« China now runs trade deficits with both Japan and Europe, so why should they allow the Euro and Yen to continue to devalue against the CNY? This has two profound implications… »
Like David Einhorn, Horseman Global had a very ugly month, in fact its 6.9% drop in June which dragged YTD performance back into the red (-2.83% YTD), was the worst month for Horseman going back to the end of 2016.
However, unlike Einhorn, who lost 8% in June bringing his YTD performance to -19% and whose woes can be mostly attributed to the relentless rise of the tech names that make up his « short basket », Horseman was hit due to something else entirely: its aggressive short dollar bet. Like so many other funds who turned bearish on the greenback at the start of the year only to suffer a violent short squeeze, Horseman was caught in the trade war tug of war, in which China – for one reason or another – saw the Yuan depreciate last month by the most on record surpassing even the August 2015 devaluation. Subsequent dovish language from both the ECB and BOJ did not help as Horseman CIO Russel Clark explains:
it seems the larger consensus position in the market is to be short US dollar. More dovish than expected messages from the European Central Bank (ECB) and Bank of Japan (BOJ) led to a surge in the value of the dollar against all currencies. As the fund strategy has been built around flows into the US reversing and creating a weak dollar, our long book suffered without commensurate gain from a short book.
Due to the violent whiplash in the dollar, technicals also promptly reversed, making the long dollar trade the biggest pain trade for the hedge fund community:
Short dollar and long commodity trades had attracted a great deal of trend following money, and Commodity Futures Trading Comission (CFTC) data and broker estimates now show that CTA and trend following funds have reversed their short dollar position, and are now long dollars, while long positioning in commodities have been largely cleared out.
The concurrent collapse in emerging markets, one of Horseman’s preferred trades for the past year, did not help performance.
Which, however, brings us to Horseman’s key point in his latest letter to investors, as well as a major question: what is prompting the yuan devaluation? Is it merely China’s stealthy, if petulant, response to the Trump’s escalating trade salvos, is it a reaction to China’s weakening economy, or is something else going on. To Clark, the answer is « something else. »
The big question which remains unanswered is why have the Chinese become willing to let their currency fall after a period of keeping it strong? Where is there self interest in letting their currency weaken when there was little need for it, and it potentially destabilises the economy?
And the response:
The most reasonable answer to my mind is that they have tired of the endless currency devaluation policies of the BOJ, and possibly the ECB.
The reason for this is due to a structural change in the Chinese economy, which « now runs trade deficits with both Japan and Europe, so why should they allow the Euro and Yen to continue to devalue against the CNY? »
Why indeed, but if that interpretation is accurate, and if China’s latest Yuan deval is the product of trade concerns and not a simplistic response to Trump, Clark believes that this has two profound implications, one for traders the other for the economies of Europe and Japan:
Firstly, that CNY weakness is a not sign of economic weakness at all, which is shown by the underlying data.
