Letter From Shanghai No 908 - The Opposite Of International Norms

As the WSJ floated the possibility that the Fed would move faster to raise rates, the 2022 US stock sell-off accelerated, and the Dollar Index hit a 19-year high. Elsewhere markets had a disruptive event, Bitcoin dropped 17% and has dropped further this morning as the market continues to flush out platform companies with untenable business models, and as Warren Buffet said, “Only when the tide goes out do you discover who's been swimming naked.”

If anything, investors from all starting points are now asking what is the end game? Following the last Fed rate hike, post-meeting dovish comments by Fed committee members, some suggesting a pause in raising rates in September, led the market to believe the terminal level for rates would be around 2.75%. Equity markets lifted on what they saw as a reprieve. That is now gone, along with a good deal of investment cash. Fed fund futures are now pricing in over 300 bps of rate hikes, implying a terminal rate of around 3.9% by mid-2023, and it is that sharp rise that is fundamental to the current disruption.

And while we are talking of naked swimmers, here we have to consider what is going on in Japan. The BOJ decided in April to leave its key short-term interest rate unchanged at -0.1% while guiding 10-year JGB yields to around 0%, and said it would buy unlimited amounts of 10-year JGBs to defend an implicit 0.25% yield cap. As of early 2022, the Japanese public debt is estimated to be approximately US$12.20 trillion US Dollars or 266% of Japanese GDP, which is the highest of any developed nation. Therefore, by printing more Yen than required the USD-Yen has fallen to 134, a 24-year low, and there seems to be no reason it would stop there. Japanese domestic inflation is still a polite 2.5%, and in 25 years of data it has never been above 4%. However, the tide is turning. Should the falling Yen prompt an inflation impulse above 4%, one would have to assume the BoJ would have to adjust rates above their current easy money -0.1%. Alert to the dangers, Japanese Finance Minister Shunichi Suzuki is in the media this morning promising, “We will carefully watch currency market moves and their impact on the economy and prices with a sense of even more urgency.” Which, when you look at it, promises nothing.

Here in China, although equity and commodity benchmarks are falling this morning (iron ore Jan is down 2.6%), investors are being told not to worry too much. Today’s China Securities Journal has a front-page article entitled "Targeting support is intensified, and there is still room for RRR cuts and interest rate cuts.” The report goes on to say “Looking forward to the second half of the year, the constraints on monetary policy by internal and external factors will be weakened. Experts said that under the influence of factors such as controllable inflation pressure and the spillover effect of the Fed's interest rate hike cycle, the implementation of a prudent monetary policy in the second half of the year will continue to increase, with sufficient room for regulation, and it is still possible to cut the reserve ratio and interest rates to deal with uncertainties.” So, as the opposite of international norms, a RRR cut will arrive, perhaps soon, we shall see.

Have a good day,

John