The Acapulco spread

In the far distant past of my career, as a fresh faced young currency trader on his first international posting, to Sydney, I picked up some interesting titbits of learning from the senior dealers in “the big smoke.” One story regaled was the strategy of the Acapulco Spread. Acapulco being a resort city in Mexico, I assumed it originated from New York. In this case, before one went away on vacation to Acapulco, you put on a huge trade. If it went well in your absence, you returned a hero. If it went wrong, you just stayed on the beach in Acapulco and started calling head-hunters. The Acapulco Spread.

Much as I miss the simple life of the late 80’s and early 90’s, I am left with a sense of Deja Vue at the moment. Mainland China remains on holiday until tomorrow, before handing the vacation baton to Hong Kong. That has effectively left the world hanging over Evergrande, with no apparent solution to their $300 billion debt pile, ratings agencies cutting and slashing credit ratings faster than Freddy Krueger did with teenagers (there is an 80/90’s theme today peeps), an interest payment due on Thursday they probably won’t pay, and no sign from the government that they are inclined to let Evergrande crash and burn or will engineer a bailout.

The China holiday has left financial markets to ruminate on possible outcomes and worries about interlinked “contagion.” To clarify one thing, Evergrande has 30 days to make the interest payment from Thursday, not on Thursday, before officially defaulting. I would not put it past Ever-teflon to pull a rabbit out of the sandy concrete foundations on that one. The timing is unfortunate, coming after over a decade of the world’s major central banks back-stopping even the dumbest investment decisions, and continuously QE-ing, even during “recovery” phases, pimping up valuations on assets everywhere. The problem is central banks addicting the world to unlimited zero percent capital to a level that would make the Sackler’s proud, not Evergrande itself. In such market conditions, though, it is no surprise that Evergrande is being compared to Lehman’s, even though it isn’t, and investors are rushing for the exit door.

Luckily for the world, China’s government will return to work tomorrow and there will be no Acapulco spread. President Xi’s “common prosperity” campaign which is dialling back the clock on China’s capitalist experiment will have far more potential ramifications then Evergrande. China was trying to deleverage the property sector long before the pandemic struck, although the landscape is more complicated now. I still believe that after letting the capitalists stew for a while longer, China will engineer the mother of all debt/equity swaps wiping out present shareholders. Certainly, their stock prices suggests that. After all, 1.8 million jobs are directly and indirectly tied to Evergrande. Another possibility is they will invite other moguls to do their “duty” and “burden share” Evergrande’s woes. I prefer the former outcome. One thing is for sure, Evergrande is no Lehman’s although the Western world is still struggling to see through the dollar signs and accept that President Xi is reshaping China in a decidedly non-capitalist way.

Japan returns to work today although South Korea remains out along with Mainland China and Taiwan. The fear factor will continue driving price actions today, although I note that one session of heavy selling everywhere, appears to have flushed out the “buy-the-dip” mafia. US equity index futures are rallying strongly along with oil and base metal commodities, with no headline action to support the moves. Whether it’s a dead cat bounce remains to be seen.

In other news, the Canadian election appears to have been a damp squib. Having been too close to call over the previous week, projections are suggesting that incumbent Prime Minister Trudeau and his Liberal Party will carry the day. The Canadian Dollar is just 0.30% higher in underwhelming price action. Mrs Halley and our two daughters are very happy. Looking at the class of 2021, mostly male, leaders of the world’s most important DM and EM countries, winning because you’re good looking is as good a reason as any to elect someone. Enjoy the victory ladies.

The sudden rally in risk sentiment in Asia may have been caused by a statement just out from the Evergrande Chairman. The Chairman has said “we will walk out of our darkest moment” and deliver property projects, while stating they would fulfil responsibilities to property buyers, financial institutions, investors, and partners. While the Chairman may be a Liverpool supporter and is refusing to walk alone, it does remind of CEOs of financial institutions at the start of the financial crisis saying they had “ample capital.” They didn’t, and they either went bust, were bailed out, or were subsumed. There’s never just one cockroach.

Asia equities show resilience

Given the meltdowns in markets around the world yesterday, Asia equity markets are showing surprising resilience today. The buy-the-dippers couldn’t resist and the Evergrande Charman’s soothing words appear to have lifted hopes, if not spirits temporarily.

Wall Street finished on a negative note, the S&P 500 sliding by 1.70%, the Nasdaq tumbling by 2.19%, and the Dow Jones retreating 1.79%. In Asia, however, futures on all three have rallied strongly by between 0.35% and 0.40%, which has perhaps also helped stabilise Asia with commodities also rallying.

Asian markets are mixed with Mainland China and South Korea closed today. The exception is Japan, where the Nikkei has played catch-up after being closed yesterday. The Nikkei 225 has fallen by 2.0%. Elsewhere though, the picture is mixed but could have been worse. Hong Kong is down just 0.90%, but Singapore has risen by 0.45%. Kuala Lumpur and Bangkok are flat, and Jakarta is down 0.60%.

Australian markets have completely unwound early losses as commodities, unloved yesterday, have rebounded sharply in Asia. The ASX 200 is down just 0.05%, while the All Ordinaries is now in positive territory, up by 0.15%. Sentiment was further boosted by the RBA minutes which suggested that no rate hikes were likely before 2024.

The dip-buying seen in Asia is likely to also lift European stocks this afternoon, particularly if US index futures maintain their strong gains this morning. I would remain cautious in the present climate however, and markets are probably just one headline away from an abrupt about face which will see investors hitting the sell button again. We can expect more of the same intra-day volatility throughout the rest of the week until Evergrande’s Thursday payment date.

Currency markets take a breather

Currency markets moved back to the side-lines in the G-10 space overnight with a fall in US yields as investors parked money in treasuries, offsetting a risk in risk-aversion sentiment globally, which left the US Dollar marooned between the two. The dollar index finished almost unchanged at 93.22 where it remains in Asia today. If the rally in commodities and stocks continues, the US Dollar may give back some of its recent gains. Currency markets look like they are now moving into FOMC wait-and-see mode.

Despite probing the downsides early, EUR/USD. GBP/USD, AUD/USD and NZD/USD are not far away from their New York closing levels, which themselves were barely changed from Friday.  AUD/USD getting a slight 20 point boost from the commodity rally today. The Canadian Dollar has reacted positively to the projected Liberal Party election win, rallying by 0.45% with USD/CAD falling to 1.2770. Until commodity prices show signs that the worst of the selloff is over, USD/CAD is probably a buy-on-dips to 1.2700.

Offshore Chinese Yuan sunk only slightly overnight on the Evergrande saga, with USD/CNH hovering around 6.4760 today with Mainland markets closed yesterday and today. The USD/CNH rally on Friday though has lifted the cross closer to a 6-month resistance line, today at 6.4950. A close above that line signals a move to near 6.6000 initially. That will probably not unfold though until Mainland markets return and if we get concrete tapering guidance from this week’s FOMC meeting. That is likely to lead to a G-10 FX sell-off and feed through to weaker CNY fixings. Tomorrows Loan Prime Rate decisions from China could also be bearish for the offshore Yuan if a surprise cut is announced. That is not my base case though.

The rest of USD/Asia is broadly unchanged from yesterday after the US Dollar had a subdued day versus G-10 FX. Asia’s traders will be content to wait for China’s return tomorrow for further directional signals and the FOMC, despite the Evergrande noise, remains currency markets primary concern.

Oil rallies in Asia after overnight sell-off

Oil, along with commodities in general, was crushed in the overnight session as China-driven risk aversion fears swept markets. Brent crude fell by 1.45% to $74.20, and WTI fell by 2.05% to $70.40 a barrel. Sentiment has improved in Asia today though, with the commodity space rallying generally, as dip-buyers appear after yesterday’s sell-off. Brent crude and WTI have added 0.50% to $74.55 and $70.80 a barrel respectively.

Although prices have recovered in Asia, I suspect that short-term sentiment remains fragile as it is elsewhere and is vulnerable to headline driven moves. A series of lower daily highs on both contracts suggests that we could still see more downside pressure ahead of China returning tomorrow, and with it, hopefully more clarity surrounding its intentions for Evergrande.

Brent crude has resistance between $75.50 and $76.00 a barrel with support at $73.50 a barrel. With sentiment fragile generally, a deeper correction to $72.00 a barrel, home to its 50 and 100-day moving averages (DMAs), cannot be ruled out. WTI has resistance between $72.00 and $73.00 a barrel, a congestion zone of daily highs. It has support initially at its overnight low at $69.90 a barrel. Like Brent crude, losses could extend to its 50 and 100-DMAs at $69.45 a barrel.

Gold loves a crisis

Gold stabilised overnight as the risk aversion wave sweeping financial markets, finally gaining some haven tailwinds which lifted it to a positive close in New York. Gold finishing the session 0.55% higher at $1764.00 an ounce. In Asia, the tentative rally in commodities and equities has seen gold fade slightly to $1762.00 an ounce.

Depending on how the Evergrande situation plays out with markets, gold could continue finding safe-haven buyers, or buying interest could evaporate once again as quickly as it appeared, particularly if the China government soothes nerves when China returns to work tomorrow. Either way, if the FOMC gives concrete guidance on a tapering timeline at Wednesday’s meeting, gold will resume its downward direction, as the former would inevitably lead to a stronger US Dollar.

Gold continues to have resistance just above at $1770.00, followed by the far more formidable $1780.00 an ounce region. Even if risk sentiment remains negative, it is hard to see gold recapturing the latter. Gold has support at $1742.00, followed by $1720.00 an ounce, followed by longer-term support in the $1675.00 region. Given gold’s recent price action, its path of least resistance remains lower despite the temporary respite.

Bitcoin isn’t happy

Bitcoin has fallen nearly 11.0% over the past 24 hours, as risk aversion elsewhere saw the blockchain herd stampede towards a very small exit door. This kind of behaviour is typical in the crypto space where liquidity evaporates causing strong directional moves, up or down before the haters start.

Crypto’s has a few headwinds to contend with overnight. President Erdogan of Turkey said he was at war with them. Meanwhile, Coinbase acceded to SEC pressure and pulled its allegedly US Dollar backed un-stable coin lending offering.

Bitcoin has seen off a bearish pennant formation last week and looked ready to resume its rally through $50,000. However, yesterdays massive tumble saw it plummet through two-month support at $44,450.00, crashing as low as $40,200.00 before recovering to $42.400.00 in Asia.

Like gold, Bitcoin’s rally looks like a dead cat bounce, and it remains vulnerable to more disorderly sell-offs in the current environment. The breakout point at $44,450.00 is initial resistance and it needs to recapture this quickly to restore confidence. The 100-DMA at $40,800.00 held on a daily basis overnight and forms a zone of support with $40.000,00. A failure of $40,000.00 on a closing basis signals a potential capitulation to $30,000.00.