Scattered Thought on the CNH Movement
- The clearly official policy action. Whether it is direct buying by the PBOC or sanctioned move led by state owned banks or other possibilities, moves of this magnitude and speed simply do not happen in China without official sanctioning.
- The CNH market in Hong Kong as a tool of price setting is nearly irrelevant. By size, it is a rounding error against any similar market on the Mainland. As a simple comparison, all of the RMB deposits in Hong Kong as of November 2016 are equal to 3 (three) days of USDCNY FX turnover on the Mainland. Why does this matter? It means that you can move the CNH market in Hong Kong with a PBOC cough. The capital needed to move the CNH in Hong Kong is tiny compared to the balance sheet strength. Keep that in mind when framing this discussion. The PBOC has been sucking out RMB from Hong Kong for sometime and is now probably beneath 600 billion RMB.
- What the CNH market does do is generally act as an expectation setter. The PBOC is actually very aware of this and uses the CNH to let the market drift lower and have the CNY follow as long as it doesn’t move too fast. However, I strongly doubt any RMB watcher is going to reset their longer term expectations based upon the past few days. These spikes in HIBOR money rates and CNH surges happen every few months and then resume the previous trend. It seems the PBOC strategy was to engineer these events every few months to prevent a piling on of one way bet taking. Now people are used to these, drawback, wait it out, and resume business as normal. I would be surprised if this was anything more than a few day blip.
- Despite all the talk of the “shorts” in the market, most people fundamentally misunderstand who is short in the CNH. Hedge fund shorts are a largely irrelevant position in this market. Despite the well known bluster of people like Kyle Bass, the CNH short is simply not a crowded position. This is because they either avoid the trade despite real attraction to the position or they construct their strategies to avoid these types of crunches. At this point, any real hedge fund manager knows the risks and patterns here of the CNH. Sometime in 2016, I was talking to a well placed person in Hong Kong and asked the shortly after a similar spike in HIBOR and mini-surge in CNH whether anyone got hit hard. They shrugged and responded (I’m paraphrasing here), “no, everybody knows the game now. The HFs are hedged on this trade and the banks and counterparties make sure not to get burned with anyone crazy enough to go naked. A couple have small losses but nothing of any significance.” Nor are the “shorts” Chinese citizens or small business owners. They don’t have the capital size or ability to move such large amounts of money. Furthermore, when their money gets to Hong Kong it is typically only a resting spot before landing in Sydney or Vancouver. The “shorts” in the market are Chinese SOE’s. They are the ones that can still move large amounts of money into and out of China and they are well known to play all sorts of games with their numbers. It was only a few days ago that Beijing ordered SOE’s to convert foreign currency into RMB. They are not typically “short” the market in a way a HF is, but they are clearly creating profit opportunities expecting the RMB to fall further.
- One of the things people fail to grasp about these capital flows, and I have heard this from many people, is that well China is cracking down on capital flight so that will stop the problem. Chinese, like any human and I mean nothing negative by this, are self interested people. They are going to do what they think is best for their self interest. Beijing can make it harder to move capital out of the country, raise the transaction costs, but short of truly draconian measures which they have not pursued yet, money is going to leave China. There are thousands of ways to evade capital controls if you choose. A big SOE wants to make a foreign acquisition. They hive off the acquisition in an SPV with some amount of their own funded equity. Then they sell a mixture of debt and equity to local investors via wealth management products for the amount of the acquisition to be made in RMB terms. Here is where it gets good. The product is linked to a decline in the RMB giving investors in Beijing partial ownership of foreign assets and improved investment performance from a decline in the RMB. This can be done either on a fixed or floating basis but there are three key points. First, local Chinese investors hold RMB denominated investment products while the underlying asset is a foreign currency denominated company or plant. Second, they are effectively short the RMB by profiting from its fall. Third, the smaller investors let the SOE’s do the heavy lifting to get the RMB out of China.
- What is even more important is what is happening to money rates not just in Hong Kong but even Shanghai. Money rates in Shanghai have been very volatile and while the PBOC always talks about the “short term” or “seasonal” nature of these liquidity problems, the absolute regularity and consistency of them leads to the conclusion that there is a systemic problem. The systemic problem is that NPLs in China are much higher and that banks don’t have the liquidity they should have because people are not making their payments.