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As CNYJPY Jumps To QE2 Levels, What Odds Are Markets Implying Of A China Hard Landing
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As CNYJPY Jumps To QE2 Levels, What Odds Are Markets Implying Of A China Hard Landing

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As CNYJPY Jumps To QE2 Levels, What Odds Are Markets Implying Of A China Hard Landing

With tonight's multi-year record CNY fixing and trillions being flushed at maintaining an arbitrary JPY line in the sand, it seems appropriate to re-consider how to hedge a China hard landing and what probabilities various asset classes are assigning to it occurring. While many are pointing to what seems an entirely capricious level of 79.20 JPY to the USD as the 'new normal' being defended, we were curious at the strange coincidence that the CNYJPY cross implied by tonight's CNY fixing and the 79.2 JPY was exactly the average CNYJPY level during the QE2 period. It seems the Japanese are hedging their tail-risk against the Chinese and a recent note by Morgan Stanley points to how various asset class traders might consider hedging their own version of a hard-landing scenario and notably they agree with us that China sovereign CDS remains among the 'best' hedge.

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Morgan Stanley recently published a series of well-considered articles on 'The China Hedge' as part of their cross-asset-research. It seems with the G-20 meeting and increasingly unilateral behavior cracking the Nash equilibrium at its margins and as usual - first one to migrate, wins. For clarity, MS defines a hard-landing as:




a slowdown in Chinese GDP growth to sub-5% for at least four quarters, driven by domestic factors, not external events.

From the MS note:




We see the probability of a hard landing as low, but not low enough to make hedging costs irrelevant: China-related assets have increasingly been driven by fears of a hard landing and hopes of policy easing. As a team, we’re not in the hard-landing camp, but we also recognise that a hard landing would have major implications for global markets and particularly for the most China-sensitive assets in equities, credit, rates and FX in Asia. For many investors we speak to, this represents the biggest downside risk to Asian markets.

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Aussie rates are the clear winner (and we have liked Aussia bank credit over corporates for a while also as a systemic slow-down trade).

And as far as the best hedges (from a risk-reward-cost perspective):




FX and credit: the best China hedges across all assets: FX puts (CNY in particular) and CDS (China sovereign in particular) look most compelling on our analysis, with equity and rates hedges generally more expensive. This is a change from earlier in the year, reflecting markets repricing in the past months.

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And specifically the pros and cons of the four most efficient hedges:

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The considerable compression in China CDS recently (combined with the rise in DTCC exposure) offers both an increasingly liquid and 'cheaper' hedge than at any time in the last couple of months and while CNY Puts (FX) make sense, there remains considerable concern with regard the jumpy-nature of the NDFs. ITRX Asia is perhaps the most basis-heavy hedge but by far the most liquid - particularly given the perspective that credit will be the first thing to be withdrawn. Of course, with tonight's actions, it is hard to say whether currency wars are escalating or this is some odd agreement among every one but the USA to ebb towards a gold standard to avoid an inevitable money printing endgame? Of course, the modest rise tonight in China CDS, bounce in gold, and 1% drop in ES suggest risk is off for now and perhaps grabbing some affordable hedges is in order.



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