By 洪灏，cpa
Summary: The circuit breaker accelerates, rather than triggers market decline. An SEC study shows that a circuit breaker should not be used to suppress volatility. Rather, it should only be triggered during crisis. Clearly, the tight stops of 5%/7% of China’s circuit breaker has the “Magnet Effect” as prices gravitate towards the breaker, and prompts a stampede that drains market liquidity. The People’s Daily editorial has shown strong resolve to reform, and compared today with 1998 – a year of reforming against all difficulties. Hastened RMB depreciation can be misconstrued by Asian neighbors as currency war, and degrade trading terms for all involved. Reform always carries sacrifices. And volatility is part of the costs that the reformers must endure.
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Volatility spills and tends to be serially correlated; the worst opening trading day for the year - ever: As we write, volatility is spilling over to the Europe and the US, after an Asian contagion during the mainland trading hours. Suddenly, the dark days of last August when the PBoC decided to depreciate the RMB déjà vu. Pundits blame the new circuit breaker – after all, today is the launch date of such mechanism to curb excess volatility in the market. In their narratives, gullibility, ignorance, wits and awe are closely entwined. And levels of reality by various observers intersect and overlap, blurring the truth that is imperative to gauge the market’s next moves.
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The circuit breaker introduction is a mainland-specific factor. As such, it can only explain the excess volatility the mainland has experienced relative to the other markets, but not the significantly declines across the board. After the plunge on October 27, 1997 that triggered the circuit breaker in the US market, the SEC conducted a thorough investigation into that day’s trading activities. It is concluded that the circuit breaker should only be triggered during crisis, rather than be used to suppress volatility.
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Further, the study found that the cool-off interval between the first and second breaker was meaningless, evidenced by an orderly re-open after the cool-off. On the contrary, the second breaker had a “Magnet Effect”. That is, the anticipation of further plunge will prompt a selling stampede before the second breaker is triggered. The lopsided sell orders will hence cause further liquidity shortage. The circuit breaker that China just introduced has a low hurdle (5%/7%) that can be easily triggered, given the intense volatility in this market. The buy orders that otherwise exist to render some market support will also disappear with an overall trading halt. Once expectation for further decline is set, it can be a vicious spiral. The first breaker on the following day can become the new “magnet” for prices to gravitate towards
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People’s Daily front-page editorial shows resolve to reform; “indecision now leads to troubles later”: So if the newly-introduced circuit breaker merely accelerated the decline, what was the real catalyst for today’s move? On Monday, January 4th, 2016, the People’s Daily published a front-page editorial of 9,000-plus words written by an anonymous authority on the supply-side reform. What is striking about this paper is its rhetoric – with an air of regal. The paper compared the current reform with the bold structural reform in 1998 that founded an ensuing decade of growth. But 1998 was also a year of more than 30 million SOE workers being laid off, bad loans being as much as 40% of GDP and plunging economic growth.
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With strong words such as “indecision now leads to trouble later”, “no more stimulus for a v-shaped recovery” and “must bury ‘zombie’ companies”, it shows strong resolve to reform, without losing sight of policy cushion for the potential downside. Any reform carries costs. Indeed, our long-held view has been that the more we look forward to from the reform, the higher short-term costs we must bear.
-
In a show of support, the PBoC weakened the RMB fixing yet again. This is one of the periods of rapid depreciation in recent history. And the expectation of further deprecation, as measured by the changes in NDF, is strong and almost equivalent to what we experienced in 2008. Orderly depreciation can nudge growth forward a little. Indeed, the direction of RMB depreciation is consistent with the weakening fundamentals and dwindling FX reserve (Focus Chart 1). But rapid deprecation could arouse concerns over a full-on currency war amongst the Asian neighbors – given what Vietnam did to its Dong fixing on Monday - and set off a race to the bottom. It is a risk that we must monitor carefully.
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Shrinkage in central bank’s reserve assets tantamount to “Quantitative Tightening”: In my recent lecture given at the Renmin University of China, I discussed with students how the central bank’s FX reserve asset has started to shrink. This could be in part due to a reserve management approach that is more market driven. But capital account movements are more significant than those in current accounts, after several rounds of QE. Emerging markets, especially China, have been leveraging up with an expectation of persistent cheap US interest rate and a depreciating dollar – unlike the experiences during previous recoveries.
-
As such, cross-border capital moves, such as hot money, will continue to pressure reserve assets. And given FX reserve expansion has been the most important part of Chinese base-money supply, shrinkage in FX reserve is tantamount to “Quantitative Tightening” – until the PBoC uses other mechanisms such as PSL/MLF to supplement money supply. Strangely, with 200bn MLF due today, and market liquidity is seasonally tight after holidays, the PBoC did not visibly inject cash into the system. Market volatility tends to spill, and is serially correlated. Traders must prepare for more market gyrations that are consistent with the resolve to reform.
----
,end
Summary: The circuit breaker accelerates, rather than triggers market decline. An SEC study shows that a circuit breaker should not be used to suppress volatility. Rather, it should only be triggered during crisis. Clearly, the tight stops of 5%/7% of China’s circuit breaker has the “Magnet Effect” as prices gravitate towards the breaker, and prompts a stampede that drains market liquidity. The People’s Daily editorial has shown strong resolve to reform, and compared today with 1998 – a year of reforming against all difficulties. Hastened RMB depreciation can be misconstrued by Asian neighbors as currency war, and degrade trading terms for all involved. Reform always carries sacrifices. And volatility is part of the costs that the reformers must endure.
---
Volatility spills and tends to be serially correlated; the worst opening trading day for the year - ever: As we write, volatility is spilling over to the Europe and the US, after an Asian contagion during the mainland trading hours. Suddenly, the dark days of last August when the PBoC decided to depreciate the RMB déjà vu. Pundits blame the new circuit breaker – after all, today is the launch date of such mechanism to curb excess volatility in the market. In their narratives, gullibility, ignorance, wits and awe are closely entwined. And levels of reality by various observers intersect and overlap, blurring the truth that is imperative to gauge the market’s next moves.
-
The circuit breaker introduction is a mainland-specific factor. As such, it can only explain the excess volatility the mainland has experienced relative to the other markets, but not the significantly declines across the board. After the plunge on October 27, 1997 that triggered the circuit breaker in the US market, the SEC conducted a thorough investigation into that day’s trading activities. It is concluded that the circuit breaker should only be triggered during crisis, rather than be used to suppress volatility.
-
Further, the study found that the cool-off interval between the first and second breaker was meaningless, evidenced by an orderly re-open after the cool-off. On the contrary, the second breaker had a “Magnet Effect”. That is, the anticipation of further plunge will prompt a selling stampede before the second breaker is triggered. The lopsided sell orders will hence cause further liquidity shortage. The circuit breaker that China just introduced has a low hurdle (5%/7%) that can be easily triggered, given the intense volatility in this market. The buy orders that otherwise exist to render some market support will also disappear with an overall trading halt. Once expectation for further decline is set, it can be a vicious spiral. The first breaker on the following day can become the new “magnet” for prices to gravitate towards
----
People’s Daily front-page editorial shows resolve to reform; “indecision now leads to troubles later”: So if the newly-introduced circuit breaker merely accelerated the decline, what was the real catalyst for today’s move? On Monday, January 4th, 2016, the People’s Daily published a front-page editorial of 9,000-plus words written by an anonymous authority on the supply-side reform. What is striking about this paper is its rhetoric – with an air of regal. The paper compared the current reform with the bold structural reform in 1998 that founded an ensuing decade of growth. But 1998 was also a year of more than 30 million SOE workers being laid off, bad loans being as much as 40% of GDP and plunging economic growth.
-
With strong words such as “indecision now leads to trouble later”, “no more stimulus for a v-shaped recovery” and “must bury ‘zombie’ companies”, it shows strong resolve to reform, without losing sight of policy cushion for the potential downside. Any reform carries costs. Indeed, our long-held view has been that the more we look forward to from the reform, the higher short-term costs we must bear.
-
In a show of support, the PBoC weakened the RMB fixing yet again. This is one of the periods of rapid depreciation in recent history. And the expectation of further deprecation, as measured by the changes in NDF, is strong and almost equivalent to what we experienced in 2008. Orderly depreciation can nudge growth forward a little. Indeed, the direction of RMB depreciation is consistent with the weakening fundamentals and dwindling FX reserve (Focus Chart 1). But rapid deprecation could arouse concerns over a full-on currency war amongst the Asian neighbors – given what Vietnam did to its Dong fixing on Monday - and set off a race to the bottom. It is a risk that we must monitor carefully.
---------
Shrinkage in central bank’s reserve assets tantamount to “Quantitative Tightening”: In my recent lecture given at the Renmin University of China, I discussed with students how the central bank’s FX reserve asset has started to shrink. This could be in part due to a reserve management approach that is more market driven. But capital account movements are more significant than those in current accounts, after several rounds of QE. Emerging markets, especially China, have been leveraging up with an expectation of persistent cheap US interest rate and a depreciating dollar – unlike the experiences during previous recoveries.
-
As such, cross-border capital moves, such as hot money, will continue to pressure reserve assets. And given FX reserve expansion has been the most important part of Chinese base-money supply, shrinkage in FX reserve is tantamount to “Quantitative Tightening” – until the PBoC uses other mechanisms such as PSL/MLF to supplement money supply. Strangely, with 200bn MLF due today, and market liquidity is seasonally tight after holidays, the PBoC did not visibly inject cash into the system. Market volatility tends to spill, and is serially correlated. Traders must prepare for more market gyrations that are consistent with the resolve to reform.
----
,end
