Analysis from AdvisorAnalyst.com

Carry Trade Withdrawal Gives China Safe Opportunity to 'Talk' Tightening

Chinese stocks, commodities, and global markets, for that matter, are not correcting due to the anticipation of reduced demand from China, as a result of its squawking about tightening. In fact, last year’s profitable trades are correcting because the U.S. dollar is climbing against the falling euro, and adding to that climb is short covering of the dollar as its carry trades of the last year are unwound.

With or without China's 'talk' of tightening – i.e. reining in credit, suspending new loans, raising the value of the yuan, raising its interest rates, and past hikes in its Required Reserve Ratio – China's stock markets would have corrected simply because carry trades tied to its market and commodities are being sold off.

What better opportunity, then, is there, than a technical global correction, to talk about the very thing, tightening, that is, which would bring about a correction in its own markets?

On another very important note, the dollar is rising. This too has nothing to do with China. The ballyhooed yuan, therefore, is rising too, particularly against currencies of critic nations, that have claimed that China has had an undue trade advantage due to its ultra cheap currency. Whether the Chinese like it or not, the rising dollar, is providing the tightening they are 'talking' up, de facto.

William Gamble, of consultancy Emerging Market Strategies, suggests that, right about now, China is "basking" in its economic success, and revelling in its appearance of superiority, especially to the U.S., which its perceives as both the source of the global debt disease, and helpless to cure it.

According to Gamble, China is not really tightening – "Turning off the monetary spigot has turned out to be much harder than turning it on." China suspended new loans in January because they were totally out of control. In the first two weeks of January, Chinese banks lent out a total of Rmb1.1 trillion ($161 billion U.S.)). This was 40 per cent more than the 2009 average, over three times the monthly average in 2008.

Jim O'Neill, Goldman Sachs, has made a call on China revaluing its currency, as a tightening move. "I have a strong opinion that they're close to moving the exchange rate," O'Neill said in a telephone interview after China's central bank told lenders on Feb. 12 to set aside larger reserves. "Something's brewing. It could happen anytime."

O'Neill said China may allow the yuan to rise as much as 5 percent in a one-off revaluation and to then trade within a bigger band or against a larger basket of currencies. That would help counter international pressure, he said.

China's curbing of lending may let some air out of the property market, especially if new loans become unavailable in the near term. Short covering, and the falling euro are lifting the dollar, and thus the yuan, relative to non-dollar countries, and helping to take the steam out of China's stock markets. The combination may be enough to scare off speculators convinced that China's trees will grow to the sky.

Some, like Bloomberg's William Pesek, suggest that China's monetary policy moves are dampened by the lack of a sophisticated secondary market. China literally does not have the people necessary to influence monetary conditions, or transmit policy moves to the broader economy. People like PIMCO's Bill Gross, that is.

Possibly, short of knowing, that may be why Jim O'Neill has "a strong opinion," of an incipient one time move to revalue the yuan by 5 per cent, along with a wider trading band. It may be the only working move China has in its toolbox, if indeed it wants to moderate growth.

As far as commodities prices are concerned, Canadian investors in the commodity complex, can breathe a sigh of relief according to William Gamble. He says, "With the amount of money China is throwing at its economy, its growth, the growth of Asia and the strength of certain commodities will no doubt continue for the coming year."

It remains to be seen what happens next. In the meantime, fear of the country's next moves are coinciding with the withdrawal of carry trade liquidity from market. Save a hike in the yuan's value, it appears China is taking advantage of the current weakness in its stock market to 'talk' through its inflationary pressure, and to talk markets down, while giving its coveted and over-advantaged export sector time to recover further.