PBOC introduces interest rate uncertainty with HIBOR surge

Who can forget the events of 11th August 2015 when the global financial system was sent into a tailspin after a decision made by the People's Bank of China relating to the way it fixed the price of it's currency, the Renminbi, brought chaos into financial markets worldwide when participants suddenly feared the abrupt devaluation of the Chinese Yuan was suggesting all wasn't well underneath the surface in China.

After heavily intervening in it's markets, the PBOC was able to bring about stability to markets again following a six month volatility spell that sowed distress throughout financial markets, an achievement that was applauded last month when market participants marked the one year anniversary since market turmoil began and subsequently referred to as the Yuanniversary.

Most commentators had said the central bank's market orientated approach to currency movements as opposed to intervention had boosted confidence in its ability to prevent financial contagion but were skeptical of it's consistency of following up with it.  

It wasn't long before those doubts cast a dark shadow over financial markets with the latest surge in the benchmark Hong Kong Interbank Offered Rate jumping to the highest levels in months on speculation the PBOC was holding back liquidity reaching the offshore market in Hong Kong.

AsiaPac Stocks Plunge Most In 8 Months As China Money Market Turmoil Accelerates https://t.co/Lkxggdnxc8

— zerohedge (@zerohedge) September 12, 2016

These latest interventional measures were prompted by the PBOC's defence of the 6.70 level on the US Dollar against the Chinese Yuan with policymakers resolute in upending the weakness that's occurred in recent months saying any further devaluation could spur on an increase in capital outflows due to concern. The outflows that happened during the height of last years panic stricken commotion is yet to return with the result being a tighter monetary supply leading to a shortage of foreign lending into the economy.

This would translate into a weaker outlook and eventually a weaker economy, something Chinese policymakers are unwilling to lose given the stability created thus far.

But in creating a liquidity shortage in the offshore market the PBOC is implying that restrictive monetary conditions are well on their way, ravaging the markets expectancy of perpetual money creation from global central banks and introducing volatility back into the system.

If contemplating the tone of a number of central banks statements, it's difficult to interpret a set pathway with the Fed providing an ambiguous thought on the continuation of rate hikes and the ECB noting it's view of seeing rates lower for longer but no discussions underway about a possible extension of its current quantitative stimulus program.

The confusion being created in the midst of monetary policymakers hesitancy to offer the market confidence is generating uncertainty that's dictating the movements. It's highly doubtful we'll see any clear direction in the short term until we see the outlook become less hazy.

Reflecting back a year after the PBOC Yuan devaluation

Calmness and confidence were the flavours of the day yesterday as the world used a moment of retrospection to remind itself of the events that happened a year ago when the People's Bank of China sudden devaluation of the Yuan marked the beginning of a financial volatility storm that blew away out of touch complacency and filled the air with fear.

Although the move helped bring about a correction in Chinese equity valuations that had drawn in so many deluded citizens hoping to cash in on the "never ending" stock craze casino, it hasn't driven it back enough for real investors to feel comfortable of a realistic outlook.

At the time I can recall making the suggestion that the weight of China in the global economic equation was truly felt by the shockwaves it sent throughout the world financial system that held it down for the next six months after it had happened. I still believe the day marked a point where China could no longer throw smokescreens in front of the market and expect it to go unnoticed.

The core of uncertainty emanated from the consistent interference from Chinese officials in various parts of the economy with many expecting such drastic action by the PBOC to imply greater intervention in the future. However the central bank must be applauded for staying its ground after realizing soon enough that such undertaking would tarnish the reputation of its fragile investment image that's suffered tremendously and possibly harm future prospects.

But the real test a year later is will they continue to abide by this stance of non-interference or will they take their chances and challenge the limitless might of the market as a whole?  

It's 9:16am in HK. Exactly a year ago, China devalued the yuan. Today's fixing 6.6255

Happy #Yuanniversary pic.twitter.com/nWB8k2v7AD

— David Ingles (@DavidInglesTV) August 11, 2016

The PBOC is speculated to be using intervention again

Last week I spoke about the ramifications of Brexit on the nature of global monetary policy going forward and said the Bank of England was poised to open its war chest of monetary tools to avert a deepening crisis in the British economy. I also said I thought a loosening stance from the BoE was likely to apply pressure on the US Federal Reserve regarding their divergent pledge to see interest rates normalised as opposed to its developed world counterparts such as Europe and Japan.

My assertiveness that this will indeed be the case was strengthened after it was reported the People's Bank of China may have intervened in the onshore currency market following an appreciation in the US Dollar which should've been offset by a devaluation in the Chinese Yuan with officials decidedly fixed the rate stronger.

The PBOC had steadied its hand with intervention when it abruptly devalued the local currency in the middle of last year causing shockwaves throughout the global financial system. After finding stability towards the beginning of this year it took the decision to allow market forces to dictate the direction of the price rather than set it itself.

Having followed this decision up until the Renminbi reached a six year low of 6.70 in the days gone by, its becoming abundantly clear that policymakers have reached an end of this resolution by observing the sudden appreciation of the local currency in an attempt to ward it away from this critical resistance.

Either the PBOC will be left to vehemently defend this level with all its might or it envisions a situation where the US economy is susceptible to economic headwinds that defer the Fed from raising rates as the global outlook remains bleak. Its own economy has yet to inspire forecasts that's turning the tide against the notion of a perpetual economic value generating machine.  

#Yuan rises most in a month as it looks like #PBOC may be defending 6.7: https://t.co/zTkiPB56w0 via @business pic.twitter.com/GQNxGI1bFQ

— Quinton Mendes (@CadeTradeR) July 20, 2016

China can no longer rely on debt to fuel growth

It's hard to believe a year has flown past since matters relating to an implosion of Chinese equity markets took a firm grip of the world's future outlook and sent global financial markets into overdrive over the spillover effects of such an event.

Although the full risks have yet to contaminate the world economy it must be said that the Chinese government has orchestrated the fixed smooth over of concerns many economists cited as persistent problems that threaten to reappear at a later stage.

One of these risks is the consistent additions to an ever growing debt pile used to spur economic activity that's seemingly wearing thin in its appropriateness as a tool to stimulate growth. The current situation in which consumers and producers have burdened themselves up with debt is weighing heavily on their ability to transform income into a value chain.

The taxing demand interest repayments impose on the borrower is far outstripping any good that would come out of it due excessive obligations as a result of an overextension of credit.

Notwithstanding the fact that debt made in the past was done so with the perception of infinite growth at abnormally high rates which don't match present reality. The difficulty in achieving escalated economic expansion requires policymakers to reign in the debt in the short term to medium term and only recommence once satisfied enough has been done.

But considering how indebted China is, roughly 250% of GDP, this would be a mammoth task for any government to achieve in a short span of time. Herein lies where the next frontier of economic thought is going, the Growth Dilemma.

How does a nation abate the long term implications of an action that motivates a short term solution to a dire situation yet leaves its citizens poorer by laddening excessive obligations to their sustanence?  

China’s mounting debt is hurting its tradition of using spending and lending to spur growth. https://t.co/3m8dUpcTUy pic.twitter.com/gbNvnHEotP

— NYT Business (@nytimesbusiness) July 15, 2016

How to analyse the Chinese yuan depreciation?

When combing through the past three months of financial market news flow you'd agree that the issue of China has gone very quiet lately which leaves investors wondering, why the sudden silence?

It's fair to say that Brexit and the rally in oil prices have dominated headlines for a while causing a disruption in the coverage on matters relating to China although it must also be said that a number of changes implemented by the Chinese government in terms of a lessening of financial market regulation have gradually been taking shape with the installment of a new Chinese Securities Regulatory Commission's chairman Liu Shiyu.

What we've seen evolve since Shiyu's appointment is a steadiness in the depreciation of the Chinese yuan against the dollar that eclipses the abrupt and sharp devaluation that took place in August last year that sent shockwaves through global markets.

The stark difference between the two events comes down to the fact that Shiyu has allowed the free market to decide an appropriate equilibrium whereas his predecessor, Xiao Gang, liberalised the market far too quickly that by the time it came to regulate the necessary parts in the market, participants saw this as signs of fear from the government.  

#China Onshore Yuan drops to 5.5yr low. pic.twitter.com/BGlT2q6YMz

— Holger Zschaepitz (@Schuldensuehner) June 28, 2016

Working hand in hand with the People's Bank of China (more commonly known as the PBOC) the CSRC has coordinated a greater certainty in policy going forward and in doing so has indirectly cooled down market fears from the height they had reached late last year.

This is yet another positive improvement stemming out from Chinese financial markets that will allow their securities to be included into global investment funds, thus broadening the diversification of investors in China.

However as much as China needs to be applauded with its efforts to align its own financial markets to a global benchmark, the actual depreciation of the yuan begins to tell a worrisome story of the future that'll have a profound impact on the global economy.

It says to us that foreign investors don't perceive a strong bounce in economic activity anytime soon indicated by the level of outflows that have exited the financial system this year alone. In the short term it may pull the brakes on the economy but over the long term it would certainly stimulate exports from China again.

Whether developed nations, who are suffering from severe currency appreciation, take kindly to this is another question altogether and will probably cause fingers to be pointed, increasing the chances of the world seeing a resurgence of currency wars.

Exclusive: China to tolerate weaker yuan, wary of trade partners' reaction - sources https://t.co/rVYUP3BnvT pic.twitter.com/10xVNrxSkj

— Reuters Top News (@Reuters) June 30, 2016