By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- What can China do to Save Stocks and FX?
- Euro Rebounds on Fresh Greek Deal Hopes
- AUD: Beware of Employment Report
- NZD Bounce = Attractive Selling Opportunity
- Dollar: No Excitement from Fed Minutes, Williams Still Favors 2015 Hike
- GBP Sells Off, No Surprises Expected from BoE
What can China do to Save Stocks and FX?
The deep sell-off in Chinese stocks has global repercussions. During the Asian trading session, Japanese and Hong Kong equities were hit hard and in North America, the contagion spread to U.S. equities with the Dow Jones Industrial Average closing down 1%. Certain currency pairs have fallen significantly and others are only beginning to slide. AUD/USD lost over 3 cents in the past 2 weeks to fall to its weakest level in 6 years while USD/JPY fell more than 1.3% today to a 7-week low. The 3% slide in the Nikkei hit USD/JPY hard and considering that Japanese stocks have only begun to catch China’s cold, more losses could follow. The yen in general has been a big beneficiary of risk aversion and while the dollar is also seeing demand, it failed to enjoy a broad-based rally on Wednesday. The Chinese government is in full-on damage control, announcing new policy measures on a daily basis to stem the slide in equities.
Timeline Of China’s Panicked Policies
- June 27 – Cuts Lending Rates and Reserve Requirements
- June 29 – Pension Funds Granted Ability to Invest in Stocks (up to 1 trillion yuan in potential flows)
- July 1 – Transaction fees lowered by Shanghai & Shenzhen exchanges
- July 2 – Threshold for margin trading lowered, Real Estate now acceptable form of collateral for margin traders
- July 3 – Futures Exchange suspends 19 accounts from trading
- July 4 – China’s top 21 brokerage firms commit to investing 120 billion yuan to lift Shanghai index to 4500, IPOs canceled
- July 5 – State owned investment company purchases ETFs to support market, PBoC plans to inject liquidity to margin finance company to stabilize market
- July 7 – 25% of Chinese stocks suspend trading
- July 8 – Trading halts on 40% of listed companies, China bans major shareholders, corporate execs and directors from selling stakes in listed companies for 6 months
Unfortunately none of these efforts have helped and as FX traders we have to watch China’s policy responses closely because the slide in Chinese stocks is having a direct impact on currencies. How far the Chinese government goes will depend on how much damage they believe the slide in the stock market will have on the economy. While the majority of Chinese stock-market investors are retail, less than 15% of household finances are invested in stocks and the free-float value of Chinese markets is about 30% of GDP. In other words, while millions of Chinese are invested in stocks, based on the size of the population, that amounts to only 1 in 15 Chinese trading stocks compared to 1 in 2 Americans. Therefore the impact on consumption and the actual economy could be a lot smaller. Also, stocks in China rose too far too fast and valuations got out of hand. Between July 2014 and mid June, the Shanghai Composite index rose 150% and the 30% correction since then brings valuations down to earth. Most of China’s measures are aimed at injecting liquidity and banning short sales. However prohibiting short sales isn’t the answer because stocks are driven down by long sellers liquidating existing positions. In 2008 when the U.S. banned short sales, it failed to halt the slide in equities. Prices only stabilized after the ban was lifted.
What Can China Do? It Could:
- Allow hedging through futures short selling
- Increase capital market participation by relaxing foreign investment rules
- Institute capital controls by boosting holding periods
- Restrict trading in more stocks
Unfortunately most of these are complicated and involved measures that are not easily implemented. Restricting holding periods or trading is a step towards greater capital controls, a backward measure that China may not be willing to take. As for foreign participation, no one is sure that foreigner investors want to catch a falling knife. Also, China does not have a policy to target the stock market and given how much valuations have ballooned, short-term pain is needed to ensure the long-term viability of Chinese markets. As we saw on Wednesday, and in recent weeks, the meltdown in China has global repercussions. If they are successful in halting the slide in their local markets, it will translate into a global risk rally that will benefit currencies and equities. In the meantime, selling NZD/USD after Wednesday’s rise remains the best bet on the premise that the turmoil will continue affecting countries heavily dependent on Chinese demand and the view that RBNZ will need to lower interest rates again. AUD/USD could also see further losses if Wednesday night’s employment report surprises to the downside.
Euro Rebounds on Fresh Greek Deal Hopes
For once, the focus was not on the euro. Between the unusual suspension of trading on the NYSE and the meltdown in Asian equities, investors sent the euro higher on signs of progress toward a deal for Greece. In fact, European equities were completely unfazed by developments in Asia with the DAX, CAC, FTSE and other indices closing higher. Greece officially sent a request to European leaders for a 3-year loan from the Eurozone’s bailout fund but failed to provide credible plans for reform. They intend to do so on Thursday so the timeline that we are looking at now is the following:
- Thurs – Greece submits more detailed reform plan
- Friday – Eurogroup decides if plan is credible
- Saturday – Eurozone Finance Ministers meet
- Sunday – Eurogroup Leaders hold Emergency Summit to decide on bailout extension
As German Finance Minister Schaeuble said, “actual examination can only begin once the full package has been put on the table.” If the package is acceptable, Eurozone leaders could consider reducing Greece’s debt burden but time is running out fast. There are 2 more weekends left before the July 20 deadline, so while Greece has temporarily fallen out of the limelight, it will return to focus before the weekend as investors rush to adjust positions ahead of the key meetings.
Dollar: No Excitement from Fed Minutes, Williams Still Favors 2015 Hike
There was very little consistency in the performance of the dollar on Wednesday. The greenback traded sharply lower versus the Japanese yen, euro and New Zealand dollar and higher versus the British pound, Australian and Canadian dollars. The FOMC minutes failed to excite. Based on the tone of the central bank, rates will probably not rise in September given the uncertainty in Greece and volatility in Chinese stocks. A number of Fed officials warned against a premature increase and several voiced concerns about Chinese growth pace and Greece. Nonetheless, most, including Williams who spoke Wednesday, believe that rates will rise in 2015. According to the 2015 FOMC voter, it is “safer to start tightening sooner and proceed gradually” afterwards. Nonetheless, USD/JPY received a triple blow on Wednesday from falling U.S. rates, risk aversion and the sell-off in Japanese stocks. We believe that losses will be limited because even if the Fed delays liftoff, it will still be the first to tighten; and sooner or later investors will remember this yield advantage.
GBP Sells Off, No Surprises Expected from BoE
Global market uncertainty has driven sterling sharply lower versus the U.S. dollar taking the market’s focus off the U.K. budget. However a number of big announcements were made including plans to phase out the bank levy by 2021, a new higher National Living Wage, scrapping of student grants and freezing of working-age benefits. While Chancellor Osborne said the U.K. economy is fundamentally stronger than 5 years ago, he downgraded the country’s growth forecast for 2015 and pushed back out the targeted date for a surplus by a year. The sell-off in sterling reflects the market’s fear that the Bank of England will postpone tightening as a result of the uncertainty in Greece but we won’t get any insight on this from Thursday’s Bank of England rate decision. The BoE is expected to leave rates unchanged and when it does so, no details will be released.