A View from the Trenches, January 14th, 2010: "From the People's Bank: "Take it but don't lend it"
Please, click here to read this article in pdf format: january-14-2009
Yesterday, the People Bank’s of China went further with its
tightening move, raising reserve requirements. Raising reserve
requirements is “wrong”, in my view. If a central bank wants to
really stop asset inflation, all it has to do is withdraw liquidity.
Raising reserve requirements does not withdraw liquidity. It only makes
it more expensive, and only in nominal terms!!! What if banks
in China manage to transfer their higher costs to borrowers? As
borrowers see the monetary expansion clearly unfold in front of their
eyes, what will happen if they accept higher borrowing rates, with the
expectation of also higher NOMINAL profits? (In Economics, we say that
agents “validate the rate of money supply”. It happened in Argentina in
the 1980s and it led to hyperinflation!)
With the news out of China, the European Central Bank’s negative
comments on Greece’s loan-relief program, Moody’s statement on Greece’s
“slow death” and the resulting 49bp widening of the country’s 5-yr
credit default swap, when at last the 10:30am oil inventory data was
released, I thought a major correction in stocks would follow…And I was
wrong, oh so wrong….However, I did not take profits in my equity
positions because there was something that had caught my attention from
the start: The strength of the Canadian dollar.
As you can see in the first chart below (source: Bloomberg), after
10:30am stocks actually started to recover, while Treasuries began
selling. The inventories of crude oil, gasoline and distillate had
risen beyond expectations and yet, stocks started to recover. With
these negative news, on the other hand, the Canadian dollar was
steadily firm. Oil is lower so far this week, having dropped from
83.50/bbl on Monday to $79.77/bbl yesterday in the afternoon. The
Canadian dollar, managed to reach 97+ USD cents intraday (second chart
below, source: Bloombreg). What is behind all these intuitive
contradictions?
First, the market may be realizing the liquidity drain may not come
in 2010, regardless of what central banks tell you. Hence, the drop in
Treasuries and steepening yield curve (=inflation on the way) and
recovery in stocks. Second, something must be cookin’ in the Canada.
The action seen yesterday clearly speaks of a large “long Canada”
position. Perhaps to profit from upcoming commodity rallies? Perhaps
escaping Euro weakness? A mix of the two?
Martin Sibileau
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