Posted by on September 4, 2017 3:27 pm
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Categories: Benoît Cœuré Bond Central bankers China Currency Economy Economy of Europe Economy of the European Union Euro European Central Bank European Union Eurozone National Congress north korea ratings recovery Volatility

Submitted by Bill Blain of Mint Partners

What we don’t know about Korea and China?

“The Chinese use two brush strokes for “crisis”. One brush stroke stands for danger, the other for opportunity.”

Everyone is guessing about North Korea! Who knows what happens next… Probably less than markets fear.. but that won’t stop us worrying about it…

The reaction of markets (on a US holiday) might mean the antics of the Hermit Kingdom are losing some of their capacity for immediate shock and destabilisation. Are markets becoming blasé about the repeated threats? Probably not – the pressure on asset prices and price volatility remains high as participants anticipate a wide range of outcomes.

What’s the right asset positioning? Risk on/off? What are the dangers in terms of the liquidity/return/safe-haven equation? Do nothing and hope it all plays out positively? (Hope is never a strategy.) How contained will it be? Take a defensive stance and miss upside if/when its resolved? Or buy the dips because the risks are massively overstated and its “opportunity”!

Either you know… or you are guessing.

Smarter political minds than I might be able to work out scenario probabilities on how this plays out.

I buy into the current impasse as a China story: To what extent can/might China exercise guidance and control? It rather suited them to watch Trump fulminating and leave him embarrassed. That may no longer be true. It rather looks like the North Koreans are not playing to the script – clearly catching China as surprised and angry as the rest of us at a hydrogen blast 10 times more powerful than Hiroshima. The potential for China to lose patience with N Korea adds a new factor.

Initially it looked like China would be the likely winner, playing the blessed peacemaker role in its own backyard. We were trying to figure what potential upside for China of scoring geo-political points if Korea goads Trump into doing something “hasty” might be? And, what would be the figurative and literal fallout if the Americans lose patience.. (pretty much a worst case scenario)? 

The current what-ifs could change in an instant… I read a number of analysts making contrarian calls about the opportunity to buy cheap Korean stocks and go long the Won. Perhaps it changes the China equation – especially if there is a flood of refugees from the North as some analysts suggest?  Putting China under pressure immediately ahead of the Peoples National Congress in October (picking the next leaders) is an “interesting” shot across the bow.

The other big known unknown this week will be the ECB meeting – and in this case I confidently expect market disappointment.  Draghi will wait before giving any definitive guidance on the direction and scope for further asset purchase schemes. In other words it will be more uncertainty about when the ECB starts to tighten (for that is what a taper effectively is.) We won’t know till later this year.

The big question is the Euro – at what stage does the ECB start to signal its “concern” about the strength when inflation remains weak and the fledgling recovery is still taking hold. Or does the market decide for them? No sign of weakness from a market still convinced Europe is a big recovery story. That could change. 

I continue to harbour suspicions on just how papier-mâché the European façade is. Last week I was reading through the lists of eligible ECB bonds – it’s a pretty complete list of every bond deal ever launched. We know what, but not how much, they buy of that list.

Based on a hint from the excellent Marcus Ashworth of Bloomberg, one issue that got me thinking is the stack of European Sovereign and Agency bonds the ECB holds: there is a letter from Draghi on line confirming the ECB holds no EIB bonds.

So what do they hold in that Euro 180 bln SSA portfolio?

There is a long list of eligible European agencies and banks with government support, ranging from French railways to Landesbanks, to Italian savings banks to Portuguese agencies.. Not saying – not for one moment – that these are tat issuers… but they are sovereign obligations with sovereign ratings for a reason..…

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