“Impossible Trinity” Shows PBOC Not In Hiking Mode
By Ye Xie, macro commentator at Bloomberg Markets
The short squeeze may be largely behind us.
U.S. stocks rallied Monday as a decline in short interest in GameStop suggested limited room for further squeezing of some of the most-shorted stocks. In fact, the 20 most-shorted stocks in the Russell 3000 have been falling since Jan. 27.
Their performance between Jan 21-27 is negatively correlated to their returns since then. Retail investors are now setting their sights on pushing silver higher, but the move has caused limited dislocation in other assets.
In China, the PBOC’s liquidity squeeze looks to be running its course, too. The interbank rates dropped Monday after the PBOC injected cash. Meanwhile, the services PMI missed expectations, underscoring the growth hit by the recent restrictions on activities due to the renewed Covid outbreaks. Bad economic news is good news for markets as it reduces the risk of policy tightening.
Beyond the near-term, the PBOC’s appetite for monetary tightening is perhaps also somewhat constrained by the yuan — the classic “impossible trinity” problem.
The theory, developed by Nobel-winning economist Robert Mundell, stipulates an economy cannot have free-flowing capital, a fixed exchange rate and an independent monetary policy all at the same time. Higher rates lead to capital inflows, which pushes the currency stronger.
The PBOC hasn’t hiked, but near-zero rates in major economies, have effectively done the job for it, pushing a torrent of foreign capital to China. Overseas investors added a record $100 billion to government bonds last year, more than the previous two years combined.
So far, the central bank has largely tolerated the yuan’s appreciation. The PBOC has been countering the inflows by easing some of the restrictions to encourage outflows. What it perhaps won’t do is to build up rate-hike expectations and create a one-way street for the currency.
Mon, 02/01/2021 – 21:40