund new credit extension.

Elsewhere in the region, we are seeing a continuation of the weakening trend in EM bonds and local currencies. Asian EM sovereign bonds and CDS are about 5-10bp wider to start the week. China CDS has given back more than what it gained on Friday and is 10bp wider overnight. Most currencies continue to weaken against the USD and the dollar index is 0.4% higher this morning. The Nikkei (-1.2%) is outperforming on a relative basis, helped by a 0.5% rise in USDJPY, after PM Abe's Liberal Democratic Party won a sweeping election victory on Sunday.

The LDP secured an overall majority in the 127-seat Tokyo metropolitan assembly with its coalition partner the New Komeito party. The victory is seen as a good sign for Abe’s government as it heads into upper house elections next month.

Returning to Friday’s session, for much of the day we had a continuation of the momentum that has gripped markets since last Wednesday’s FOMC. Indeed, the S&P500 was languishing at a low of -0.68% early in Friday’s session and was
poised to close weaker for the third straight session, before staging a comeback on the back of a couple of Fed headlines. The first set of headlines suggested that the Fed could delay QE tapering if worsening financial conditions, in the form of rising bond yields and lower stock prices, hurt the economy. There wasn’t much detail behind the headlines though, and the Fed sources were unnamed. As we discussed in our EMR on Friday, volatile markets could keep the Fed on hold for longer than they and the market now think. We continue to expect a difficult few weeks for risk followed by a realisation that the pace of tapering will actually be slower than flagged on Wednesday which in turn will eventually provide some good buying opportunities before the summer is out.

Several minutes after the first Fed headlines hit screens, the WSJ’s Hilsenrath was on the newswires again suggesting that the market had overlooked a number of dovish signals in Bernanke’s post-FOMC press conference. These signals included the Chairman hinting that rate rises would be gradual, and that “a strong majority” of Fed officials had concluded the Fed won’t ever sell its growing portfolio of mortgage-backed securities. This was followed by dovish comments from the Fed's Bullard who said on Friday that the decision to taper was “inappropriately timed” because inflation and economic output has been soft. Interestingly, 10yr yields continued to push higher despite the headlines, and managed to cross the 2.5% mark in the final minutes of Friday’s trading (closing 11bp higher at 2.53%). Selling pressure continued in EM equities despite the better tone in US equities. The MSCI EM index closed 0.88% weaker for its 4th straight loss. Across the EM world, bonds and currencies were generally weaker amid negative reports of outflows. Mexican and Turkish 10yr yields added 11bp and 32bp respectively.

Turning to the day ahead, we have little on the radar today outside of the latest monthly German IFO survey. Indeed, we have a relatively quiet week ahead of us compared with the events which have transpired over the course of the past seven days. Tomorrow, the data flow begins to pick up with US durable goods orders, new homes sales and consumer confidence in the US. On Wednesday, the third and final estimate of US Q1 GDP is scheduled. On Thursday, the UK’s Office for National Statistics will release its annual revisions of past data alongside its third estimate of first-quarter GDP. Other data on Thursday include US personal income /consumption and jobless claims together with an update on German employment. The 2-day European Council/EU Leader's summit starts on Thu with the agenda to consider country specific recommendations on economic policy + bank supervision. To round out the week, Japanese CPI, industrial production, unemployment and retail trade for the month of May is due out on Friday. In the US, the Chicago PMI will also be released on Friday. With the focus on yields, and the patchy demand in recent auctions, it worth keeping an eye on the UST auctions this week: We have US$35bn in 2-year notes on Tues, $35b of 5-year notes on Wed and $29bn in 7-year bonds on Thu. In addition, we get another round of post-FOMC Fedspeak with Fed Governor Powell and Atlanta FedPresident Lockhart speaking on Thursday, followed by regional Fed presidents Lacker, Pianalto and Williams on Friday.

http://www.zerohedge.com/news/2013-06-24/china-crashing-shanghai-composite-tumbles-most-2009

China Crashing: Shanghai Composite Tumbles Most Since 2009

Submitted by Tyler Durden on 06/24/2013 05:21 -0400

Australia

Bond

China

Gross Domestic Product

Reverse Repo

Yen

Those who have been holding their breath until China joins the overnight market fireworks can finally exhale.

Following yesterday's unprecedented formal announcement of epic capital misallocation, the PBOC tried to continue the damage control when a few hours ago it announced that Chinese banking system liquidity "is at a reasonable level", but that banks must control liquidity risks from fast capital expansion, especially credit expansion, according to a statement on management of banks’ liquidity on website. The implication: no easing any time soon, and sure enough no repo or reverse repo activity was logged in the overnight session meaning Chinese banks, for the time being, continue to be on their own, without any hope of the central bank stepping in to bail them out.

The PBOC announcement appears to have restored some stability in the interbank market if only for a very brief amount of time: the 1 Month SHIBOR drops 234 bps, most since Oct. 2007, 7.3550%, with the one-day repo rate falling 204 bps to 6.6540%. Longer-term liquidity also improved modestly, with the seven-day repo rate drops 159 bps after sliding 237 bps on June 21. However, as Market News reported , the PBOC won’t cut reserve ratio, interest rates in near term, and if anything will just use more open-market operations. The problem with this kind of opaque intervention is that it once again raises the specter tha behind the scenes one or more banks are getting direct bailouts. In other words, look for real interbank liquidity to be abysmal at best.

Not helping the PBOC's credibility was the news that China Development Bank canceled a bond sale up to CNY20 billion planned for tomorrow for "reasons."

Certainly not helping China was that late on Sunday Goldman cut its China growth forecasts for 2013 and 2014, "on the account of soft cyclical signals and recent tightening of financial conditions. We now expect real GDP growth to be at 7.5% yoy in Q2 2013 (from 7.8% previously), and 7.4% and 7.7% for 2013 and 2014 respectively (from 7.8% and 8.4% previously)."

End result: the Shanghai Composite, which had largely been able to weather the recent dramatic shocks to both liquidity and the economy, finally threw in the towel and crashed. Moments ago the Shanghai Composite fell 5.5%, the biggest intraday slide since August 2009, and dropping below 2,000 for first time since December.

The brodest China index is now down 14% year to date, with the Property Index leads slump with 7.7% drop to lowest since November.

Needless to say the world's second largest economy imploding, and its stock market crashing were enough to send all of Asia lower, with the Nikkei225 unable to sustain gains on a weaker Yen, and swining from up over 1% to down 1.3%. As for that China derivative, Australia and specifically its currency the AUD, it just hit a fresh 52 week low against the USD at 0.9155.

Of course, if the BIS's warning about what is coming to the "developed markets" is accurate, this is nothing but a pleasant rehearsal of what one can expect in the US and in other G-7 places.

As for China, if Goldman is correct, look for much more pain below. Here is the summary of the firm's downgrade of the Chinese economy:

We are cutting our China growth forecasts for 2013 and 2014, on the account of soft cyclical signals and recent tightening of financial conditions. We now expect real GDP growth to be at 7.5% yoy in Q2 2013 (from 7.8% previously), and 7.4% and 7.7% for 2013 and 2014 respectively (from 7.8% and 8.4% previously).

The recent tightening of the interbank market has sent a strong policy signal that the strong credit growth earlier in the year will likely not continue. We estimate this to tighten the FCI by another 30-40 basis points (bp) in the coming months, in addition to the FCI tightening of 100 bp so far this year driven by the rapid CNY appreciation on a trade-weighted basis.

The liquidity tightening is another indication that the new government has put priorities on tackling the structural problems. These policies help to foster more sustainable medium-term growth, but will test the government’s tolerance for a cyclical downturn. A reversal of the recent tightening is the main upside risk to our new forecast. Continued DM stagnation or spreading overcapacity problems will imply downside risks.

MONDAY, JUNE 24, 2013

The BIS Loses Its Mind, Advocates Kicking Citizens and the Bond Markets Even Harder

If anyone doubted that Ben Benanke’s “we’re convinced the economy is getting better, so take your lumps” press conference after the FOMC statement last week was awfully reminiscent of 1937, the newly-released Bank of International Settlements annual report is tantamount to a kick to the groin. And to change metaphors, if the Fed’s sudden hawkish posture is playing Russian roulette with the real economy, the BIS just voted loudly for putting a couple more bullets in the cylinder.

Investors took the news badly, with 10 year Treasury yields rising from 2.18% before the FOMCstatement to 2.53% at the end of Friday. And the selloff continues, with the 10-year yield as up to 2.62% as of this writing.

Some commentators thought the Fed talk was misread, pointing to the various thresholds and triggers the central bank set for for commencing its QE exit and they actually weren’t so terrible. Others refused to believe Bernanke was serious, with Marc Faber saying that bonds, stocks, and equities were “very oversold” and arguing, “We are going to go with the Fed to QE99.”

Unfortunately, the worry warts are looking to have the more accurate reading. Tim Duy zeroed in on a key bit of information, namely, St. Louis Fed James Bullard’s speech on Friday, on his dissent from the FOMC’s vote (Bullard thinks low and falling inflation means the economy is weaker than his colleagues believe). This was Duy’s takeaway:

Why would the Fed lay out a plan to withdraw accommodation – which in and of itself is a withdrawal of accommodation – at a meeting when forecasts were downgraded? Because, as a group, policymakers are no longer comfortable with asset purchases and want to draw the program to a close as soon as possible. And that means downplaying soft data and hanging policy on whatever good data comes in the door. In this case, that means the improvement in the unemployment rate forecast. Just for good measure, let’s add on a new policy trigger, a 7% unemployment rate. In my opinion, it is not a coincidence that they picked a trigger variable where their forecasts have been most accurate or even too pessimistic. They loaded the dice in their favor….

I think market participants clearly heard Bernanke. After weeks of being soothed by analysts saying that the data was key, that low inflation would stay the Fed’s hand, Bernanke laid out clear as day a plan for ending quantitative easing by the middle of next year. Market participants then concluded exactly what Bullard concluded: It’s the date, not the data.

That’s been my reading as well. Something is driving a new-found eagerness to get QE over. Could it be the mid-term elections, that they believe their own PR (that the economy really really is gonna lift off once that little sequester bump is over) and they want any market adjustment (which they also view as temporary) to be over before the fall election? Remember, the Fed was very much criticized for easing on the late side in 1992. Bush senior believed it cost him the election. Yanis Varoufakis presents another theory from one of his correesondents:

What had happened was that interbank lending rates were rising in China. Unlike other credit crunches (e.g. that in Italy now), this particular credit crunch was effected by the Chinese government for the purpose of pricking the gigantic speculative bubble in China before it inflates further with devastating potential. This same bubble is intimately linked to the US economy: both US finance and the midwest mining areas of the US are fully involved. Shortly afterwards Chairman Bernanke started talking about relaxing QE3. If the Chinese government no longer wants to provide unlimited liquidity then the whole burden of sustaining the bubble would fall on the Fed. Mr Bernanke considers this to be far too dangerous and for this reason he may have brought forward the Fed’s exit from QE. In this reading, the Fed’s signal that it is exiting QE has nothingto do with the actual health of the US economy and everything to do with China’s economic situation and government intentions.

I’m not endorsing that view, but it does seem as if something is driving the Fed’s sense of urgency, and what that something is is not readily apparent. Remember that another lesson that the central bank supposedly was well aware of, indeed, this was the practice Greenspan and Bernanke both appeared to adhere to, was that of signaling intentions to tighten interest rates well in advance. When the markets reacted badly to the “t” word, the Fed not only failed to make reassuring noises, but also, in the mind of the market, moved the timetable up.

Now before you say, “This is no big deal, QE didn’t do much for the real economy” bear in mind what it was intended to do: to goose asset prices to help growth. The immediate object was to repair bank balance sheets. By making bond prices higher, they not only made equity levels looked better, but that operation also enabled banks to sell equity, something that would have been impossible if they looked feeble.

Now who gets whacked the hardest when bond prices go down fast? Banks and securities dealers (who are pretty much all banks these days). Banks are structurally long. Derivatives markets aren’t deep enough for them to get net short (and have the bet actually pay off). The best they can do to minimize damage is reduce their inventories, particularly of the long and medium term bonds (yes, and do as much hedging as possible, but that’s only a partial remedy). So Bernanke’s apparent renouncement of the “give banks plenty of warning so they can get out of the way” practice is a great big test of whether the banks are really as healthy as all the regulators have been insisting they are.

Now remember that Treasuries are also the foundation for valuation of all other securities. So hitting the Treasury market hard hits all other financial instruments because it raises the risk-free return rate. As Ambrose Evans-Pritchard points out:

The Swiss-based institution said losses on US Treasury securities alone will reach $1 trillion if average yields rise by 300 basis points, with even greater damage in a string of other countries. The loss could range from 15pc to 35pc of GDP in France, Italy, Japan, and the UK. “Such a big upward move can happen relatively fast,” said the BIS in its annual report, citing the 1994 bond crash.

The BIS poured more gas on the bond bears’ fire. The word most commonly used in polite circles to describe it is “remarkable,” and not in an approving way. From Ryan Avent at the Economist:

The annual report is a remarkable document, one which might well come to serve as the epitaph for an era of central banking spanning the Volcker disinflation and the Great Recession—the epoch of the central banker as oracle, guru, maestro. If the end of this era is upon us, we can credit a series of revelations: that central bankers learned the lessons of economic history less well than they’d thought, that they displayed an unfortunate tendency to set aside economic rigour in favour of an obsessive focus on price stability, and (perhaps most importantly) that they are in more need of democratic accountability than is often assumed. Above all, the report captures what may be the most critical error of the modern central banker: eschewing a focus on his proper domain—demand stabilisation—in favour of an arena in which he has no business sticking his nose—the economy’s supply side.

The article is a full-on shellacking of the BIS’s policy whining. For instance, it takes on the BIS’s call for more “fiscal consolidation” which is Troika-speak for austerity:

Something something fiscal policy. Central bankers have strong views on what governments ought to be doing with their budgets, many of which make most sense when given the least scrutiny. The BIS knows what it wants to say: that fiscal consolidation is almost universally necessary and the only real question is how to pursue it. Picking a path toward this argument that doesn’t immediately cave in under the weight of self-contradiction proves to be a difficult task.

The BIS fails to wrestle with the fact that borrowing costs for sovereigns without central banks have risen while those elsewhere have not; it finds itself relying on discredited ratings agencies for assessments of non-euro-zone sovereign creditworthiness rather than market prices. The BIS also dances around a parallel, uncomfortable fact: that austerity within the euro-zone has often enough been associated with falling market confidence and not the other way around. In other words, where markets are least frightened of sovereigns austerity is most easily tolerated, precisely because central banks are free to pick up the slack. And where markets are most reluctant to lend, austerity is almost entirely self-defeating thanks to the absence of a flexible central bank.

Evans-Pritchard is also gobsmacked by the report’s recommendation:

The call for double-barrelled fiscal and monetary contraction is remarkable, challenging the widely-held view that easy money is crucial to smooth the way for budget cuts and deep reform.

And Evans-Pritchard also points out that history shows that exiting extraordinary monetary measures on the late side isn’t the big deal that inflationistas have made it out to be:

Scott Sumner from Bentley University said the BIS is wrong to argue that delaying exit from QE and zero rates is itself dangerous. The historical record from the US in 1937, Japan in 2000, and other cases, is that acting too soon can lead to a serious economic relapse. When the US did delay in 1951, the damage was minor and easily contained.

And Frances Coppola stresses that the idea that QE caused inflation was a myth:

There is zero chance of domestically-generated inflation while wages are falling, contractionary fiscal policy is depressing real incomes, banks are not lending and corporates are failing to invest. Externally-driven inflation is possible, and we are of course seeing inflation in asset prices as a consequence of QE. But the core trend is disinflation in developed countries – I hesitate to say “deflation”, since inflation is still above zero, but core inflation is on a downwards trend in nearly all developed countries.

Now the wee problem is the super clumsy execution of whatever the Fed intended to do, compounded by the BIS hissy fit in the form of its annual report, means we are not only going to have some serious damage in the bond market. We’ve already seen 30 year mortgages go from under 3.50% as of March to 4.24%, and we’re probably not close to done with this “adjustment”. Pimco’s normally sober Mohamed El-Erian also warns to brace for a wild ride in the Financial Times:

3. Considerable disconnects between asset prices and more sluggish fundamentals make this phase particularly volatile and disorderly. Remember, central banks saw artificially-elevated asset prices as a MEANS to meet their growth, job and inflation objectives. But herd behavior among market participants ended up pricing this as an END itself, inserting an even bigger wedge between valuations and fundamentals.

4. Judging from Chairman Bernanke’s remarks, the Fed is confident that improving fundamentals will overcome current turbulence and validate high prices. With others less sanguine about economic prospects, prices are now converging down to fundamentals rather than the other way around.

Translation: odds favor all sorts of assets being repriced downward. And what do you think that is going to do for the confidence fairy?

Now Faber is likely right and we’ll see a bounce sometimes, but from what level? The one thing that might change the equation is that the Fed thinks it’s really been misread, and dispatches some key folks to give reassuring speeches this week. But remember, the Fed has never cared that much about the real economy, despite its gestures in that direction. The very fact that Board of Governors member Sarah Bloom Raskin had to visit a job fair before she understood how desperate unemployment conditions are speaks volumes as to how out of touch the central bank is.

While Tim Duy concluded that economic data has to be “pretty bad” to persuade the Fed not to taper, it might be even worse than that, that it will take signs of stress in financial markets or financial institutions to get them to relent. So brace yourself for a rough ride.

The Bank Of International Settlements Warns The Monetary Kool-Aid Party Is Over

Submitted by Tyler Durden on 06/23/2013 - 16:10

"Can central banks now really do “whatever it takes”? As each day goes by, it seems less and less likely... Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now. Monetary stimulus alone cannot provide the answer because the roots of the problem are not monetary. Many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity...Continued low interest rates and unconventional policies have made it easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system...Overindebtedness is one of the major barriers on the path to growth after a financial crisis.Borrowing more year after year is not the cure...in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits." - Bank of International Settlements

Catharsis Ours

Monday, June 24, 2013

US Traders Walk In To Another Bloodbath

China Crashing: Shanghai Composite Tumbles Most Since 2009

MONDAY, JUNE 24, 2013

The BIS Loses Its Mind, Advocates Kicking Citizens and the Bond Markets Even Harder

The Bank Of International Settlements Warns The Monetary Kool-Aid Party Is Over

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