It has been an incredibly busy week for the global financial market. Starting with China and it’s falling stocks, the world is beginning to feel the true impact. Among all of the chaos, we have also learned of yet another “glitch” – actually a few mysterious “glitches” that happened on Wall St. this week. Most remember the “glitch” in July that happened on Wall Street. That was the same day that by “coincidence” United Airlines and the Wall Street Journal had “glitches”.
Well, ironically (or not), the same week that the global market went into free fall, we learned that there were more glitches. This was all kept very quiet, as there were apparently a series of several thousand power outages, as well as some “glitches” where subways in New York just halted out of nowhere for no reason.
From The Last Great Stand:
Not to worry, I’m sure the trading “glitch” this week when the Dow dropped 1500 was nothing too. It’s not like any foreign governments have been caught hacking our computer systems or anything.
In the video below, Freedom Fighter discusses, the “glitch” that disrupted trading briefly on Thursday, and how it affected over 300,000 stock trades with an investment technology group named “Dark Pool.” Here is where things go South. August 11th, China devalued the Yuan, and it made wide news around the world. As if that news is not alarming enough, while in the process of devaluing, China dumped over $100 BILLION in U.S. treasury bonds onto the open market the same week. All total, since July, China has dumped almost exactly 10% of it’s holdings in U.S. Dollars. Despite that, the drop in bond yields was nowhere near as profound in as it was in stocks. This is HUGE! China confirms it has been liquidating treasuries. The real question that should scare the snot out of anyone is, “What if other emerging markets all simultaneously began to dump the Dollar.” That is explicitly what Peter Schiff was referring to in the second video below. But what does Peter mean when he says the Chinese won’t be there to “catch the Dollar” this time?
Let me phrase it another way. Assume we were all stranded on an island, with virtually no food, other than fish. Let’s say for example that a select few had all the fish. Survival of the fittest dictates that more than likely, the strongest, and the most powerful would maintain control over the fish, and therefore everyone else on the island wold be beholden to those individuals (Sound a bit like our economy?). Now, where the fish (money) was once used as a means to motivate people to work, imagine if it started raining fish. Now all of sudden the fish would be worthless. There would be no incentive to work together to produce new goods because whether the island community produced anything or not, they still would have plenty to eat. Who cares about “working” right?
Later, let’s assume a neighboring island stopped by, with iPads, televisions, cars, etc., and the tribe from the isolated fishing island wanted some of those fancy goods. Then problems set in. The reason they have problems is because there are so many fish, they are worth nothing, so the neighboring island wants no part of a trade. Furthermore, because the fishing village no longer had motivation to produce, because they’d achieved “social justice” where everyone on the island had the same thing, the natives of the fishing island no longer worked for food, they had fish that were of no value, and they had nothing to trade the visiting tribe in exchange for the really nice stuff. That story could end any number of ways, but I promise you this: In NO scenario does it end with anyone singing Kumbaya! Catch my drift? The more Dollars that flood the market, the more worthless those already in the market become, and the worse off Americans are.
I highly siggest reading, 2 Day Crash That Was Larger Than Any 1 Day Market Crash In U.S. History. We followed all of this up this week by noting that thanks to the new FX regime (which, in theory anyway, should have required less intervention), China has likely sold somewhere on the order of $100 billion in US Treasuries in the past two weeks alone in open FX ops to steady the yuan. Put simply, as part of China’s devaluation and subsequent attempts to contain said devaluation, China has been purging an epic amount of Treasuries.
But even as the cat was out of the bag for Zero Hedge readers and even as, to mix colorful escape metaphors, the genie has been out of the bottle since mid-August for China which, thanks to a steadfast refusal to just float the yuan and be done with it, will have to continue selling USTs by the hundreds of billions, the world at large was slow to wake up to what China’s FX interventions actually implied until Wednesday when two things happened: i) Bloomberg, citing fixed income desks in New York, noted “substantial selling pressure” in long-term USTs emanating from somebody in the “Far East”, and ii) Bill Gross asked, in a tweet, if China was selling Treasuries.
Sure enough, on Thursday we got confirmation of what we’ve been detailing exhaustively for months. Here’s Bloomberg:
China has cut its holdings of U.S. Treasuries this month to raise dollars needed to support the yuan in the wake of a shock devaluation two weeks ago, according to people familiar with the matter.
Channels for such transactions include China selling directly, as well as through agents in Belgium and Switzerland, said one of the people, who declined to be identified as the information isn’t public. China has communicated with U.S. authorities about the sales, said another person. They didn’t reveal the size of the disposals.
The latest available Treasury data and estimates by strategists suggest that China controls $1.48 trillion of U.S. government debt, according to data compiled by Bloomberg. That includes about $200 billion held through Belgium, which Nomura Holdings Inc. says is home to Chinese custodial accounts.
The PBOC has sold at least $106 billion of reserve assets in the last two weeks, including Treasuries, according to an estimate from Societe Generale SA. The figure was based on the bank’s calculation of how much liquidity will be added to China’s financial system through Tuesday’s reduction of interest rates and lenders’ reserve-requirement ratios. The assumption is that the central bank aims to replenish the funds it drained when it bought yuan to stabilize the currency.
Now that what has been glaringly obvious for at least six months has been given the official mainstream stamp of fact-based approval, the all-clear has been given for rampant speculation on what exactly this means for US monetary policy. Here’s Bloomberg again:
China selling Treasuries is “not a surprise, but possibly something which people haven’t fully priced in,” said Owen Callan, a Dublin-based fixed-income strategist at Cantor Fitzgerald LP. “It would change the outlook on Treasuries quite a bit if you started to price in a fairly large liquidation of their reserves over the next six months or so as they manage the yuan to whatever level they have in mind.”
“By selling Treasuries to defend the renminbi, they’re preventing Treasury yields from going lower despite the fact that we’ve seen a sharp drop in the stock market,” David Woo, head of global rates and currencies research at Bank of America Corp., said on Bloomberg Television on Wednesday. “China has a direct impact on global markets through U.S. rates.”
As we discussed on Wednesday evening, we do, thanks to a review of the extant academic literature undertaken by Citi, have an idea of what foreign FX reserve liquidation means for USTs. “Suppose EM and developing countries, which hold $5491 bn in reserves, reduce holdings by 10% over one year – this amounts to 3.07% of US GDP and means 10yr Treasury yields rates rise by a mammoth 108bp ,” Citi said, in a note dated earlier this week.
In other words, for every $500 billion in liquidated Chinese FX reserves, there’s an attendant 108bps worth of upward pressure on the 10Y. Bear in mind here that thanks to the threat of a looming Fed rate hike and a litany of other factors including plunging commodity prices and idiosyncratic political risks, EM currencies are in free fall which means that it’s not just China that’s in the process of liquidating USD assets.
The clear takeaway is that there’s a substantial amount of upward pressure building for UST yields and that is a decisively undesirable situation for the Fed to find itself in going into September. On Wednesday we summed the situation up as follows: “one of the catalysts for the EM outflows is the looming Fed hike which, when taken together with the above, means that if the FOMC raises rates, they will almost surely accelerate the pressure on EM, triggering further FX reserve drawdowns (i.e. UST dumping), resulting in substantial upward pressure on yields and prompting an immediate policy reversal and perhaps even QE4.
Well now that China’s UST liquidation frenzy has reached a pace where it could no longer be swept under the rug and/or played down as inconsequential, and now that Bill Dudley has officially opened the door for “additional quantitative easing”, it would appear that the only way to prevent China and EM UST liquidation from, as Citi puts it, “choking off the US housing market,” and exerting a kind of forced tightening via the UST transmission channel, will be for the FOMC to usher in QE4.
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