10 Things You Need To Know Before The Opening Bell, Thursday, March 20, 2014

10 Things Before Opening Bell

March 20, 2014

Good morning. Here's what you need to know.

FOMC dominating the discussion. Yesterday's FOMC meeting and inaugural press conference for new Fed chair Janet Yellen is setting the tone globally. "There is quite a bit of re-evaluation about just how hawkish the FOMC actually was, especially regarding Yellen’s off-hand remark that 'considerable period' represented six months or something like that," says David Ader, head of government bond strategy at CRT Capital. "The sense we’re getting — and trust that we are very much in this camp and so risk talking up our own view — is that the Fed really didn’t change things too much at all and that the market’s reaction was more a case of positions and expectations for a bit more dovishness which didn’t materialize as opposed to being really more hawkish."

The yuan continues to slide. The U.S. dollar-Chinese yuan exchange rate rose 0.6% to 6.2286, trading more than 1% higher than the PBoC's daily reference rate again on Thursday following a widening of the daily trading band to 2% over the weekend. The moves are likely being exacerbated by hedging needs related to structured products designed to appreciate on a rising yuan. "While some observers have placed a greater deal of emphasis on the 6.20 level as triggering large-scale losses on highly-leveraged investment instruments, our understanding is that it is more dynamic and the pressure has been increasing since 6.15," says Marc Chandler, head of global currency strategy at Brown Brothers Harriman.

Markets. Both S&P 500 futures and U.S. Treasury futures are losing ground this morning in the wake of Wednesday's FOMC-induced sell-off. Eurodollar futures continue to slide as market participants price in a faster rate-hike path. European equity indices are sliding across the board, and Asian indices gave up more than 1% overnight. Gold and copper futures are both down more than 1% as well.

Merkel on Russia. German chancellor Angela Merkel told the German parliament that "the EU summit today and tomorrow will make clear that we are ready at any time to introduce phase-3 measures if there is a worsening of the situation" between Ukraine and Russia, marking the latest comments from Western powers in the ongoing conflict. She also hinted that Russia may be expelled from the Group of Eight, saying, "As long as there is no political climate for an important format such as the G8, as is the case at the moment, the G8 no longer exists, neither does the summit nor the format as such."

Japan flows. In the week through March 14, Japanese investors bought ¥143.1 billion of foreign bonds after selling ¥617.9 billion in the previous week, and sold ¥137.1 billion of foreign stocks, following sales of ¥92.2 billion the week before. Meanwhile, foreign investors were buyers of Japanese bonds to the tune of ¥482.6 billion after selling ¥267 billion in the previous week, and sellers of ¥1.09 trillion of Japanese stocks, following purchases amounting to ¥383.9 billion the week before.

Initial claims. Weekly jobless claims figures are due out in the United States at 8:30 AM ET. Economists predict initial claims rose to 322,000 in the week ended March 15 from 315,000 the week before. Continuing claims are expected to have risen to 2.88 million in the week ended March 8 from 2.86 million in the previous week.

Philly Fed. At 10 AM, the Philadelphia Fed releases the results of its monthly Business Outlook Survey. The report's headline index is expected to rise to 3.2 from -6.3, marking an improvement in business conditions for regional manufacturers 0ver the last month following deterioration the month before.

Existing home sales. Also out at 10 AM are monthly existing home sales data. Economists predict sales fell 0.4% in February to 4.60 million units at a seasonally-adjusted annualized pace after tumbling 5.1% to 4.62 million units annualized in January.

TIPS auction. The U.S. Treasury will auction $13 billion of 10-year TIPS today. "The tremendous market volatility post-FOMC is adding much uncertainty to the $13 billion 10-year TIPS reopening," say Nomura interest rate strategists. "Prior to the Fed meeting we had thought demand could be decent for the 10-year TIPS supply, potentially from foreign accounts, while domestic investors should also embrace the liquidity event in their preference to own real, rather than nominal, yields. However, the massive real curve bear flattening after a hawkish Fed event should keep investors on a more cautious stance in bidding for $13 billion 10-year real duration."

MH370. Investigators have a new lead on missing Malaysia Airlines flight MH370. Australian authorities spotted two objects floating in the southern Indian Ocean off Australia via satellite imagery, and are looking into whether this may be possible debris from the missing plane.

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Below is a Q&A with Stephen Green, head of greater China research at Standard Chartered.

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BUSINESS INSIDER: China fears have resurfaced as a catalyst for risk aversion in global markets this week. Are those fears justified?

STEPHEN GREEN: Well, it depends on what you’re scared about. More non-performing loans (NPLs) and some defaults on bonds and trust products? You bet, they’re coming. A systemic financial crisis and a hard landing for the economy? Unlikely, we think. There are a number of reasons but the main one is that for all the worry about “shadow banking” in China, the credit intermediation by non-banks is no more than 15% of GDP, and its unleveraged and unsecuritised. So, unlike in the U.S. system, a few bad loans do not have to generate a financial crisis. Now, of course, a large amount of NPLs within the banking and trust systems will be a problem, and there will likely need to be a recap of the system in the next 2-3 years, but that can be accomplished without too much disruption for the broader economy we believe. Overall, the new administration has decided that to do the reforms that everyone has been asking them to do, they need to run some risks. So for the bears to turn around and argue that the results of slower credit growth etc. for which they were calling will be the collapse they predicted is a bit cheeky, I think.

BI: The PBoC has been moving to shake investors out of carry trades designed to make money on a rising renminbi. Do you think they will be successful in having a lasting effect, or will trades just get put on again when the renminbi resumes strengthening?

SG: As an economist, I think the problem is simple: still large current and capital account surpluses. In 2013, the PBoC bought at least $430 billion in intervention operations, and $70 billion in January alone. I don’t think the PBoC has dissuaded the market of a medium-term CNY appreciation story, but it's clearly raised the costs, and potential costs, of betting on that expectation. As a central bank in the last few months, the PBoC has discovered the utility of behaving a little crazy — both in the interbank system and now in the FX market. It affects behaviour — domestic banks are more cautious about their liquidity management, and now speculators are more cautious about positioning on the CNY. To keep that up, I think the CNY continues to be moved around — and maybe even breaks 6.20 on the upside, while 6.30 would I think be pretty aggressive. More volatility on the way down to a 5.9 handle by the end of the year I think.

BI: What do you think the impact of the sell-off in the copper market this week has had on the state of affairs in China's shadow banking system?

SG: Limited. The sell-off has been partly triggered by local regulators guiding banks away from accepting copper as collateral on loans. Some firms have liquidity problems repaying loans since the funds they borrowed having been tied up in business, or in loans. To raise cash, they sell their copper, which has pushed prices down. It's generated a lot of noise, and it’ll probably carry on for a while, but we think it will have limited impact. Most copper traders do not appear to be under financial pressure to unwind their positions. Fundamental physical demand for copper at present has weakened a bit — housing construction appears to have slowed, and onshore air conditioner manufacturers are holding quite a bit of inventory. That said, this year’s grid build-out is expected to be strong, which could impact demand a lot.

BI: More generally, the prospects of corporate defaults have many investors wondering what's next in China's onshore bond market. What should they expect?

SG: A few more defaults — which is what the central government wants (though local governments will often to their best to restructure and evergreen the debt). Credit conditions will remain tough this year — as loan growth slows. And this is the third year of relatively slow growth, and some parts of the corporate sector, especially heavy industry, are leveraged up. High leverage and weak cash flow means more trouble. If we are going to solve the issues of over-capacity in a few industries, and remove some of the moral hazard problems, this is needed. I think Beijing is ready to accept some bankruptcies. They also believe that the banks and other losses will be absorbed and written-off without systemic effects. In the U.S., which had a housing bubble and a financial crisis, much of the seriousness of that crisis was created by leverage in the financial sector and securitisation of assets. Neither of these things — leverage or securitisation — exists to any meaningful scale in the Chinese financial system. So we’ll likely be dealing with simpler and cleaner financial market problems — rising NPLs and the need to recapitalise banks over the next few years. As long as nominal growth can remain around 10%, that growth will ultimately forgive many of those sins.

BI: The Standard Chartered Renminbi Globalization Index has been surging, and the PBoC took historic action over the weekend in widening the daily trading band in which the yuan is allowed to fluctuate. When do you expect them to abandon the daily reference rate and embrace a fully market-determined exchange rate?

SG: Well, let's be patient. They've got their hands full with the current ambition — to limit FX intervention and at the same time prevent excessive moves. Given the current account is in significance surplus, they need a certain amount of capital account outflow to balance things up. With the weaker CNY trading, they seem to have achieved that. For the moment. At the back of my head though I still think we are on an appreciation path, but with more volatility, which will mean some of the speculative money will leave. A lot of people say that the CNY has appreciated a lot; it is now near fair value. It's just PBoC bought at least $430 billion last year, and $70 billion in January. I don't see any fundamental change since then.

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