Dissent Was Repressed

Those leaders in Brussels agreed
That bailing-in banks may proceed
But as many guessed
Dissent was repressed
More problems are still guaranteed

The yen has been the main loser in the overnight session, with many comments about it being a risk on environment. First, let me be clear in that short of a crisis event, I think recent evidence belies the idea that risk-on/risk-off is a viable paradigm any more. And second, I am trying to figure out what would have encouraged investors to take on more risk because of what we saw overnight.

Was it the fact that the Chinese liquidity crunch remains in place, albeit moderating slightly? 7-day repo rates remain at 6.74%, double their average this year and it has become pretty clear that the PBoC is not about to flood the market with liquidity. The Chinese economy is going to need to adjust to the new ideas about monetary policy and that will be a painful and volatile process, hardly a harbinger of buying risky assets.

Perhaps it was the fact that, as I suggested, the EU announced a compromise on the banking situation, which essentially stated that countries need to abide by the rules unless the situation is such that they don’t think they need to abide by the rules for national reasons. This was not the strong and clear rulemaking that is likely necessary for success of the banking safety net. And let’s take a moment to consider the EU meeting that starts this afternoon. Last June, they pledged “immediate action” on growth and jobs. Today, with unemployment having risen since then from 11.4% to 12.2% and GDP having fallen by 1.1% in that time, they are going to pledge “determined and immediate action” on growth and jobs. I know if I were unemployed in Europe I would feel much better now! At any rate, this does not strike as a reason to jump on the risky asset bandwagon.

I know. It was yesterday’s downward revision of US GDP to 1.8% in Q1 from the previously reported 2.4%, with the Personal Consumption piece falling to 2.6% from 3.4%. That type of news would certainly warrant jumping into risky assets, right?

Ultimately, I think all that is going on is market position adjustments ahead of the quarter end. Remember, Friday is the end of Q2 and many investors are massaging their portfolios to appear in the best possible light for reporting purposes. As such, I am not convinced that the recent gyrations are caused by changing views of the global macroeconomic situation, or changes in policy settings. The market remains quite concerned, and rightly so, that as the Fed removes policy accommodation, equity prices and bond prices will decline.

But looking across the FX markets, we have seen some strength and some weakness with no discernible pattern. Today’s US data will reveal Personal Income (exp 0.2%) and Personal Spending (0.3%) as well as Initial Claims (345K). None of these are likely to move markets greatly. Several Fed speakers are slated for today, NY’s Dudley and Atlanta’s Lockhart, and they may have a much bigger impact on things. For now, it seems that virtually all markets revolve around the Fed’s next steps, and indications that the ‘taper’ is closer will result in further selling of both bonds and equities.

Some days it’s just hard to get excited about the markets, and today is one of those. The long term trends remain in place, but the day-to-day is still subject to the next headline.

There will be no commentary tomorrow as I will be traveling and unable to observe the market.

Good luck and good weekend

Ministers With the Clay Feet

In Brussels they’ll once again meet
Those ministers with the clay feet
The question at hand
The German demand
That banks fix their own balance sheet

It has been a mixed day in the FX markets as traders await further US data, but more importantly, await any further news from the Fed as to the possible timing of the next actions. Central banks have been the focus of most traders lately, between the Fed and all the talk of the ‘taper’, the PBoC and its efforts to deflate the real estate bubble without causing an economic crash, the BOE and its pending change in leadership as Mark Carney starts on Monday, and finally, the ECB, where Signor Draghi continues to assure the world that they have plenty of tools at their disposal, but seems unwilling to use very many of them. That’s quite a list and it didn’t even include the BOJ, which we all know is on a mission to double the money supply in Japan over the next two years.

Starting in Europe, more comments from Draghi indicating that the ECB will remain accommodative for now and urging individual nations to address the fiscal problems that bedevil the Eurozone were sufficient to undermine any support for the euro. It is now approaching 1.30 and I continue to believe is heading steadily toward 1.25 over the next several months. The very clear difference in tone between the Fed and the ECB will continue to weigh on the euro going forward. Perhaps just as importantly, the EU FinMins will be back in Brussels trying to iron out the banking resolution process for the future. Remember, late last week they could not agree on the measures to address bank failures and when the new banking regulator should be called in to support a particular bank. I see no reason that positions would have changed in the past 5 days, and so as I wrote Monday, the outcome is likely to be no real resolution, but some announcement that things are solved. Politically, they cannot afford to fail again, but economically, neither side will give in. As I also wrote Monday, this remains an underlying reason the euro will continue its decline.

The pound is also a bit softer this morning, following the euro and seemingly anticipating the onset of the Carney era. Remember, the entire world is expecting great things from Carney, who is on record as calling for ‘flexibility’ in inflation targets (read higher inflation) and has been willing to push the envelope with regard to innovative monetary policy measures aimed at easing policy. Certainly, if the BOE votes for more QE, one of the possibilities at next week’s meeting, the pound will suffer further.

Down Under, the political situation is heating up as PM Gillard lost the Labour Party leadership election and the Labour Party will now be lead by Kevin Rudd in the September elections to come. But the Aussie’s weakness over the past months has not been political, it has been the result of position unwinding. Aussie had been one of the favored destinations for investors seeking a combination of yield and safety with a modicum of liquidity thrown in. It is apparent that much of that positioning has been reduced. Add to that the tepid economic growth and the apparent weakening in China, and Aussie suddenly doesn’t look so attractive. Remember, the 10 year average price of AUDUSD is 0.8575, with recent time spent above 1.00 as the historic outlier. Aussie has further to decline.

And let’s talk about China now, where the PBoC continues to moderate the liquidity problems that have arisen in the banking system. While they are working hard to prevent a melt-down, and certainly do not want to see any bank failures, it has become clear that the Xi Administration is keen to make major adjustments in the Chinese economy. The effort to diversify away from an export led economy to one that is more reliant on domestic consumption has been fraught with periodic problems, like this liquidity situation. This is the conundrum in which the Chinese find themselves. It is easy to add liquidity and reduce the short term lending rates, but in so doing, they would continue to encourage the property speculation they are trying to defeat. So they are trying to find a middle ground, and the short term gyrations are the result. This highlights just how difficult it is for a country to make monetary policy adjustments and have markets behave as desired. And this is in China, where the government has much greater control over everything. Remember that when thinking about the Fed and its ability to control its message, policy and market responses, or rather its inability to do so.

Finally, a quick word on India, where the Rupee traded to a new historic low vs. the USD at 60.765, falling a full 1.75% on the day. The problem has been a steady outflow from the Indian stock markets by international investors combined with the domestic problems of slowing growth and rising inflation. The RBI has not yet focused on either growth or inflation, trying to manage both simultaneously. This has reduced international confidence in the currency, and quite frankly, I expect it will continue to slide. There is nothing that says it cannot reach 65 at some point on this move, regardless of the RBI’s modest intervention efforts.

Good luck

The Fed’s Consternation

I have begun the process of archiving my old verse on my blog.  As of now, everything I have from 2009 is on www.fxpoetry.com so if you are interested, click the link and peruse them.  While you are there, you can sign up to follow the blog, which will automatically send you each morning’s report.  I expect to have 2010 and 2011 done over the next several days.

Much to the Fed’s consternation
The market’s most recent translation
Of Chairman Ben’s speech
Was QE would screech
To a halt, causing Ben much frustration

In response we got speeches from two
Presidents of the regional crew
The word ‘exit’s not right
Nor will money get tight
When QE’s days are finally through

Markets are funny things.  Understanding what drives prices and anticipating how they will respond to particular signals is a game fraught with difficulty.  As I wrote last Thursday, historically Central Bankers (and truly government officials on the whole) typically don’t do this very well.  At least based on the remarkably stupid things that they regularly seem to say.  Anyway, it is clear that the Fed was unhappy with the market’s interpretation of Bernanke’s recent press conference and so he sent two of his minions, Fisher and Kocherlakota, out to try to explain further the Fed’s thought processes.  What we learned was that “the word exit is not appropriate” for what the Fed is doing, according to Fisher, and that even if it is, policy would still remain accommodative “for a considerable time” afterwards according to Kocherlakota.  On the surface, these seem somewhat contradictory statements.  It is almost as if they want their eventual reduction in purchases to be ignored as a market signal.  Rather, they would prefer that the economy continue to merrily roll along without the Fed having to do anything special.  Alas for them, that is never going to be the case, and so the process of messaging will remain highly uncertain and extremely difficult.

All that said, the message from the two non-voters seemed to be accepted by the markets as we have seen equity markets bounce modestly, Treasuries rally slightly and the dollar soften a bit.  I don’t think it was the overnight data, which was extremely light, but the other possible catalyst for this bounce could have been comments released from the PBoC, where they indicated that they will keep money market rates at a “reasonable” level going forward.  Those comments were sufficient to reverse a 6% decline in the Shanghai Composite, and perhaps settle market players’ nerves a bit further.

One of the other things I have learned over my extended time in markets is that high volatility tends to come in short bursts.  It is very difficult for traders to continue trading in high volatility environments for extended periods, they literally just get too tired and step away, so given what we have seen over the past several weeks, it would be reasonable to expect a bit more quiet until next week when we get the payroll data.

For the rest of this week, we do have some interesting data being released, notably Durable Goods this morning and the PCE Deflator on Thursday.  The latter is the Fed’s preferred measure of inflation (clearly not one that has anything to do with our everyday lives), but they will respond to that signal rather than CPI.

Today Durable Goods


-ex Transport


S&P/Case Shiller


Consumer Confidence


New Home Sales


Wednesday GDP (Q1)


Personal Consumption


Thursday Personal Income


Personal Spending


PCE Deflator


Initial Claims


Continuing Claims


Friday Chicago PMI


Michigan Confidence


So for today, I expect that we will continue the consolidation of the bulk of the recent moves without significant volatility.  Of course, this is subject to any comments from other Fed officials, and things remain on edge regardless.  I didn’t mention the yields on peripheral European bonds, with Spain above 5%, Portugal near 7% and asking about the ECB’s willingness to actually use the OMT.  Remember, too, we have the EU meeting in Brussels on Thursday to try to hammer out the details of who is going to be on the hook for any necessary capital infusions into European banks if they should arise under the mooted bank regulator.  In other words, there are plenty of things around which can cause a market dislocation, I just have a feeling that today will be without much drama.  Take advantage of the quiet to establish hedges here.  It is much easier on a quiet day than on one where the s*it hits the fan.

Good luck

Confusion Prevailed

In Europe confusion prevailed
As once again countries there failed
To work out the rules
For bank-closing tools
Which were to have just been unveiled

On the whole, the dollar continues to gain, with only a few minor currencies able to rally as we begin the week.  The notable stories over the weekend were the failure by the EU to come up with a bank resolution mechanism to sever the connection between weak banks and the their national debt problems and the ongoing tightness of Chinese money markets, where the PBoC is trying to rein in ultra loose credit without causing a bank failure or two.

Let’s look at the EU situation to start.  One of the key problems driving the Euro area crisis has been the fact that the peripheral nation’s sovereign debt has largely been held by domestic banks, so Spanish banks own Spain’s debt and Italian banks own Italy’s debt, etc.  That’s all fine and well until the nation’s creditworthiness is called into question.  At that point, the holders of that debt (the banks) are also under the gun.   Given the incestuous relationship between bank and country, problems get multiplied as the viability of the banks is called into question alongside the viability of the nation.  The EU has been trying to address this issue for two years, and last year they ‘agreed’ to a resolution mechanism in one of their meetings with the details to be worked out later.  The idea was that there would be a pan-European entity (under the auspices of the ECB) which would be funded by the members of the Eurozone and would be able to directly recapitalize failing banks.  This would prevent the individual countries from having to take on more debt to save their banks, thus preserving their own creditworthiness.  This all sounded great in principal.  Alas, at the meeting this weekend to hammer out the details, they could not agree on a formula for allocating risk.  In other words, the nations that have to fund this idea (Germany, Austria, Finland and the Netherlands) are not keen to have their taxpayers own bank shares in places like Spain and Italy.  Of course the Spanish and Italians are very keen for others to take that risk.  While it would not be a surprise that, eventually,  European leaders took on this risk despite what could happen to their citizens, it would be a surprise if it were to occur before the German elections in September, as that would open Chancellor Merkel to substantial attacks from her opponents.   And so, despite assurances that they will resolve this issue at yet another meeting this Thursday, I doubt they will reach anything other than a weak compromise with no commitments by the players who matter, although they will describe it as the solution to all their problems.  This is simply another facet of my underlying bearishness on the single currency, the inherent structural flaws in its design.  And while the euro has edged lower overnight, it remains relatively well bid, at least compared to most other European currencies.

I believe the euro’s relative bid is a result of continued unwinding of trades where investors had used the euro as a funding currency to purchase emerging market currencies and assets.  This is exactly analogous to the yen’s behavior in the wake of the financial crisis in 2008.  Back then, the yen was the key funding currency (remember, only they had zero interest rates at the time) and so short-term investors borrowed yen and used the funds to buy other assets.  This was the carry trade, and it was established in very large size.  When things went south after the Lehman bankruptcy, these positions were liquidated very quickly, which resulted in lots of yen buying, and a much stronger yen1.  I think we are seeing the same thing happen in the euro, although not to the same extent, as the euro had been a popular funding currency for many emerging market trades.  As those trades get unwound, the investor needs to buy euros to repay the funding.  Hence, the euro’s resilience in the face of USD strength elsewhere.  German data was benign, with IFO as expected at 105.9, and I believe all eyes remain on the Fed for now.  I maintain my view that the euro will continue lower over time.

Now, quickly, on to China.  The PBoC is trying to hold the line against the massive real estate speculation that has been occurring in the country, as well as limit the shadow banking system.  However they don’t have the same array of tools to adjust policy that we see in the developed world.  In addition, as there is no semblance of independence, it is widely expected that they will implement whatever policy the government chooses, rather than simply address the monetary concerns in country.  As such, recent gyrations in the short term funding market have been extreme.  A combination of increased demand for funds because of maturing debt and savings withdrawals because of the recent Chinese holidays forced many banks to pay up to fund themselves driving the overnight and 7-day repo rates to records late last week.  While those rates have since fallen, they remain well above recent averages and continue to exhibit a real tightness in markets.  It is becoming clear that the Chinese government is prepared to accept slower growth in order to prevent the inflation of a significant real estate bubble, and that does not bode well for the many exporting nations who rely on China as a key market.  So Chinese monetary foibles are displayed via a much weaker AUD and NZD, both of which count China as their number one export destination.  So too, KRW, MYR and, in fact, the rest of the Asian currency world.  The weakness across all these currencies has further to run.

There is no significant US data today, so we will look at data tomorrow.  Futures are pointing lower and Treasuries are continuing their rout.  (3% in the 10 years anyone?)  I see no reason for those trends to change, nor for the dollar to show any weakness in the near term.  Receivables hedgers, the pressure is continuing and will do so for the rest of the summer at least.

Good luck

1 – This was the genesis of the idea that the yen was a safe haven.  The fact that the yen rallied alongside the dollar as investors fled their carry trades has been confused into a causality.  People weren’t buying yen because they felt it was safe, they were buying yen because they had to repay their debts.  However, the correlation was extremely high, and so many believed the story.  To be clear, yen is NOT a safe haven!

Inappropriately Timed

The boys in the Fed are now fighting
Which could make things much more exciting
Bernanke explained
QE could be drained
Then Bullard had words that were biting

The Chairman’s speech was premature
Since right now we just can’t be sure
Of how the US
Will meet with success
Which our buying bonds did ensure

As we walk in to the final day of what has been a pretty dramatic week with respect to market movement, the headline that jumps out to me is the comments from St Louis Fed President Bullard that the Chairman’s remarks were “inappropriately timed”.  This is the Fed’s dirty laundry out in the open and it has been sufficient to roil markets.  One of the things Bernanke has been doing while Fed Chairman has been his effort to bring transparency to the Fed process.  And while I am fully in favor of transparency, I understand that one of its consequences is that there will be more volatility resultant from that transparency.  The question is, does Ben?  After all, think about how markets work.  Traders and investors take the information they have, analyze it and establish their views, then take a position accordingly.  We all know that there are both bulls and bears in any given market, so there are always going to be different views.  But what transparency adds to the situation is that as internal dissent within the Fed becomes clear, it can serve to undermine the perception of the Fed having conviction in its actions.  Any sign of weakness in a central bank, especially the Fed, is an open invitation for markets to test that weakness.  And so now we have dissention in the ranks of the FOMC being played out in the open.  There is more volatility to come.

Yesterday’s FX movements were pretty impressive overall, with multiple currencies falling more than 2% vs. the dollar.  The overnight session has seen a bit of a rebound in the yen, but actually we have seen a continuation in the other major currencies.  The euro has suffered following the news that in Greece (remember them?) the coalition government has been weakened after its decision to close the national radio and television broadcaster, ERT, and fire 2700 government employees.  While this is a condition of the Troika bailout funding, the manner in which this occurred has not gone down well with the smallest member of the coalition.  This has also served to focus attention on questions about Greece’s ability to fund itself for the next year and called into question whether the IMF will continue adding money to the pot.  Euro weakness seems likely the future, although I don’t foresee a collapse, rather a steady decline.  The pound is softer despite better than expected budget numbers, with its deficit much smaller than expected.  However, the impetus from the ending QE story remains the key driver here.

In emerging markets, the PBoC finally injected some cash into the system last night.  This helped ease the growing credit crunch there and overnight rates fell by 442 bps.  It appears that the Chinese are still trying to figure out the best way to manage monetary policy in an economy that is growing at a much slower pace than in the past.  While the CNY is not likely to become extremely volatile any time soon, the impact on other Asian currencies is almost certainly going to be large.  The combination of the Fed changes and the PBoC squeeze has resulted sharp declines in all Asian currencies during the past week, led by INR, but pretty much across the board.  Funds continue to flow out of emerging market economies, both equity and fixed income, and this process is just getting started.  Asian central banks have been actively intervening to prevent a collapse in their currencies, but the weakening trend is going to continue as long as the Fed story remains.  Right now, most of these countries are fine, as they were actively selling their currencies during the past two years to prevent excessive strength, but history shows that defending a weakening currency is a much more difficult process, and if this pressure keeps up, we could start to see other macro policy changes that have real economic impacts, rather than simple FX intervention.  This is simply more of the fallout from Chairman Ben’s transparency initiative.

Finally in Brazil, the protests that I mentioned earlier this week are growing, with more than 1 million people taking to the streets around the country yesterday.  While Sao Paolo has rolled back the bus fare hikes that started it all, it has not been sufficient to end the protests.  Last night resulted in the first casualty in the situation, but I fear there will be more before it is over.  The question is: will President Rousseff be able to address the concerns, which seem to center on corruption in the government?  It is always difficult for a government to look inward and address its own foibles, and I don’t see any reason to believe that this situation will be different.  So to me, these protests are likely to continue for a while, possibly right up until the World Cup, and the BRL probably has further to fall.  I wrote that there was only a 20% chance of a more substantial decline in the Real, to beyond 2.50, but as I read more about what is happening on the ground there, I fear that probability is growing.  I think it is up to a 1/3 probability of a significant decline and those odds are likely to grow.  If you are a receivables hedger in BRL, be very careful.   Things could get ugly in a hurry.

Good luck and good weekend

Cold Feet

Bernanke is getting cold feet
Bond buying he may soon complete
So it’s no surprise
That bond yields did rise
And stocks beat a hasty retreat

In case anyone doubted that the reason equity markets around the world have performed as well as they have over the past two years was directly attributed to the massive liquidity infusion by central banks, those doubts have been erased.  The entire idea behind QE has always been to force investors out of bonds and into riskier assets.  (The underlying premise was that banks would lend the money out to business for expansion, but that’s not really what happened).  Now that Bernanke has intimated conditions may soon lead to the end of QE, it was inevitable that this is how things would play out in the markets.  It doesn’t seem to matter that every time a policy change is made by a central bank, especially the inflection from easing to tightening or vice versa, markets respond with significant volatility.  Central bankers just don’t seem to get it.  The reason for this disconnect between market behavior and central bank desires is that central bankers are traditionally academicians, with little or no market experience, and quite frankly, they simply don’t understand how markets respond to news.  Traders don’t wait around for the eventual changes in the economy to materialize; they adjust their positions at the first hint of a change.  Trading too early is generally a much better error than trading too late.  And this is also why markets tend to trade far beyond any sense of fundamentals.  So if we don’t get some further ‘clarification’ from other Fed members soon, notably Yellen or Dudley, that there is no imminent change in the pace of QE, this market condition can extend quite a bit further.  Higher US yields, lower US stock prices and a rallying US dollar, just like yesterday, will be the norm.  That has been my underlying belief for several months, and I see no reason to change that view.  (Of course if we do get that clarification, look for even more volatility as markets reverse course to some extent.)

Let’s look briefly at just how far things have moved in the past two days:



















These are quite substantial movements for a 2-day period, and this increase in volatility is likely to be seen far more frequently as the transition from infinite monetary ease to ‘normal’ monetary policy proceeds.  The market is going to be highly sensitive to comments from all central bankers.  But it is also going to be highly sensitive to US data, because Chairman Ben has made it clear that data is the key.  If growth achieves their forecasts (which have been raised to 3.0-3.5% for 2014), they are going to stop buying bonds and let them start rolling off.

Today’s US data upcoming is as follows:

Initial Claims


Philly Fed


Existing Home Sales


Leading Indicators


I think that the first 3 have the opportunity to move markets.  Indications of a better labor market are key, but if the Philly Fed follows the Empire Mfg number, which was much better than expected, and the Housing market continues to show strength, traders are going to be abandoning bonds pretty aggressively.  In fact, in these transitional periods, cash is the best thing to hold, and my guess is that is where we will see investors heading.

Data overseas had limited impact on the FX markets as all eyes remain on Bernanke, but the picture in most places remains bleak.  China’s HSBC PMI data was much weaker than expected at 48.3, and tightening monetary conditions continue to plague the markets there.  Adding this to the Fed change has helped AUD to be the worst performer in the G10 space.  My earlier estimates of 0.90 may be too timid.

In Europe the PMI data for German Mfg was disappointing at 48.7, but its services data was better than expected at 51.3.  In the EU as a whole, the PMI Composite was modestly better than expected at 48.9, still indicating extremely low growth, but edging toward a positive outlook.

The only truly positive story remains the UK, where Retail Sales were up a much better than expected 2.1% in May, continuing the improving economic data there.  It should be no surprise that the pound has been the best performer of all European currencies over the past sessions, as its macro story remains the best of the bunch.

For today the market is likely to continue with its volatile ways.  I believe the trend for dollar strength will underlie most movements, especially in the emerging markets, but I am reluctant to believe that another 2% is in the cards for the rest of the day.  But over the next several weeks, there is ample time for a much stronger dollar.  Do not be looking for other central bankers to stop the USD strength, but do not be surprised if in the emerging market space we see interventions to try to moderate the volatility.  For all you payables hedgers, your time is going to come in the not too distant future, and quite frankly, another layer of hedges after recent moves would not be a bad idea.

Good luck

Completely Arcane

The G8 confirmed what we knew
The eight of them haven’t a clue
Seems most people think
Their policies stink
And waste time is all that they do

They talked about taxes and trade
But progress was sadly delayed
All details remain
Completely arcane
While photo ops cap the charade

Today is Fed day, with the FOMC’s 6-weekly meeting ending and any policy changes to be announced this afternoon.  We also get a press conference from Chairman Ben at 2:15 pm, although I would be surprised if there is any new information forthcoming.  He must still be licking his wounds from his comments about tapering bond purchases back in May.  After all, since then, 10 year Treasury yields have risen by 25bps, and equities fell more than 5%, although they have since regained about half those losses.  So while all eyes today will be on the Fed, I would be very surprised to see anything even remotely new in the statement or press conference.

Finishing up the G8 meeting, our illustrious leaders spent a small fortune to meet in Northern Ireland, discuss a range of topics and decide nothing.  It was a standard performance I would argue.  In fact, it is not clear to me that the G8, or G20, or G(anything) has shown any value in the last decade.  Perhaps halting these biannual meetings would be an effective way to reduce each government’s expenditures, photo ops be damned!

Looking at the FX markets today, there has not been a great deal of activity overnight with the euro remaining in a 27 pip range, the pound showing a bit more life with a 65 pip range and the yen the most dramatic of the big three with a 83 pip range.  That said, none of them have moved very far from yesterday’s closing levels as they await the Fed comments.  Overnight we saw strong data from Japan, with Department Store Sales surging by 5.1% nationwide and the Trade Deficit expanding by a less than expected 12.6% to ¥993 billion.  While export volumes fell, the yen value of those exports rose by more than 10%.  This was attributed to the weaker yen, and has helped reinforce the idea that Abenomics is doing its job.  The market response to the data was one of immediate yen strength, halting the recent decline in the currency.  But there has been limited follow through as there are several stories this morning of how major hedge funds remain committed to the yen weakening trade.  I am in complete agreement with the hedge funds, and continue to believe current levels remain attractive for yen receivables hedgers.  Once the Upper House election is over, look for the next wave of yen weakness.

The euro story is virtually non-existent today, with no economic data, no comments of note and no expectations of change in the market.  Any movement will be entirely dependent on the Fed.  And the pound, which has rallied steadily over the past month appears to have reached the end of this move.  While it did edge through the levels I thought would cap things, there seems to be no momentum to the trade higher and it feels like it is setting up to head back to the 1.52 level in the next week or two.  The BOE minutes were a non-event, with outgoing Governor King outvoted 6-3 again in his attempt to increase the asset purchase program.  And finally, in the UK, tonight is the Mansion House speech, where Governor King lays out his views of the economy.  It has oftentimes in the past resulted in both market movement and government action, but with King about to step down, my sense is it will have a limited impact.  Incoming Governor Carney is the one that markets will now focus upon.

In emerging markets, a story I have not been discussing directly is Brazil, where protests have been gathering pace over the past two weeks.  It seems that the people of Brazil have become upset with the general level of corruption, the lack of opportunity and the rising inflation that is eating into their living standards.  The catalyst was a rise in the bus fare by 20 cents in Sao Paolo, but it has spread around the country and forced the government to respond, not only to the protestors directly, but to the issues that they have raised.  During this period, BRL has fallen some 5%, and it is down more than 9% in the last month.  Can this continue?  My experience in emerging markets tells me that there is a chance, maybe 20%, that it can extend dramatically.  While the highest likelihood is that the BRL will settle back between 2.00 and 2.10 over the summer, do not rule out a move to 2.50 or beyond.  While this may be unwelcome news, the thing about emerging markets is that the risk comes not so much from the underlying economy, but rather from the lack of market liquidity that is found in developed markets.  And lack of liquidity can produce quite dramatic results.  Pay close attention to this story if you have exposures in country.

Good luck

A Banker Named Ben

There once was a banker named Ben
When asked he said, never again
Would he take a role
That’s taken its toll
On quite a long list of good men

Now markets are somewhat concerned
The next chairman might not have learned
The lessons that showed
Why growth really slowed
Soon they’ll wish that Ben had returned

It seems to be official now, Chairman Bernanke will not be returning to the Fed when his term ends on January 31, 2014.  President Obama made it clear in an interview that Ben was ready to move on.  So what does this mean for markets in general and FX markets in particular?  I think we are likely to see an uptick in the level of nervousness across the board in markets.  Despite the controversy he courted, market response to Bernanke’s unprecedented monetary policies has been pretty impressive overall.  Concerns over newly inflating asset bubbles are growing, but for most people, who simply hold equities in their portfolios, the rally that has taken place over the past 4 years has been a welcome relief from so much of the overall economic anxiety that has accompanied life since the onset of the Financial Crisis in September, 2008.  During that same period, the dollar has been anything but stable, rallying sharply in 2010, falling sharply through 2011 and edging back higher since then.  I think the biggest uncertainty for market players is that whether or not they agreed with Bernanke’s policies, they grew to understand his behavior and were able to trade accordingly.  But with a prospective new Chairman coming on board, aside from all the speculation about who it will be, there will be the matter of learning a new communication style as well as determining if the new Chairman’s policy ideas are seen as positive for markets.  This is another factor that will, at the margin, increase volatility for the rest of the year.

As to the FX markets overnight, the dollar has had a better session than yesterday, rallying against most currencies, notably the JPY and AUD in the developed space, and the ZAR and INR in the emerging space.

The session started with worse than expected Japanese IP data, a rise of only 0.9% in April, and the initiation of weakness in the yen.  Moving on to Europe, EU auto sales fell to their lowest level in 20 years!  Both these items were sufficient to help boost the dollar in the G10 space.  The euro was able to shake off its early weakness after a combination of better than expected German ZEW figures (38.5 vs. 38.1 expected) and comments from Signor Draghi, repeating that they ECB will do “whatever it takes” to keep the euro in one piece, and that other nonstandard measures, whether negative deposit rates or further liquidity injections are all possible.  The euro reacted positively to these things and is the only currency in the developed space higher this morning.

Meanwhile, UK inflation data was released at a higher than expected 2.7% in May, up from 2.4% in April and higher than the 2.6% forecasts.  Inflation in the UK remains stubbornly above the 2.0% target and seems to be a hindrance to the BOE in its efforts to support the UK economy further.  Remember, Mark Carney will be taking over as the new BOE governor on July 1, and all eyes will be on him to see if there will be more stimulus coming regardless of the inflation situation.  At any rate, the pound is softer this morning, down from recent highs at 1.57, and I continue to believe it is a better sale than buy at these levels.

Perhaps more importantly, data on Chinese home prices continues to show they are rising sharply and are creating concerns that the PBoC will not be able to support the broad economy while inflation is so prevalent.  It was the latter story that helped undermine so many of the Asian currencies, including the AUD.  If China is embarking on a period of slowing growth and rising prices, then all those nations that rely on exports to China as a key part of their growth strategies, a.k.a. the rest of Asia, are going to find themselves in significant difficulty and their currencies are going to suffer for that as well.  Remember, one of the reasons that Asian currencies had performed so well over the past several years was the idea that most of these nations were growing rapidly, albeit in the shadow of China, but that they had learned their lessons from the Asian crisis in 1997-98 and fixed their fiscal issues.  This resulted in a combination of strong underlying fundamentals and rapid growth, drawing in lots of investment.  While their fiscal situations remain in good stead, the potential slowdown in growth is going to have very negative repercussions.  We continue to see investment funds flow out of the area and I see no reason for that to abate in the near future.  This large scale exiting of financial investments will certainly weigh on these currencies.  India seems in particular difficulty, with inflation still above target and growth below target.  Last night’s 1.5% decline was precipitated by a widening of the trade deficit, which has simply been adding to their problems.  We also saw significant weakness in ZAR (soft commodity prices combined with ongoing local labor strife) BRL (weaker Chinese growth restricting its exports) and HUF(declining bond yields discouraging investors).

Yesterday’s Empire Mfg number was much better than expected, and today we see Housing Data (Housing Starts exp 950K, Building Permits exp 975K) as well as CPI (exp 0.2% headline and core).  This is the area of the US economy that has performed best of late, and more strong numbers should translate into both higher yields and a stronger dollar.  I like the dollar from here, especially against the pound in the short term, but receivables hedgers need to be on their toes.

Good luck

Havoc No More?

The G8 is meeting this week
Bernanke, as well, gets to speak
Will either present
A good argument
That havoc they no more will wreak?

Bernanke will “want to emphasize that a tapering of asset purchases is not a tightening of policy and isn’t necessarily irreversible,” said Michael Feroli, a former researcher with the Fed board in Washington and chief U.S. economist for JPMorgan.

I had to start with the comment I read this morning, which I think highlights why economists have a reputation for being out of touch with reality.  If asset purchases by the Fed constitute their Quantitative Easing policy, designed expressly to loosen monetary policy despite interest rates at zero percent, then how can tapering asset purchases, the opposite of executing them, not be policy tightening?  It is this type of muddled speaking and messaging that leads to market volatility.  As an investor, my concern is that either the Chairman doesn’t understand what the word ‘taper’ means, which I doubt; or that he is afraid to describe what he believes the Fed will need to do going forward.  It is the latter concern that will continue to drive markets for the time being.

So after several weeks of pretty significant volatility across all markets, the G3 central bankers are starting to figure out that market participants will not simply do exactly what is needed on the back of verbal cues.  In fact, Bernanke, Draghi and Kuroda need to enact policies very clearly and carefully, a level of precision that has always been difficult to achieve in the monetary policy realm, and one made even more difficult because of the unprecedented situation in which they each find themselves each having previously committed to, and enacted, extreme policy measures.  Once again, I will remind you all that as the current set of policies gets unwound, markets will remain quite volatile.

So let’s look at the markets this morning.  The dollar is mixed, with the yen weakening a bit, the Aussie rallying a bit, and emerging markets all over the map.  Equity markets are feeling better, with the Nikkei regaining 2.75%, Europe largely higher by more than 1% and US futures pointing to a higher opening.  Bond prices are mixed as well, with Treasury yields edging lower, but yields in Europe mixed and JGB yields higher.  In essence, we have no trends on which to hang our hat this morning, with each currency and product trading to its own internal issues.  In many ways, I feel this is the healthiest thing for markets, if traders and investors react based on data and news for each product.  But that is the hardest for any analysis to capture because of the disparate stories that exist.

The likeliest market movers this week are, in order, the FOMC meeting and press conference on Wednesday, any one of a number of pieces of US data to be released, and finally the G8 making some meaningful comments.

Here is the week’s data:

Today Empire Mfg


Tuesday CPI


-ex food & energy


Housing Starts


Building Permits


Wednesday FOMC Rate Decision


Thursday Initial Claims


Continuing Claims


Philly Fed


Existing Home Sales


Leading Indicators


I would expect that the Housing data have the best chance of driving a market move, if it misses in either direction.  And what of the G8?  It is hard to believe that given PM Cameron’s stated focus on Trade, Transparency and Taxes, that they will be saying things that impact FX markets greatly.  The Fed, on the other hand, will have much to say about where things go later in the week, and I will discuss that tomorrow.  For today, unless the Empire number is a big miss, the markets appear to be taking a breather from the recent market volatility.  On the surface, I still think the euro has difficulty rallying from these levels, the yen has ample opportunity to decline sharply by the end of the summer, and the pound has seen about all the good news it can handle.

Good luck

Deflating His Massive Bond Bubble

The Chairman is having some trouble
Deflating his massive bond bubble
His stated intent
Is to circumvent
The market collapsing in rubble

The consequences of the recent market volatility are that it is very difficult to figure out what’s next.  In the past three sessions we have gone from concern over the end of the world to an all clear signal.  Yesterday started with serious concern as the Nikkei had tumbled further overnight and European markets were roiled.  US data was certainly better than expected, with Initial Claims falling and, more importantly, Retail Sales showing more strength than expected, but it seems that it was a Fed planted article in the WSJ by Jon Hilsenrath that was able to turn sentiment.  In it, he explained that any Fed reduction of QE would be verrrrrry gradual and anyway, even when they finally stop buying, there will still be no raising of short term rates for a long time thereafter.   In fact, this morning there seemed to be more articles discussing the concerns over falling inflation in the US, or at least falling inflation expectations, than on anything else.  And that would imply increasing the monthly purchases, not cutting them back.  What I do know is that the Fed finds itself in a very uncomfortable position.  It has followed a policy that has not directly addressed its targets (which in fairness are not directly addressable), but which has led to a significant distortion in price signals in asset markets.  And any attempt to unwind this policy is going to result in very severe market responses.  This, my friends, is why market volatility is high, and why it is likely to remain so for a while yet.  The Fed is not done in its attempts to force the market to respond as it sees fit, and that process is inherently volatile.

So what does this mean for the FX markets?  My thoughts go as follows:

1)   EUR – This remains capped by virtue of its internal flaws, which are playing out every day.  There remains no reconciliation over the need for a unified fiscal policy to complement the single currency and unified monetary policy.  Throughout history, nations in trouble like Spain, Greece, etc have always been able to devalue their currency, suffer early consequences but simultaneously realign their labor productivity with global competitors and get their economies growing again.  But this arrangement doesn’t allow for that, and so the tension of the German led core vs. the peripheral weak links is going to prevent substantive strength here.  Despite trading at 1.33, I continue to believe we will see 1.25 before 1.35.

2)   JPY – The recent strength in the yen is a consequence of the market correcting its massive move since last fall.  The Abe – Kuroda plan of doubling the money supply is still going to have the desired effect of weakening the currency.  To me, this remains a timing situation, with the Upper House election on July 21 a key date.  Once that is past, and assuming Abe gains a strong majority there, as currently forecast by the polls, the Japanese will take the next steps toward aggressive fiscal policy and double down on their monetary policy actions leading to a much weaker yen.  If you add in the idea that US rates are likely to move higher over the summer, it simply adds to the case for USDJPY to trade back above 100 before Labor Day, and still achieve my 110 target by year end.

3)   GBP – The pound has seen less activity lately for two reasons, I believe.  First, it has run into pretty strong resistance at the 1.56ish level, and needs another catalyst to take any further steps higher, and second, with so much ongoing in the euro and yen, traders’ propensity to be active in the pound, which is much less liquid than the big two, is diminished.  There is no story crying out for a significant move here, and I don’t foresee one upcoming.  While the recent trend has been higher, and the UK economy continues to perform modestly better, I expect that we are more likely to drift back toward 1.54 in the next weeks than rally further.  When Mark Carney chairs his first MPC meeting in July, we can look for some fireworks.

4)   Commodity currencies – Aussie continues to underperform on the weakness in commodity prices and the uninspiring Chinese economic picture.  Growth forecasts in China continue to be downgraded, and monetary policy there seems to be tightening, which will lead to still weaker growth.  (Last night the Chinese Finance Ministry had a 9-month bill auction with bids for less than 2/3 of the planned amount signaling there is a lack of available liquidity in the economy.)  If Chinese GDP doesn’t pick up, Aussie has further to decline.  CAD on the other hand has performed pretty well during the past month as it benefits from the better than expected US data that has been showing up.  While we have been trading between 1.00/1.04 for the past six months, it appears that we are going to test parity again, implying further modest CAD strength.

5)   EMG – For the past several years these currencies were traded en bloc as almost a single unit.  Yield seekers were willing to buy into virtually any market if the nominal returns were high, regardless of the fundamentals underlying things.  But these days, we have seen a pretty steady outflow of funds from these markets, with another $6.8 billion leaving EMG funds last week.  These currencies are having to live on their own merits, which some can do much better than others.  MXN has rebounded smartly from its weakest point on Tuesday, as has ZAR, while both BRL and INR have lagged that rebound a bit.  During periods of increased volatility like we are seeing currently, history shows that these currencies will underperform.  I see no reason for that to change.  Eventually, investment will flow back to these nations and the currencies will strengthen again, but for now, a trend toward volatile weakness seems the most likely outcome.

Good luck