Notes From Underground: Did The Chinese Fudge The PMI???

First, Happy Memorial Day to all the readers of Notes From Underground. If you are a veteran of the U.S. Military, thank you for your service. If you aren’t a veteran, take the time to thank those who have served to fight for the freedom to write blogs and entertain the free interchange of ideas.

***The U.S. markets were greeted with the news that the NIKKEI had dropped 7% overnight and the European stock markets were also down between 2 and 3 percent. Some analysts blamed the Bernanke testimony while others noted that the markets dropped precipitously after the release of the Chinese PMI. Expectations were for a PMI of 50.5% while the actual number dropped under the MENDOZA LINE of 50% (inside baseball joke). This was an unusually large  miss for the Chinese statistics authority, an agency that I have maintained can massage data and economic growth almost as well as Jack Welch when he was CEO of GE.

The slowing in the Chinese economy so copper immediately fall and everything else correlated to the Chinese economy also come under pressure. Yesterday, I linked to an article by Professor David Li in the FT’s opinion page. The Chinese are purportedly very unhappy with ABENOMICS, therefore we may continue to see weak economic releases as a reason for China to press for the removal of pressure from the G-7 and G-20. China will make itself the aggrieved party. While economic theorists posing as central bankers easily separate domestic economic impact from global outcomes, the” laboratory” of the real global economy is not a vacuum.

***The FT had a GREAT piece by Manmohan Singh: “Fed Must Avoid Collateral Damage When It Exits QE.” This man is a master plumber when it comes to understanding the capital flows in the international financial system. My friend and teacher, James A. of Wimbledon, alerted me years ago to the work of Mr.Singh. (James himself is a master plumber of the credit system). The piece details the importance of high quality collateral for the operation of the repo market. The short-term interest rate market is really a “bifurcated entity” because only depository institutions can avail themselves of the FED‘s Interest On Excess Reserves (IOER), thus receiving 0.25% from the Fed on overnight deposits. “… Non–depository institutions keen on keeping money invested in liquid and safe investments have to fight over an ever-smaller pool of good collateral.”

QE has sucked some very good collateral out of the market and also events like MF GLOBAL have made holders of high-quality collateral reticent to part with it. When collateral is in short supply the repo rate is lowered. When it is plentiful rates go higher as so much is offered. The collateral scarcity is global in nature as the problems in Europe have meant that only Germany, Holland and France have the quality short-term debt qualified as good collateral as repo. The article will alert traders to the importance of the IOER and REPO rates as coming threats to the FED‘s effort at tapering. PRACTICE IS MUCH MORE DIFFICULT THAN THEORY.

***Lastly, I urge my readers to look at the bond prices in the futures or cash markets after the announcement of the three QE programs. This is to get a sense of why I believe the “hysteria” about tapering is overblown. QE1, which commenced in March 2009; QE2 in November 2010 (although announced at Jackson Hole); and QE3 in September 2012. The impact from the FED‘s asset purchases in QE1 and QE2 were to send yields higher, while post-QE3 the Treasury yields remained in a very narrow range. This is very simplistic and will require more analysis but the point to be established is that the market defied conventional wisdom. Will tapering provide a similar outcome? Just more things to ponder during the next few months.

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3 Responses to “Notes From Underground: Did The Chinese Fudge The PMI???”

  1. Carl HT Says:

    If it’s the same James A. I am thinking of, the man really knows his stuff!

  2. Joe Says:

    **dropped under the MENDOZA LINE of 50% (inside baseball joke). This was an unusually large miss for the Chinese statistics authority, an agency that I have maintained can massage data and economic growth almost as well as Jack Welch when he was CEO of GE.**


  3. yra harris Says:

    Carl HT–I have the idea from your comments it would be the same bloke.A brilliant analyst of the plumbing of global credit markets.He has taught me much over many years–

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