t Shadow Capitalism

possibly attributable to frontrunning the employment of the

new policies. More importantly from a political standpoint,
however, is how the PBoC will decide to frame its monetary
MARKET COMMENTARY BY NAUFAL SANAULLAH
policy, with inflation risk and a yet-existent borrower
dependence on extremely low rates and high lending/deposit
Wednesday, October 20, 2010
spreads serving as dually warranted factors to target. In
short, the PBoC rate hike seems to be in response to plunging
Chinese data comes in about in-line, provides clarity to PBoC
real rates this year as inflation ticks up and banks lend at
hike motivations
excessive amounts, to calm depositors, and representing
typical Chinese political posturing ahead of G20. In the near-
Yesterday’s PBoC hike is definitely a significant theme behind
term, however, Geithner’s comments about the majors being
markets right now, especially ahead of G20. Yesterday’s
“roughly in alignment” is the more significant news driver,
selloff was in reaction to the Chinese tightening, as the
sending EURUSD plunging almost a full big fig before
prevailing view took hold that the PBoC was unwillingly late
recovering into the Chinese data announcement. The
to the game with tightening measures, due to growth risks
implication is that Geithner is finally easing up on his
absent the current emergency low rate environment, and
(indirect) calls for further debasement, considering current
that inflation is forcing the Chinese into liquidity withdrawal
levels “acceptable” and consequently potentially marking a
measures, showing both a lack of success from easing and
bottom in USD.
stimulative measures from the Chinese central bank, as well
as an undesirable shift in policy to inflation risk targeting The S&P rallied about a percent today as it reasserts its
before the growth risk targeting policy cycle really finished (or rangebound activity and discredits interpretations of
completed its task). Today, however, markets reacted to the yesterday’s moves as a breakdown. Volume lagged a bit after
strong rally overnight in Chinese equities, and sold USD the previous session’s strong showing but the market is back
heavily, reversing yesterday’s entire move, while risk was bid up to near the top of its range and looking constructive,
strongly. The thesis behind this was that the hike was though inconclusive as of yet.
telegraphing strong September Chinese IP/GDP/retail
sales/inflation data, and the initial reaction selloff post-hike
was a move to be faded and a dip to be bought.

The data just was released and it came in pretty much in-line,
with CPI in-line at 3.6% YoY, IP missing expectations of 14%
YoY with a 13.3% print, PPI a bit higher than the 4.1%
consensus at 4.3% YoY, retail sales beating at 18.8% YoY vs
18.5% estimates, and Q3 real GDP slightly better than
expected at 9.6% YoY vs 9.5% consensus. The combination of
slowing growth and inflation ticking up probably was a major
factor behind PBoC reigning in liquidity with its hike
yesterday, but the take-away conclusion is that the Chinese
CB was not acting in response to above-consensus data. As I
mentioned in last night’s piece, the hike was probably in large
part due to new lending in September coming in almost
¥100b higher than the expected ¥500b, and this seems to be
the more likely motivation now that the GDP data is out.
Though it is premature to jump to conclusions (the market’s
initial response has been quite muted thus far as it is), it will
be interesting to see if these figures discredit the drivers
behind yesterday’s rally in the Shanghai Composite. Political
factors seem to be among the biggest in play going forward in
China, especially as property prices are up about 20% since
summer lows and many Chinese are being priced out of the
market, and the new home purchase restrictions may lead to
a slowdown in transaction volume after recent strength
The strong reversal in USD, sending EURUSD back up to test
1.40 and AUDUSD to test 0.99, was the theme of the day.
USD remains offered on strength, although it remains to be
seen whether the extreme short positioning in the USD ($33b
as per CFTC data) has been unwound at all or is being
reversed. G20 on Friday is also a significant factor, especially
considering recent posturing from Geithner claiming that USD
devaluation is not policy, as well as the BoJ’s absence from
more intervention despite USDJPY dipping below 81 today,
on top of yesterday’s Chinese hike. Global coordination and a
pause from the race-to-debase seems to be what the FinMins
are pushing for ahead of G20, however disingenuous their
statements may be. I cut down my position sizes in my long-
USD trades into today’s risk-on strength, but I’m still holding,
although I don’t have a lot of conviction either way regarding
the USD’s direction in the near-term here. The fact that
traders added short on USD strength may be telling in the
near-term, but dovishness out of BoC and BoE may be the
bigger issue going forward, particularly as the MPC struggles
to keep its inflation risks from staying elevated longer than
desired or expected, while still dealing with both global and
domestic growth risks. And let’s not forget the impact
foreclosuregate will have on securitization/shadow banking
system, which is behind the massive contraction in money
supply and will most likely lead to further velocity contraction
as a result of continued frozen securitization-based lending.
Technically, we remain in the bottom area of the channel and
are trading above the important triangle support around 76.
But back to the mortgage/MBS mess, midterms may be
significant in that context as well, as the GOP retaking the is
important to FNM/FRE reform as Barney Frank will no longer
be able to run the show freely and without care. The
implications for MBS holders and the continuing repurchase
requests from GSEs to banks will be interesting to see play
out, especially as the BLK/NYFed/PIMCO putback suit against
BAC lends more credence to GSEs demanding MBS
repurchases at par.
Back to the usual macro musings, Ireland’s decision to scrap
this week’s bond auction (as well as another one next month)
appears to be a last-ditch effort to get yield spreads back
down. With a deficit amounting to a third of GDP after the
Allied Irish bailouts, the numbers surrounding the means by
which Ireland can meet its 3% deficit/GDP target by 2014 are
staggering. Tapping yourself out of market funding to
convince lenders to accept massive deficit reductions as
collateral for lower current rates is quite the gamble,
especially as the more reserves you use up, the harder your
unrealistic deficit targets are to believe. Perhaps Ireland is
preemptively exiting market funding ahead of imminent
spikes in borrowing costs in coming years, to get “non-
concessional” IMF funding later on at rates that would indeed
be concessional in the future, if judged by the market’s
valuations.
OPEN TRADES
Long /ZN | 125’15 | stop 124’20 | +1’15
Short APOL | 51.90 | stop 54.00 | +28.98%
Long AGU | 80.00 | stop 75.00 | +8.58%
Short STRA | 160.00 | stop 165.00 | +18.78%
Short ESI | 67.31 | stop 73.15 | +12.48%
Long MEE | 35.35 | stop 34.30 | +11.03%
Long TBT | 32.65 | stop 31.80 | +1.29%
Short /ZB | 133’24 | stop 135’15 | +1’05
Short BAC | 13.32 | stop 13.75 | +11.79%
Short ISRG | 285.10 | stop 295.00 | +9.00%
Short BLK | 179.89 | stop 182.20 | +5.77%
Short COF | 40.04 | stop 41.20 | +3.20%
Short VMW | 80.00 | 83.20 | +8.26%
Short PNC | 51.94 | stop 53.75 | -1.54%
Short AKS | 14.20 | stop 14.95 | +1.69%
Short EUR/SGD | 1.8220 | stop 1.8330 | +105 pips
Short GBP/SGD | 2.0740 | stop 2.0900 | +15 pips
Short GE | 16.73 | stop 17.50 | +4.06%
Short /SI | 24.30 | stop 25.10 | +2.22%
Long AMZN | 159.10 | stop 152.00 | -0.27%
Short EUR/USD | 1.4060 | stop 1.4210 | +190 pips
Short AUD/USD | 0.9935 | stop 1.0005 | +125 pips
Short AUD/SGD | 1.2865 | stop 1.2955 | +100 pips
Short NZD/USD | 0.7575 | stop 0.7610 | +75 pips
Long EUR/NZD | 1.8530 | stop 1.8300 | +20 pips
Short CAD/CHF | 0.9500 | stop 0.9610 | +100 pips
Long ZSL | 17.58 | stop 17.15 | +3.98%
Long MIPS | 9.90 | stop 8.90 | +3.74%
Long VECO | 39.00 | stop 36.30 | -0.92%
Long JCP | 32.55 | stop 31.85 | +1.26%
Long /LE | 100.51 | stop 99.50 | +1.16%
Long USD/JPY | 81.00 | stop 80.65 | +25 pips
Short GBP/USD | 1.5805 | stop 1.6050 | +15 pips
Long USD/CHF | 0.9635 | stop 0.9550 | +45 pips
Long UNG | 5.58 | stop 5.45 | +0.54%
Short CLR | 45.82 | stop 48.50 | -1.59%
Short /CL | 81.84 | stop 85.00 | -0.21%
Short CHK | 22.55 | stop 23.15 | +1.73%
Long USD/SGD | 1.3020 | stop 1.2950 | +0 pips
Long NOG | 18.08 | stop 17.20 | -2.05%
Short PRU | 53.55 | stop 55.10 | -1.27%
Long YHOO | 15.65 | stop 15.35 | +1.00%
Short /ES | 1164.00 | stop 1183.00 | -0.86%
Short SHLD | 74.36 | stop 76.40 | -1.68%
Short LULU | 43.45 | stop 45.50 | -0.23%
Short HRB | 10.85 | stop 11.50 | +1.11%
Long RDN | 9.20 | stop 8.00 | -0.87%
Long MBI | 12.13 | stop 11.15 | +5.94%
 CLOSED TRADES

Short WFC | 26.00 | cover 24.60 | +5.38%

Short EUR/CHF | 1.3435 | cover 1.3380 | +55 pips
Long USD/JPY | 81.26 | cover 80.80 | -46 pips
Short NFLX | 149.37 | cover 155.65 | -4.20%
Long VXX | 14.50 | sell 14.08 | -2.90%
Long AVARF | 4.00 | sell 4.60 | +15.00%

NEW TRADES

Long /ZC | 559.10 | stop 511.25

Long TWX | 31.25 | stop 30.80
Short GBP/CAD | 1.6160 | stop 1.6250

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DISCLAIMER: Nothing contained anywhere in this commentary, including

analysis and trade ideas, constitutes or should be construed as investing or
financial advice, suggestion, or recommendation. Please consult a financial
professional and do due diligence before engaging in any purchase or sale of
securities.