Hive Intelligence Report: Is China Dealing with COVID Better than the West?

Every week, we bring together our community of macro experts to discuss the latest market developments. In this piece, we distil the insights from our conversations up to 25 April. These are views from our network rather than the views of the Macro Hive research team. ‘[Day]’ indicates the day the comment was made.

US

Inflation and the FFR [Wednesday]

• Dominique thinks the terminal FFR will eventually approach 8% in 2023 or 2024. In short, 1. Ukraine/China-Covid has pushed US on a higher inflation plane and inflation has a lot of inertia; 2. The Fed inflation model is deeply flawed, R*, inflation expectations have no logical or empirical basis; since WW2 every inflation stabilization has required closing the gap between actual and Taylor rule FFR, with the latter currently about 8%.
• The Fed will go to 8% only after all other avenues have been exhausted. I.e., FFR above 3% and inflation above 4%.

A 2023 recession seems logical

• It’s clear the Fed now wants to put the brakes on, but stocks don’t care. It is still possible that one day stocks will go, maybe not 20% but a move to scare people.
• Since 1967, the number of quarters between first hike and first QoQ GDP contraction is six to 15. So, a 2023 recession seems logical.

Housing [Thursday]

• US mortgage rate reached 5.11%. Pre QE-1 level.
• Many are now looking at real mortgage rates. As in a house is a better inflation hedge than cash. Borrow and let the bank worry about high inflation.
• Yes, it is a great inflation hedge. But for many it is about affordability: income vs the mortgage payment. And the Fed want to kill affordability as much as possible. Otherwise, this time inflation will be extremely permanent.
• One of our network has heard that people are paying the fee to get out of current five-year fixed rates which only have a few years left to expiry to get the certainty of a lowish rate for a further five years.
• If the Fed raise rates to 5/6%, house prices will come down. That is, home prices will probably decline and then rise, based on the inflation level. Historically home prices had a beta higher than one with overall inflation.
• Partly because real yields have been coming down through time. Lower real yields force more deposits to go into housing or so. It goes back to r* and i* (trend inflation). One more thing is that the replacement cost has gone up a lot. That’s more for rural. Building it from scratch has become more expensive than buying an old house!

Market views

• One participant is extremely bullish USD. They think there is an elevated risk of a rerun of the Eurodollar crisis. They can’t see any near-term inflation relief. Supply-side plus the inflationary position of the balance sheets of household, banks, and the governments in the US will likely more than offset slowing economy headwinds. Too much price momentum in the system. The Fed may have to extend hiking versus expectations. Politics adding to the pressure. The offshore debt mountain has been supported for years but never materially reduced despite the near death GFC. The permanency of the Fed offshore facilities could be very challenging, and I think they might be called on.

Tesla [Thursday]

• Tesla had great numbers and deliveries. Then Musk promised a new launch date that will never happen. The truck isn’t even ready yet, but apparently, we’ll have robo-taxis.
• It’s been Elon’s modus operandi for years, promise the world and deliver half of it. Why change a winning strategy? He can get away with it while others cannot.
• It’s a Silicon Valley approach, which drives traditional public market investors crazy. It’s hard to make a case either way though.

Tracking China

Read my quick take on USD/CNH. On other China trades, I’ve exited my long China rates (FX unhedged) trade but will look to re-enter short USD/CNH when the policy picture is clearer, and Bert likes to use the coming weeks to pay CNY swaps on the expectation that yields will rise.

Lockdowns

• This video about the Shanghai lockdown is doing the rounds on social media in China. Criticism towards the government is reaching a point unseen for decades. It’s hard to say if this will have any implications at the top level, but surely Xi must be under pressure now. So far Xi has been entirely absent in the debate around the zero-COVID strategy as of late.
• And on the same theme.

Have China dealt with COVID well?

• On latest developments, Beijing is starting with mass testing much sooner than Shanghai did. So, there is a chance they can escape the full lockdown. But the odds do not look good.
• It looks like Xi sees it as the Communist party versus nature and the Party must win. Especially ahead of the fall meeting where he will get his mandate.
• Yes, but he must be under a lot of pressure now.
• It seems idiotic.
• But, in comparison the US have lost one million lives, India have lost four million lives (according to WHO estimates), globally more than ten million. China has, so far, 14k reported deaths. And they haven’t done it right?
• It’s hard to believe those numbers. But second, it’s idiotic to fight nature. Their lockdowns might work and in six months they lock down again. Vaccines are only a small part of the immunity. People need to get it even once vaccinated. So, they can keep chasing.
• Okay. But they did not pay much of a price in economic terms (relatively speaking) either. A slight slowdown, booming exports, and not a lot of inflation.
• The problem is not what happened in the past, but about what will happen next. Either China locks down the country fully, with a sharp recession that the CCP cannot tolerate. Or they let COVID rip and belatedly they will see one million plus deaths. At first glance you might think the lockdowns are the lesser evil, but people are now comparing the Shanghai lockdown as a second ‘cultural revolution’. When have you ever seen so many usually pro-China people express their doubts about XJP as this week?
• This may be a mistake politically by Xi. It may also reflect a lack of coordination between local and central governments in China. But is this equivalent to the cultural revolution? What they do in Beijing will be interesting to watch.
• It’s initially hard to understand, but the analogy goes as follows. During the cultural revolution, Mao delegated the punishment of anti-communists to the lowest ranks. Anyone, even the poorest and least educated, could judge and punish. Today the Shanghai lockdown is run by community groups, often made up of elderly and less educated. That’s the reason why the food delivery, lockdowns don’t work, and why COVID still spreads. In the meantime, hundreds, or more likely thousands of people, have died from a lack of nutrition, lack of medicine, etc. Still there is no end in sight for the lockdown. Stories of vengeful community elders that are locking up rich people in their penthouses etc. A lot of top CCP cadres live in Shanghai. E.g., Ziang Jemin still lives in SH. Questions arise about the Shanghai versus Beijing rivalry etc. It’s ugly.

Why it can’t go to 7.00 [Friday]

• The PBoC are trying to strike a balance: a weaker FX is helpful to support a slow economy. But they don’t want to exacerbate the capital outflows that got started because of the Ukraine-Taiwan parallel.

USD/CNH [Thursday]

• Play it through call spreads. China isn’t going to create another problem for themselves by letting USD/CNH get out of control. PBoC have defended the downside around 6.30 for months. It’s their choice that it’s going higher. Remember that lockdowns mean less imports and a wider current account surplus.

USD/CNH [Friday]

• It keeps moving up. At least the PBoC didn’t add fuel on the fire with a weak fix like Wednesday. It’s still going to slow down from around here. We haven’t had a 1000pip move in such a short time since the trade war days.
• Accounts in London and New York had the long USD/CNH but Asian and onshore accounts didn’t. So, they were chasing.

USD/CNH [Sunday]

• No verbal intervention from the PBoC this weekend against USD/CNY going higher. That’s meaningful.

USD/CNH [Monday]

• The CNY fixing didn’t have any signal. So, the market took it as ‘keep going’. This CNH went super-fast. This participant took half of their position above 6.59 and tightening their stop on the balance to 6.58.
• CNY/CNH touched 1.0110 overnight. Maybe that’s bad data but that’s towards the outer limits of this cross. But this is wide. Onshore doesn’t believe in a protracted depreciation. Offshore there are increasingly more believers of reaching 7.00 and a lot of FOMO offshore.

USD/CNH [Tuesday]

• It will get harder to be bearish CNH over the coming two weeks. First, PBoC showed its displeasure with the pace of the move in three ways (i.e. verbal, fixing, FX RRR). Second, next week is a one-week long holiday in China, and PBoC will want ‘stability’. It might be sensible to accumulate USD/CNH under 6.55 if you want to add to your position, but be prepared to wait out the 1 May holiday week.

Trading Japan

• One participant isn’t shorting JGB as they don’t expect a BOJ change this week (28 April).
• The repo on shorting JGBs is awful. Same as what happened in Australia when the YCC was about to break.

Will you get that repo bleed via short JGB futures as well then?

• Yes. The futures is a 7-year CTS and the implied repo is awful. If they move the YCC from 10-year to 5-year next week, then the futures will not move as much as the 10s obviously. CTD repo is -50bp.

Kuroda Says BOJ Must Keep Aggressive Easing

• This is Japan’s chance to get out of their multi-decade deflationary trap. Why would they spoil it by prematurely raising rates?
• Yes, totally agree. We trade 130.0 pre-BOJ. It pretty much removes the tail risk.
• And 133 after.

Europe

Can Germany, Austria etc turn off Russian gas?

• There would be no such impact for now, but it would be a close call to get through the coming winter. There would have to be a campaign of energy rationing and a further search for alternative sources of energy to build up a sufficient margin. But surprisingly there is a majority of the German public in favour of ending Russian gas as soon as possible.

Not many politicians will remain in power when people cannot heat their homes or have electricity.

• Clearly to blame are the greens with their no nuke policy, but that was a long time ago. Also, one solution may be to break up these duopolies with their restricted inter connectors between countries. There is no logical reason it’s so hard to move power throughout Europe. For example, do Spain or France have headroom in electricity production that can make it to Germany at low cost?
• Building some power lines could be done by winter. If you force it past the nimby and environmental lobby. You can imagine there are some solutions, but the entrenched providers lobby against anything like that.
• It’s not a surprise that the big German think tanks have come out with recession forecasts in the case of a Russian oil and gas stoppage, whereas independent thinkers see a decline of just 2% of GDP growth. But it is a risky business no doubt, but a powerful weapon. Also, it means turning back on the old oil-fired power stations. Oil you can transport easily, and those plants are low-tech, but they pollute. Coal too. You can’t imagine it’s that hard to get some old ones extended, move their maintenance schedule by a year or two.
• The key pushback from critics is, during the eurozone crisis Germany forced a mega recession in Greece. Whereas now, Germany is not willing to what would be at most a mild recession which anyway could be smoothed by a large fiscal package. Double standards.
• Not all our network agreed with this.
• But the energy ministry in each country should by now have an idea of what is realistic. Those facts should come out with the math. The good thing is we know how much energy is consumed and we know how we can import or produce it. This should not be hard.

German Politics

• The fact that German politics has been systematically corrupted by Russian oil and gas money is not open to interpretation. We know what happened. Now all EU collective focus needs to be on stopping Russian aggression. This is existential. The EU cannot fund such aggression as it will be used against EU members.

Russia will invade Europe?

• If his campaign in Ukraine wouldn’t have been such a failure, he could have taken the Baltics and part of Poland etc.
• Russia won’t invade but it will attempt to further undermine Western democratic order.
• If Russia could so easily undermine Western democratic order (influence elections etc) how come it could not do the same in Ukraine and spare us all this brutal, horrible war? If Russia could so easily undermine Western democratic order, then surely there is something not quite right with that order, no?
• The West had taken its supremacy for granted and taken its eye off the ball. After the full of the iron curtain, we got lazy. Russia, but in particular China, were quietly undermining the West. But now we have woken up. So yes, the Western democratic order has sleepwalked into a fragile state, but now that it’s woken up it should be defended tooth and nail.
• But we got pretty busy after the fall of the Iron Curtain. NATO expanded massively. Russia became a ‘minnow’ relative to being a giant, while what you see as China undermining the Western democratic order was simply China rising economically.
• The jury is out on China but increasingly the evidence is that they have grander plans than just to rise economically.
• The Western democratic order has been undermined more by itself. An inability and unwillingness to listen to, or accept, measured debate. And Russia was clever and plugged its bots right into that Western system. And the architects of these systems have done absolutely nothing to create adequate systems to safeguard anything.
• America’s search for global supremacy went on steroids after the fall of the Iron Curtain – look up the Project for the New American Century – it was founded in 1997. I think the opposite of what you think happened after the Cold War finished.

Commodities

• This week’s commodity price action. With Energy, Metals, Softs and Agri all down it’s all left up to Livestock as the only sector positive on the week. CBOE Futures reflect the continuation of concern about shortages for delivery in Oil Markets, Sugar, Coffee, Lean Hogs and most Agricultural commodities, however the broad trend is that supply has improved (or demand pulled back?) and the market is not as stressed as was reflected in the first week of March.

Trade Ideas

• Long US 2-year [Wednesday]. Tactical trade.
• Short GBP/USD [Thursday]. Central Bank talking stagflation. If a country is in stagflation, that is the most bearish opportunity you will ever have.
  • Others joined after retail sales.
• Covered half of their equity shorts [Friday].
• Exit USD/CNH [Monday]. Will wait to re-engage.
• Short AUD [Monday]. Risk fade.
• Short JGBs [Tuesday]. Into the meeting. Not much downside to the trade, even if the odds for a policy change are tiny.

Read, Listen, and Watch…

Read

• Didi’s Fate in Limbo As Officials Object to Proposed Penalty | Bloomberg Quint (This is why Didi suspended plans to list in Hong Kong)
• What is crypto yield farming? | Bloomberg

Listen

• Using Deliberate Cold Exposure for Health and Performance | Episode 66 (Huberman Lab)

Watch

• HyperNormalisation | BBC

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)