WESTON NAKAMURA: Hi, everyone, it's Wednesday, April 27th, 2022. Welcome to the Real Vision Daily Briefing. My name is Weston Nakamura, and I am joined once again today by Mr. Darius Dale, founder and CEO of 42Macro. Darius, how are you, sir?
DARIUS DALE: I'm doing well, man, you should have told me you're wearing a suit. I wouldn't have worn one myself if I would have definitely known.
WESTON NAKAMURA: Suit? These are my pajamas. This is how I sleep.
DARIUS DALE: You're always ready to go, man. Really appreciate you guys checking in on Japanese hours. I know it's tough.
WESTON NAKAMURA: It's global hours. Now, usually, the last few times you and I get together, it's because of Japan had blown up that day. However, this time is different. We might actually be frontrunning potential blowing up of Japan, but maybe not. The reason I'm saying that is because tomorrow we have a BOJ, Bank of Japan, monetary policy meeting, which is probably the first one that's been in focus in years.
We'll touch on that in a moment. But for now, just taking a look at markets as we're closing up here, it looks like US indices for the most part ended up more or less flat on the day giving up some incremental gains here at close, positive. In Asia, you had a reversal in the Chinese indices and Chinese stock markets to the upside. But again, this was following pretty severe selloffs happening over the last several days, which we can get into as well.
This is the pre-BOJ meeting day rather, and we're going to touch on that, but Darius, a I want to talk to you about China. Oh, yeah. Because I know, you've been certainly all over this. Market price action, we've seen, let's start with the currency, the yuan had been getting just killed since really last Friday or so. Youve been seeing two consecutive days of 1% moves on USD/CNY, which is huge for a managed currency. And minus 3% over a three-, four-day span.
Those are some very serious moves. And then, of course, the equity indices too have been selling off. And then they had a short squeeze rebound today on headlines of infrastructure from President Xi. Just give me your view on what you see happening in China right now.
DARIUS DALE: Yeah, let's take a step back and paint the picture for those who're may be new to the Chinese economic situation. Obviously, the world's second largest economy, but not many investors follow it with the same rigor, analytical rigor that they do the US and other economies. The Chinese economy has been cyclically slowing since the early part of 2021.
They are towards the tail end of their cyclical slowdown, at least according to our models. But by that admission, they're certainly in the lowest level of the activity that we've seen. And part of the reason we're seeing such low levels of activity in China, it's a function of their zero COVID policy. They have the entire city of Shanghai more or less completely locked down right now. That's their largest city by GDP and population.
Obviously, Beijing being one of the top three cities by GDP and population, they're actually rumored to potentially be ramping up testing that could potentially lead to a lockdown in Beijing. We're not there yet. But it's certainly an issue as it relates to the very near-term Chinese growth outlook. Talking about this two, three months later, I don't think any of this will be relevant anymore. But certainly, from a very near-term perspective, it's a big deal.
As a function of the Chinese growth metrics whether you look at hard data, whether you look at expectations, GDP estimates continue to get slashed across economists consensus, or whether you just look at it from a market standpoint, Shanghai Composite hit a two-year low before rebounding this morning. The markets, the economists and pretty much everyone out there understands that the growth outlook in China is very challenged.
As a function of that, there have been a lot of calls from investors for the PBOC and for Beijing, for Chinese fiscal authorities to ramp up stimulus. And there have been actually a rhetoric out of the out of those entities in supporting some of those calls. You go back a few weeks ago, we had [?] come out and say they need to do more to step up policies to promote the stock market.
Then like a couple of weeks after that, or a week after that, they effectively pushed the central [?], which is the entity that owns all these state assets in China, to buy more stocks, to buy more to support Chinese asset markets and also to [?] the signal to Chinese asset managers. And then most recently, this morning, we got President Xi Jinping out with a pledge to step up infrastructure investment as if to counter the growth slowdown, which, ironically, is partially his fault as a function of the COVID policy.
We're here today trying to figure out what is the most likely outcome from an economic and more importantly, monetary and fiscal easing standpoint in China. I'm happy to unpack that.
WESTON NAKAMURA: Yeah, let's actually just address the policy steps before the actual-- the policy steps he's taken it before the jawboning measures, if you will. Recently, what they did was, so I believe it was, correct me if I'm wrong, Darius, but it was two days ago, or three days ago that the officials stepped in and what they did in light of this falling yuan, was that they raised the-- I'm sorry, they lowered the foreign exchange reserve ratio for banks by 1% down to 8% starting in mid-May.
And basically, what that does is it's to reduce the requirements to hold domestic currency that should basically dampen the desire to hold foreign currency, USD, for example, and therefore support the yuan. And that actually did have that market outcome that they had had it intended for.
Now, the problem with doing that is that last year in 2021, the FX reserve ratio, this rate, they raised it twice. And at that time, they did so by citing that they're trying to combat yuan strength. And they were also saying at the time that yuan strength, that this is market forces driven. Well, not anymore as of two days ago. That goes against that. I guess that's like a hybrid between actual policy and implementation as well as some jawboning going on.
DARIUS DALE: Let's take a step back, they did ease policy to a slight degree by the yuan devaluation that we saw over the weekend. It was nothing to write home about in terms of where we've been in historical yuan depreciation cycles, but it was a big pit move relative where we have been trending, certainly from a realized volatility perspective, and also a levels perspective, we pretty much gapped up, let's call it from just above 6 to 6.60, or just under 6.60 on the USD/CNY or USD/CNH.
That move you're discussing now was effectively to release capital to allow Chinese banks to sell dollars on behalf of their clients and cap, put a floor into the depreciation cycle. It's my interpretation that the monetary authorities, the PBOC, and the fiscal authority in China effectively did that slight devaluation as a shot across the bow to their counterpart across the pond in Japan to say, hey, look, you continue to allow the yen to depreciate at this pace, it's going to have implications because we're going to do what we need to do to maintain our competitiveness.
Obviously, Japan is probably China's number one principal export competitor, if you will, and certainly the implications to the yuan. And the reason we're having this discussion, by the way, is because historically, we've seen going back to 2015, 2016 is the most recent major example of yuan depreciation having a massive impact on global asset markets.
And the reason it has a massive impact on global asset markets is because sometimes it can coincide with disinflation cycles. Brian, if you pull up that chart, yuan devaluations chart I sent you, you can see what I mean. Now, there would have been six disinflation episodes since the Global Financial Crisis in the US and global economies, three of them have coincided with managed depreciations in the Chinese yuan.
And that makes sense. China's the world's largest source of export, or in terms of import demand, China's the number one exporter to the US at about 18% of total imports, and the number one exporter to the EU in about 20% of total imports. Obviously, the price of the yuan and what the Chinese yuan goods are being priced in on a dollar swap basis clearly has an impact on inflation cycle.
That's why a lot of investors were so very concerned about this, because a lot of folks would have been offsides being long reflation, or inflation, the two regimes associated with inflation accelerating in terms of those exposures, and a lot of folks are just simply not positioned for deflation or disinflation at this particular juncture. We saw a lot of pain on Monday from a lot of different accounts.
WESTON NAKAMURA: Yeah, and just to remind people, that August 2015 deval, that was huge. That was cross asset volatility across the board. And it was really not that big of a devaluation but basically, it was the signal that was sent.
And that almost accidental firepower they have. What I mean by that is it's almost like when they're trying to actually instill a policy or jawbone a policy in or a market desired outcome in, they find temporary success at best. On the other hand, when they use some of their monetary tools, they're basically bringing an axe to a surgery.
DARIUS DALE: Yeah, exactly. Yeah, a samurai blade to a surgery. That's been the history of Chinese monetary and fiscal policy responses to growth. That's, Brian, if you pull up that other chart I sent you, the China 3M SHIBOR versus China credit impulse, let's set the stage, if you will, for why we're here today.
The reason China slowed to this place is because the PBOC, the Chinese Beijing, the state council has been unwilling to do the broad base wide scale physical infrastructure style stimulus that we've become associated with in previous Chinese reflation cycles. If you go back and look at the last five big easing cycles we've seen in China, as denoted by the charts, the red dotted line, the blue dotted line in those charts are the beginning and end of those easing cycles.
If you compare it to today, you'll see you notice that hey, look, we've hardly seen any easing in the Chinese financial sector in recent months. We've only seen a 25-basis point decline in 3M SHIBOR year-to-date. The reason I tracked the 3M SHIBOR is PBOC has a variety of tools that it uses to control the cost of money and availability of credit in the Chinese financial sector. It's got open market operations, medium term lending, RRR, reserve requirement ratios, different other ratios and loan primaries, etc.
3M SHIBOR, given that about 80%, 85% of all private non-financial sector in China is on-bank balance sheet, more or less captures all those moving parts in totality. And historically speaking, when you've seen these massive easing cycles in China, the kind you need to be afraid of as a bear, to be very clear, you typically have seen already 200 to 300 basis points of easing in 3M SHIBOR as a function of all those other moving parts.
But we've only seen really 25 basis points of easing thus far. And it's certainly not enough, in our opinion, to get the Chinese economy's meaningfully resuscitated in any systemic reflation that catalyzed a different outlook from a medium-term asset market response perspective.
WESTON NAKAMURA: Yeah, so what do you make of the fact that they-- take loan prime rate, that they left unchanged, that they're not really doing anything in that realm, but I've never seen a jawboning like this. I don't mean just for-- from anyone, like you were talking about earlier. This is like this was a day of March FOMC, when they just came out of nowhere, and they basically just did this verbal intervention in the equity markets, explicitly saying, foreign long only investors, add to your shareholdings.
This is market bottom and flipped on every single thing that they had-- every single cloud that was overhanging Chinese equity markets, be it the tech regulatory crackdown, the Evergrande, the property sector deleveraging, all of that just flipped on a dime. They'll do that. But then actually, when it comes to the actual policy, they're on hold. What do you make of that divergence?
DARIUS DALE: Look, I think they're in a tough spot. They understand that they need to hit a certain level of growth target. Now, we can debate what that should be or what it's likely to be. I think we have a good clip from my friend Leland Miller over at China Beige Book on that particular topic. That number is coming down, it's coming down sustainably over the long term.
Now, they don't need or want it to crash, it would do no one any good in Beijing to have Chinese growth fall off a cliff. They're going to do and tinker whatever tools they can tinker with. The problem is, and this is what I was trying to say earlier, is that for whatever reason, in this particular growth slowdown that we're engaged in in China, we have simply not seen the response we've seen in previous growth slowdowns.
Now why is that? Maybe it's a tacit admission that China's getting further and further, closer and closer to the brink of the abyss from the leverage cycle perspective in the sense that it can no longer continue extending credit at the cost and at the supply to continue capitalizing what is very unproductive investment. It's proven to be unproductive investment. And if you look at Chinese inflation statistics, which I think the headline CPI is somewhere around 1.5%, core CPI is somewhere around 1%, 1.2%.
If you look at their inflation statistics, they look more like Japan than they do like most emerging market economies. And you can make the case that a lot of the overbuilding of property supply, the overbuilding in the manufacturing capacity that we've seen in the prior two, two and a half decades, has really been something that's weighing on the Chinese inflation and nominal growth in China.
At the end of the day, I think they're aware, aware of the longer-term implications of continuing to, for lack of a better term, build empty cities to build on productive capacity from manufacturing standpoint. I think they're reluctant to do that, which means they're just going to continue to do what they can to put a floor on their growth, and maybe tilted back towards the upside, but certainly not do anything that would cause a reflationary boom across the global economy.
WESTON NAKAMURA: Actually, let's take a look at that clip of Leland Miller from China Beige Book, CEO. This was an interview from 19th with Maggie lake on the Plus and Pro tier. Let's take a look at that clip.
LELANDMILLER: But in China, they want to rule forever, so the party is much more focused on the structural problems in the economy in a way that Western analysts don't even pretend to understand. They are stepping in to change the economic growth model. They changed it already.
It's happening right now. All these growth projections about growth going down a 10th of a percentage point in 2021. It's nonsense. It's nonsense. We're in a new regime. And we need to treat it like a new regime. And we need to have the expectations about China's role in the world, and China's growth numbers that are concomitant with that understanding going forward.
WESTON NAKAMURA: All right, so that was Leland Miller and Maggie Lake. Leland Miller, once again, from the China Beige Book, CEO. That aired on April 19th for the Plus and Pro tiers for Real Vision. Let me just now just pivot over to, Brian, if you put up chart three that I have. The reason that I'm talking about China, we're talking about China, as it relates to the BOJ and the yen, this is just a chart of dollar/yen and the 10Y US Treasury yield, which we all know this chart, they basically mirror one another.
And then as well as also threw CNY/JPY, so Chinese yuan/yen cross rate. And that peak that you see, and then that reversal and plummet, that peak point right there, that is when the Bank of Japan first announced their latest round of fixed rate operations, which had been running for what is it now, six consecutive days.
Then that basically ends, those fixed rate operations, to buy an unlimited amount of JGB 10s at a yield of 25 basis points, that ends as of today, later today, which is going to be BOJ day, which is also the last trading day before Japan goes on very long holiday and the world is absent. The world's largest foreign capital allocator amidst all this. We are in very interesting times ahead, Darius, what do you make of what's coming within, I guess the next 24 or 48 hours, the BOJ meeting basically, and the market response potential?
DARIUS DALE: If they're going to change the yield curve control policy they're doing it in the worst possible way, they certainly would do-- they're doing it in a way that would create the most amount of financial market volatility and create the most destabilizing impact across global financial markets. We have a view that they're not going to. We obviously got a pretty strong message from Governor Kuroda couple times last week, actually, in terms of renewing their commitment to yield curve control.
Again, this goes back to it's not about what these people want to do, it's what they have to do. Inflation dynamics in Japan continue to be well shy of Japan's target and they continue to obviously have some struggles, big struggles in terms of achieving those objectives. Until they achieve the objectives, which, at least according to our forecast over the next 12-month time horizon, they're not going to achieve their inflation target.
They're very likely to maintain yield curve control, unless there's some political objective in Japan that comes down the pike that is just very against the speed and pace of the yen depreciation, but we put up a chart last week, we tweeted out, it actually might have been two weeks ago, where we're showing the relative volatility in the Japanese yen relative to prior intervention cycles.
And we're nowhere near the volatility we've seen on average in prior intervention cycles, so we continue to be pretty steadfast in our belief that it's going to be mum, mum's the word with respect to yield curve control and the yen depreciation that we're seeing in the cycle.
WESTON NAKAMURA: Yeah. First of all, I got to plug in again that chart, because it was awesome. But I was looking at it, I was like, oh, this is so simple. Why didn't I think of this?
DARIUS DALE: I'm trying to keep up with your charts and kill them.
WESTON NAKAMURA: But if you haven't seen that chart, I have it on my Twitter feed, but basically, what Darius track was just the historic moments in which there were yen intervention from top-down policy directed manner and realized volatility