Thursday, February 4, 2016

The Biggest Short: Gaming China's Bankruptcy

ZH: Feb. 4, 2016
China Reserves Could Spark Global Meltup or Meltdown

This coming weekend ahead of the Chinese New Year, China announces the current state of their Foreign Exchange reserves as of the end of January. Hedge funds far and wide will be dialed in to this number since shorting the Chinese Yuan is the biggest bet since subprime, only far larger.

China has two parallel currencies, the onshore Yuan (CNY) and the offshore Yuan (CNH). The offshore is for foreigners and the onshore is for domestic.

The over/under for this historic bet is a decline of $108 billion i.e. the record FX reserve outflow from December. Bank of America is assuming that the FX reserve drawdown slowed in January to -$37 billion, which they believe will spark a colossal RISK ON short-covering rally. 

However, Goldman expects a COLOSSAL drawdown:

"GS revised up the magnitude of the Chinese FX spot intervention to $197bn in January 2016, when adding a $12 billion valuation adjustment, lowering the total FX reserves to just $3.133 trillion!"

Here is a chart of the Yuan onshore (red) and offshore (black). Throughout January, the PBOC intervened continously to converge the two rates and to drive speculators out of CNH. So it's hard to see how FX reserve drawdown improved over December. However, other factors in the equation are net exports, capital outflows, currency volumes, and of course stabilization intervention. As we see, the currencies were far more stable in January than December where they declined almost ever day:

If Goldman's figure is right, then their annualized drawdown is $2.3 trillion assuming no acceleration, meaning they're fucked company.

Data is from:

As I showed previously, the decline is accelerating. Currency devaluations have a momentum feedback loop - the more a currency declines, the more capital is forced to flow out of the country via carry trade unwinds, as the devalued currency makes them unprofitable...

Speaking of carry trades, the Japanese Yen is telling us that hot money is flowing out of China back to Japan...the carry trade is unwinding...which bodes poorly for the S&P and every other risk asset on the planet...

CNY with oil
The stakes are high...