DRIVING THE DAY
1. The unintended consequences of PBoC’s window guidance
Bond traders are taking advantage of the PBoC.
After the central bank gave guidance to increase purchases of low grade bonds (see yesterday’s Tip Sheet), market participants immediately found a loophole.
Rather than buying the bonds of smaller private companies like the PBoC intended, on Thursday banks started to buy more city investment bonds (aka chengtou bonds).
Some context:Chengtou bonds are issued by quasi-government entities to fund public spending. Although basically fiscal instruments, they technically fall into the category of corporate bonds that the PBoC has encouraged banks to buy.
What’s going on: Banks don’t feel that the incentives to buy the lower quality bonds of private enterprises are sufficient to offset the credit risks of those investments. So instead they are buying chengtou bonds in hopes that the PBoC will honor the letter of its new policy – even if banks are violating the spirit.
Get smart: This is classic. The central bank has trouble directing cash to illiquid parts of the market because domestic players simply aren’t interested. When the PBoC tries to alter that dynamic, banks find ways around it.
21st Century Biz: 央行窗口指导效应追踪：中低等级城投债“沾光”
FINANCE and ECONOMICS
2. Is China’s currency in freefall?
China’s currency is getting hammered.
The CNY fell by almost 1% on Thursday and has fallen by almost 8% from its peak in April.
That’s a huge move for the CNY. And it speaks to the PBoC’s evolving stance on the currency.
Previously, the central bank would have never countenanced such a concerted weakening. But since 2015, a few things have changed.
- First, the dollar is soaring. The PBoC does not want to defend the CNY when other major currencies are also depreciating against the greenback.
- Second China’s in a trade war with the US. CNY depreciation is a straightforward outcome of trade tensions. So it doesn’t make sense to fight against that.
- Finally, market participants now fear the PBoC. They know that if the currency falls too far, too fast the central bank can step in to intervene. So they are not aggressively shorting the redback.
The upshot: For now, the PBoC is happy to let markets determine the price of the currency – it’s not targeting a specific exchange rate as it has in the past.
That means that CNY weakness will continue – in a managed way – as long as trade tensions hang around.
CNN: China’s currency is plunging again. But how low will it go?
POLITICS and POLICY
3. He said, Xi said – trade war edition
Speaking of trade tensions…
China and the US are at an impasse with regards to negotiations over trade.
On Wednesday, US National Economic Advisor Larry Kudlow said it is Xi Jinping’s fault (CNBC):
- “I do not think President Xi at the moment has any intention of following through on the discussions we’ve made.”
- “President Xi at the moment does not wish to make a deal.”
- “I think Xi is holding the game up.”
That did not go over well in Beijing. Here’s what Ministry of Foreign Affairs spokeswoman Hua Chunying had to say:
- “Right in front of everyone’s eyes, the US went back and forth and ate its own words, and the US official still dared to call white black and tried to shift the blame onto China.”
- “That honestly entails some extraordinary imagination and is just preposterously shocking.”
- “Right is right, and wrong is wrong.”
- “What the US did once again chips away at its own credibility and will not help solve the issue in any way.”
Get smart: Both sides believe they are in the right, which means that neither is willing to back down.
The upshot: This trade war is not ending any time soon.
CNBC: CNBC EXCLUSIVE: CNBC’S JIM CRAMER INTERVIEWS LARRY KUDLOW FROM CNBC INSTITUTIONAL INVESTOR DELIVERING ALPHA CONFERENCE
Foreign Ministry Spokesperson Hua Chunying’s Regular Press Conference on July 19, 2018
POLITICS and POLICY
4. China’s plan for ag imports
The trade war is disrupting the supply of key agricultural imports.
Ye Xingqing, head of agricultural economy at the State Council’s in-house think tank, shares his thinking on how the country should deal with the problem (Caijing).
Ye says increasing domestic production is not an option:
- “[China’s] external dependence on agricultural products will continue to increase.”
- “China won’t…force more domestic production because of trade frictions.”
So how can China ensure stable supply? Ye’s suggestions:
- “Diversify…import sources, transportation routes, import ports, and trade channels.”
- “Priority should be given to setting up a number of overseas agricultural cooperation demonstration zones…in key countries.”
- “[We should] enhance the ability of [Chinese enterprises] to control key links in the global market for important agricultural products by increasing investment in infrastructure such as warehouses, logistics and terminals in important foreign producing areas.”
Get smart: This is very similar to China’s approach to energy imports.
What it will mean: More imports from more countries, and more overseas investment in agricultural production and infrastructure.
POLITICS and POLICY
5. Top antitrust body gets a makeover
Personnel at the State Council Anti-Monopoly Commission have been reshuffled.
Some context: The commission coordinates China’s antitrust enforcement.
The reason for the reshuffle: As part of the MASSIVE government restructuring, China has reorganized its antitrust authorities.
How things were: Previously, anti-monopoly enforcement was split among three agencies, the National Development and Reform Commission, the Ministry of Commerce, and the State Administration of Industry and Commerce.
How things are now: All antitrust regulators are now housed in the newly-created State Administration for Market Regulation.
State Councilor Wang Yong is the new head of the commission.
What’s different: That appears to represent a downgrade. The previous two heads of the commission were both vice premiers.
Get smart: We don’t think too much should be read into Wang’s appointment. Previously, a heavyweight was needed to coordinate the three regulators. But now that the regulators have been consolidated, there should be less butting of heads. And SAMR is already under Wang Yong’s portfolio.
Get smarter: Antitrust enforcement will continue to grow in size and sophistication.
POLITICS and POLICY
6. NSC unchecked
In March, China created a new branch of government – the National Supervisory Commission (NSC).
Some context: The NSC has a broad mandate to punish bad behavior among public officials.
Since its formation, there have been questions about what kind of legal constraints there would be on the commission.
Turns out…not many (SCMP):
- “A recent case in the central Chinese province of Hunan has exposed how the commission’s activities could be used to deny detainees held by other law enforcement agencies access to legal counsel, even over unrelated offences.”
The Hunan case is not an isolated example:
- “Wuhan University law professor Qin Qianhong said complete denial of legal access had become common practice in the past few months.”
- “’Current understanding and practice is that once the…commission launches an investigation, legal counsel will not be allowed,’ Qin said.”
That’s in line withstatements from Liu Jianchao, former head of the Zhejiang discipline commission (Southern Weekly):
- “The involvement of lawyers will make our investigation work very complicated.”
- “We must eliminate this interference.”
The bigger picture: Xi Jinping professes to want a “rule of law” country. But he has created a new body that functions above the law.
POLITICS and POLICY
7. Will SOEs have their wings clipped?
The July 2017 National Financial Work Conference decided to restrict the ability of non-financial entities to invest in financial institutions.
The country’s SOE regulator (SASAC) is making enforcement of that provision a priority for H2.
Some context: As of August 2017, two-thirds of central SOEs were invested in financial businesses. Nearly one-fifth had outright control of at least one financial institution.
Why it happens: Financial institutions are often more profitable than SOEs’ core business.
What SASAC plans to do (Economic Information Daily):
- “Enterprises that have a lossmaking core business, high asset-to-liability ratio, or a financial services business that is highly risky or does not have an obvious role in servicing the main business are strictly prohibited from making new investments in financial services.”
This follows on from animportant policy document released two weeks ago. That doc vowed to build a firewall between state-owned financial capital and industrial capital (Gov.cn).
Get smart: SOE involvement in the financial sector is a key source of moral hazard. It needs to be addressed.
Get smarter: We have doubts about how successful SASAC will be. SOEs are loath to get rid of their profitable financial businesses, and there is likely to be significant pushback.