Three Developments to Note

There have been three developments to note in the first half of the week, while much of the world has been on holiday.  

First, on December 24, the People's Bank of China bowed to the run-up in short-term money market rates and conducted an open market operation that injected CNY29 bln (~ $4.8 bln). This was the first such operation since the start of the month.   Instead, in recent days, the PBOC had injected CNY300 bln that were specifically targeted for certain banks.

The fact that the seven-day reverse repo was done at the same rate that prevailed before the crunch is an important signal.  This is not about a stealth tightening of policy that so many had feared.  The much-watched seven day repo rate fell dramatically but only briefly.  They remained at elevated levels on Wednesday.  

There are two broad interpretations of what is happening:  one attributes the money market squeezes, the second significant one in six months, to purposeful or mistaken action by the PBOC. The second places most of the onus on to the banks and shadow banking activity.  

 Both may be true in the sense that the PBOC may be taking advantage of money market pressure  that happens from the normal course of events to pursue its own agenda.   Specifically, Chinese officials do not want Chinese banks to rely on short-term credits to finance higher risk long-term ventures.  Tolerating greater volatility in the very short-term money market drives home the point of the associated risks.  

It is also possible that the PBOC officials under-estimated heightened competition for cash balances caused by the shift out of traditional bank deposits and into less liquid wealth management products.   Some reports also suggest the PBOC may have over-estimated government spending in the final weeks of the year, as the new government in Beijing has been discouraging ostentatious celebrations.  

Some accounts have played up the fact that the open market operation took place 10 minutes earlier than usual or that officials have announced its actions on Weibo, China's version of twitter. While it may be interesting minutia, it should not obscure the official message:  there is plenty of liquidity in financial system.  The banking system has approximately CNY1.5 trillion of excess reserves.  The size of China's money market is estimated at about CNY100 trillion.  

Chinese shares snapped a nine-day losing streak and advanced both Tuesday and Wednesday.  In addition to the money market squeeze, the prospects for slower growth in 2014 and the resumption of IPOs may also have encouraged some recent selling pressure.

Second, on December 24, the US reported a much stronger than expected rise in durable goods orders and a sharp upward revision to the October series. The November increase of 3.5% well above the Bloomberg consensus of 2.0%.  The 2.0% decline in October was revised to -0.7%, owing primarily orders excluding transportation equipment.  Core capital goods orders rose an impressive 4.5% in November; the shipments of which are used as a proxy for equipment spending for GDP calculations rose 2.8%.   The nominal value of durable inventories also rose (0.3% after strong Q3).  

The take away is that many economists will revise up their estimates of Q4 GDP, which is now looking to be closer to 2.5%.  Real equipment spending appears to be running nearly twice what were previous thought and the consumption also appears stronger.  Inventories still appear to be expanding.  

However, economists may take down their Q1 14 forecasts.  Those inventories will have to be run off and all the more so if consumption softens again.  We note that the way it stands down, on January 1, the Emergency Unemployment Compensation program expires.  It allowed benefits for up to 99 weeks instead of the standard 26.  An estimated third of the total beneficiaries of unemployment compensation were receiving assistance via the emergency programs.  

As we have noted before, the expiry of the program may see the unemployment rate fall as some discouraged people drop out of the labor force.  However, the impact will also be on real income, which can be expected to weigh on consumption.   Separately, debt ceiling is looming in February and the eventual compromise could see 1) more spending cuts and 2) some kind of deal that renews some of the emergency unemployment compensation programs.  Neither are done deals, but should monitored.  Lastly, some state-funded emergency programs are also set to expire in Q1. 

Third, the political crisis has escalated in Turkey.  It weighed on the Turkish lira, though the dollar remained capped near the TRY2.10 level that has effectively blocked the upside in recent days. Turkish equities dropped around 4.2% on December 25.  

At the heart of the matter is a corruption scandal that snarled the sons of three cabinet ministers, all of whom resigned.  The corruption investigation is not being led by agents of secularism who disapprove of the more Islamic direction that Prime Minister Erdogan is leading the country. Instead, it is being led by supporters of a former ally of the prime minister, a Muslim cleric who previously been forced to leave the country by the army and lived in exile in Pennsylvania.  

The scandal also involves Halkbank, whose chief executive officer has been arrested on suspicions of bribery.  The US has long argued that Halkbank is facilitating evasion of the sanctions against Iran.   In among the worst political crises Turkey has experienced in a decade, Erdogan, who has been elected and re-elected since 2002, has announced a reshuffling of his cabinet.  

Erdogan has replaced the resigning Economic, Interior and Environment/Urban Planning ministers. He has also replaced the minister responsible for EU relations, who was implicated (but not charged) in the scandal.  Some reshuffle was inevitable, even with the scandal.  Three of the government's ministers are due to stand in local elections in March.   

Calls for Erdogan's resignation have been heard, but the government reshuffle will help the prime minister rebuff these calls.  Yet the political crisis may not be over and there is an important fissure in the US-Turkey relations.  There are multiple points of difference presently.  Egypt and Syria developments stand out, but so does Turkey, a NATO-member signing a missile defense deal with a Chinese company that is under sanctions for dealings with Iran, North Korea and Syria.