Pro Perspectives 2/4/20

February 4, 2020

In the face of a pandemic threat, yesterday we talked about the two spots to watch in the coming days that will dictate broader global market sentiment.

One was Chinese stocks.  The other was the Chinese currency (the yuan).

It turns out, it was the yuan, overnight, that set the tone for an explosive rally today in global stock markets.   

As we discussed, the currency is where we see China's perception on how economically damaging they perceive the coronavirus to be.  Weakening the yuan has been the go-to tool for priming exports and pumping up economic activity in China for three decades.  When things get bad, expect them to weaken the yuan. 

After weakening the yuan more than 1% on Sunday night, to above the 7 yuan per dollar level (a big psychological level), the expectation was for another adjustment lower.  But the Chinese central bank reversed course, and reset it back under 7.00. That was a signal.

It may seem like trivial adjustments in the currency, but what China does with the yuan is (and has been) a major policy signal.  Importantly, they accompanied this with another injection of liquidity into the system.  This adds up to a quarter of a trillion dollars pumped into the financial system since Sunday, to keep credit flowing and to (in their words) "keep ample liquidity in financial markets."  

So, with a ban on shorting Chinese stocks already in place, and a war chest of capital at the disposal of state-owned banks and brokerages, what do they do with all of that cash?  They go on a buying spree, to stabilize not just domestic markets, but global markets. 

This massive buying interest was clear across Asian stock markets very early in the session overnight.  It was unabated, and that carried on through Europe and the U.S.  What is behind the big surge in Tesla, up 44% in two days?  Likely a huge, relentless buying wave from China, which has forced the short sellers to run for the doors (exacerbating the move).   

So, does this move in the currency overnight reflect optimism about the coronavirus outcome?  Maybe.  What it does signal is that China can, and is willing to, print unlimited money to (in their words) "prop up" the financial market.  My guess is that they turn to the beaten-down commodities markets next and start stockpiling cheap commodities (again, as they did in 2010).