To: TobagoJack who wrote (104537 ) 2/22/2014 9:22:50 AM From: carranza2 Read Replies (2) | Respond to Bank of America research on the effect of the unwinding of Emerging Market carry trade in China [unwinding because Fed no longer supplying liquidity for the carry]. BOA's research is top notch. A friendly heads-up for you:zerohedge.com The potential consequences of Trust defaults and a China carry trade unwind as collateral quality is questioned , the sources of China’s forex reserve accumulation will need to change. Perhaps to bigger current account surpluses, more equity FDI and portfolio investment through privatization and more open equity markets. If that does not happen, expanding the Chinese monetary base might require PBOC to increase net lending to the financial system and/or monetize fiscal deficits (this last part has not worked so well in EMs). 2. Potential asset deflation is a risk, as the carry trades diminish/unwind. Property prices are at risk – the collateral value for China’s financial systems. This is not a dire projection – it simply seeks to isolate the US QE as a key driver of China’s monetary policy and asset inflation, and highlights the magnitudes involved, and the transmission mechanism. Investors should not imbue stock-price movements and property price inflation in China with too much local flavor – this is mainly a US QE-driven story, in our view.Concerns about China’s Trust sector, and its underlying collateral value, sees some of this carry trade unwound, the RMB could be under pressure. HK property prices and its banking system should be watched carefully for signs of stress. They should be on watch if the Trust rollover risk materializes and creates a growth shock in China. See Chart 15. 6. Safe haven bids for DM government bonds, overseas property and precious metals might emerge from China. Could the party go on? Yes, if for some reason a significant deterioration in the US labor market, or a deflationary shock from China, or any other surprise that could lead to a cessation of the US tapering could prolong this carry trade. This is not the house base case. We believe it is better to start preparing for a post-QE world. As one of our smartest clients told us: “the main theme in the past five years was QE. If that is coming to an end, investments and themes that worked in the past five years must therefore be questioned.” We agree.
