China Foreign-Exchange Reserves Drop as PBOC Supports Yuan (China’s Volatility Scowl)

China’s Central Bank (The People’s Bank of China) has intervened in the market once again and the result is a volatility scowl.

(Bloomberg) — China’s foreign-exchange reserves shrank to the smallest since 2012, indicating that the central bank sold dollars as the yuan’s retreat to a five-year low exacerbated depreciation pressure.

The world’s largest currency hoard decreased by $99.5 billion in January to $3.23 trillion, according to a People’s Bank of China statement released on Sunday. The contraction was less than a Bloomberg survey’s median estimate of a $120 billion drop. The stockpile slumped by more than half a trillion dollars in 2015, the first-ever annual decline.

Policy makers fighting to hold up the weakening yuan amid slower economic growth, plunging stocks and increasing outflows have been burning through the reserves. The draw-down has continued since the central bank’s surprise devaluation of the currency in August, when the stockpile tumbled $94 billion, a monthly record before December’s unprecedented $108 billion decline.

“While the remaining reserves represent a substantial war chest, the rapid pace of depletion in recent months is simply unsustainable,” said Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight in Singapore. “Domestic private investors and global currency traders see a one-way bet against the currency. This has resulted in large-scale private capital outflows since early 2015 as expectations mount that the PBOC will eventually be forced to capitulate once its reserves are sufficiently depleted.”

Outflows Rise

Capital outflows increased to $158.7 billion in December, the most since September and were $1 trillion last year, according to estimates from Bloomberg Intelligence. That’s more than seven times the amount of cash that left in 2014.

The PBOC has stepped up efforts to stem the exodus, warning speculators that they will be punished. It intervened in the Hong Kong market last month after the yuan’s offshore exchange rate sank to a record 2.9 percent discount to the onshore rate. Apart from selling dollars, the monetary authority also gave guidance to some Chinese lenders in the city to suspend yuan lending to curb short selling, a move that contributed to the overnight interbank lending rate surging to an all-time high of 66.8 percent on Jan. 12.

Yuan Outlook

The median estimate in a Bloomberg survey is for the yuan to drop to 6.76 a dollar by the end of this year, with Rabobank Group the most pessimistic with a 7.53 prediction. The currency has declined 1.24 percent so far this year, closing at 6.5755 in Shanghai on Friday. Chinese financial markets are shut for the Lunar New Year holiday.

China’s top economic planner said that the objective for this year is for an expansion in the range of 6.5 percent to 7 percent. The 6.9 percent growth in 2015 was the slowest in 25 years. Exports probably declined for the seventh straight month in January, according to the median estimate in a Bloomberg survey before data due Feb. 15. China increased its gold hoard in January, raising its holdings to 57.18 million ounces at it looks to diversify its foreign-exchange stockpile.

“The smaller decline in the reserves suggests that some capital outflow restrictions imposed in January worked, ” Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, wrote in a note on Sunday, adding that he estimates the drop in February will be “much smaller.”

Here is a short history of the Renminbi (or Yuan) and China’s Monthly Foreign Exchange Reserves.


As Central Banks continues their intervention into financial markets, its as if they can’t say no to more and more intervention. As The Fed’s Janet Yellen sings “I’m Just A Girl Who Can’t Say No” to Central Bank intervention.

How is this Central Bank intervention impacting volatility smiles? Volatility smiles are implied volatility patterns that arise in pricing financial options. In particular for a given expiration, options whose strike price differs substantially from the underlying asset’s price command higher prices (and thus implied volatilities) than what is suggested by standard option pricing models. These options are said to be either deep in-the-money or out-the-money. Graphing implied volatilities against strike prices for a given expiry yields a skewed “smile” instead of the expected flat surface. The pattern differs across various markets

For the Euro, we see a typical volatility smile.


For the Yen, we see a typical volatility smile.


For the Renminbi (or Yuan, pronounced “you-en”), we see a contorted smile. In fact, the USD/CNY volatility smile is more like a scowl.


Yes, it is a volatility scowl for the USD/CNY.


Wall Street Pulls Back From Mortgage Market That Fed Made Boring (Regulation Didn’t Help Either)

Bloomberg — Matt Scully — The U.S. Federal Reserve is squeezing a good deal of the profit out of mortgage bond trading, and Wall Street banks are increasingly heading for the exits.

Barclays Plc cut 20 jobs in its U.S. government-backed mortgage bond business in January as part of a broader bank reorganization that is cutting 1,200 jobs, according to a person with knowledge of the matter. Deutsche Bank AG and Societe Generale SA have also scaled back in the market in recent weeks, people with knowledge of those moves said.

As the Federal Reserve has vacuumed up nearly a third of the government mortgage bonds in the market as part of its quantitative easing program since early 2009, average daily trading volume has plunged by more than 40 percent. Unlike other investors, the central bank rarely trades its mortgage bonds.

“What incentive do banks have to stay in the business in a largely price-controlled market?” said Danielle DiMartino Booth, a former policy adviser at the Dallas Fed. Eric Kollig, a Federal Reserve spokesman, declined to comment.

True, The Fed’s repression of the short-rates on the yield curve and attempts to manipulate the longer-term rates has made the world of agency mortgage-backed securities … boring.

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But the same can be said as to why big banks remain in the mortgage market at all. Heavy regulation from the Consumer Financial Protection Bureau (CFPB) and rate repression/manipulation from The Federal Reserve makes mortgage lending problematic.

Indeed, large banks are shedding their residential lending.


But seeing investment banking firms shedding agency MBS is just the other shoes falling.

Take a Fannie Mae 3.5% coupon RMBS. Its yield is highly correlated by the US Treasury 10 year yield. And yields are plunging.


As is the duration (weighted-average life) of the Fannie Mae RMBS.


As we approach (perhaps) the lower-bound on longer-term interest and mortgage rates, this could cause a lack of appetite for lenders and investors.


If the 30 year mortgage rate and the 10 year Treasury yield have bottomed out, there is no where to go but up.

We now live in a plain vanilla mortgage and mortgage-backed securities world. Boring!!!


Hey Bartender! 151K Jobs Added, Mostly Low-wage Like Bartenders (Home Prices Growing At >2x Wages)

Hey bartender! Your ilk is growing!!

(Bloomberg) — Job growth settled into a more sustainable pace in January and the unemployment rate dropped to an almost eight-year low of 4.9 percent, signs of a resilient labor market that’s causing wage growth to stir.

The 151,000 advance in payrolls, while less than forecast, largely reflected payback for a seasonal hiring pickup in the final two months of 2015, Labor Department figures showed Friday. The jobless rate fell to the lowest level since February 2008. Hourly earnings rose more than estimated after climbing in the year to December by the most since July 2009.

Yes, job growth settled into creating low-wage jobs such as bartending, waitstaff and retail sales.


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Average hourly earnings YoY remained at 2.5%, lower than in the 2007-2009 period.


And home prices YoY are growing at >2x average hourly wage growth.


“Do you know where I can score a cheap apartment?”


Heartache Tonight! Baltic Dry Shipping Index Sinks To All-time Low (Sinking Global Trade)

If we were sitting around in March 2014, what would have been the odds that West Texas Intermediate Crude Oil prices would fall from over $100 to near $30 and the Baltic Drying Shipping Index would fall from 1,606 to 303?


About the same odds of Hillary Clinton flipping a coin in the Iowa Democrat Caucuses to win delegates and going 6 for 6! The probably of winning every flip out of six flips is one in 64, or 1.56 percent. Even more of a longshot, Hillary’s $1,000 cattle futures investment netted $100,000 where her odds of winning on the cattle futures contracts was one in 12,000,000,000,000,000.

But WTI Crude oil prices and the Baltic Dry Shipping Index have declined substantially putting downward pressure of the US Treasury 10 year yield.


Its been a heartache tonight .. for the global economy.

Labor Productivity Down 3% In Q4, Third Lowest Reading Since Q1 2008 (Flint Mortgage Denials)

US Labor Productivity sagged in Q4, declining 3%. It was the third lowest reading since Q1 2008.


Given the decline in factory orders and Durable Goods orders in December, the 30 year Treasury yield fell 2.4 basis points. Things really haven’t gone well since The Fed raised their target rate on December 16th.


At least the 30 year mortgage rate will likely fall.

But that won’t help borrowers in Flint, Michigan.

From American Banker: The water-contamination disaster in Flint, Mich., may have a new consequence: mortgage lenders appear ready to put a clamp on most home purchase loans. Lenders have started to require that home buyers must provide proof that a property they want to buy does not have contamination. Nonbank lender Michigan Mutual and banks Wells Fargo and Bank of America have sent notices saying they won’t make loans on properties that don’t have drinkable water.

Flint is suffering. Low family incomes, high unemployment, lead in the drinking water, Michael Moore, Jackie Moon … now mortgage denials.


Risk Barometer Increasing In US, Europe and Japan (Danger Janet Yellen!)

Danger Janet Yellen, danger!

The risk barometer for the USA, Europe and Japan are rising.

The LIBOR–OIS spread is the difference between LIBOR and the OIS (Overnight Indexed Swaps) rates. The spread between the two rates is considered to be a measure of health of the banking system. It is an important measure of risk and liquidity in the money market, considered by many, including former US Federal Reserve chairman Alan Greenspan, to be a strong indicator for the relative stress in the money markets.

For the USA, the 3 month LIBOR spread over the 3 month OIS rose in December and remains elevated.


For Europe, the Euribor spread spiked earlier than in the USA, calmed down a bit, but is rising again.


Now Japan. the spike in the ICE 3 month LIBOR is rather obvious.


As we proceed down the road to negative interest rate policies.


Danger Janet Yellen!


European 2Y Sovereign Yields Go MORE Negative, Deutsche Bank CDS Explodes

The Bank of Japan announced negative interest rates on deposits … then promptly cancelled an auction of government bonds targeted for consumers.

Now we see 2 year sovereign yields in Europe plunging further into the abyss of negative rates.


Meanwhile, my former employer Deutsche Bank (aka, “The Teutonic Titanic”) is seeing a large increase in their 5 year credit default swap signalling “Iceberg ahead!!!”


How are those negative interest rates working out for you DB?>

Negative interest rates are about as welcome as the sequel to “Hot Tub Time Machine” without John Cusack.