Yen Roars back into favor
Last week’s currency trading review
The Dollar was mixed to stronger against most currencies except the Yen which took back all of Non Farm Payrolls gains during the week. Data was a lot weaker than expected with US retail Sales down -0.1% vs. 0.8% forecast and August UoM Consumer Confidence slumping to 63.2 vs. 68.5 forecast. The Fed Meeting was a non event with a slight improvement in economic outlook being countered by a slight extension of the Treasury buying program with the net result neutral for the Dollar. The Euro was volatile as the USD strength story falling apart given the US retail sales disappointment on the same day the German and French GDP turned positive. Stock weakness on Friday pressured the pair onto the back foot with heavy EUR/JPY selling clouding the outlook. The EUR/USD gained 0.14% closing at 1.4202, after opening the week at 1.4181.
The Japanese Yen saw nothing but strength for nearly the whole week as US data underperformed and a series of heavy losses on the Shanghai Stock Index forced the USD/JPY back to below 95. AUD/JPY was also hit hard as the markets risk barometer slid 3%. CAD/JPY lower on the commodity slump fell 4%. The USD/JPY closed down -2.78% at 94.91 after opening the week at 97.55. The GBP continued on the downside slide that began last week with risk aversion and GBP/JPY dragging the pair towards 1.6400 supports. The BOE Inflation report was bearish as forecast although the pound did find support as the pull back from 1.7000 entered oversold territory. RICS House Balance improved to -8 from -17 in July. GBP/USD fell -0.86% closing at 1.6540 after opening at 1.6683. The AUD slumped with stocks after heavy AUD/JPY selling hit the markets on Friday Night. Earlier in the day fresh Year highs were seen on the back of RBA governor Stevens speaking about the need for rate rises as soon as conditions normalize. NAB Business Confidence rose to 10 from 4 previously and Consumer Confidence rallies another 3.7% in August. The AUD/USD closed down -1.27% at 0.8325 after opening at 0.8431.
Thursday, August 20, 2009
FX Market Update - AUD softer overnight
August 14th, 2009
Given the market’s focus on Reserve Bank of Australia Governor Stevens’ comments overnight – which boosted expectations that Australian interest rates are very unlikely to fall further and may well rise before the end of this year if the economy holds up – the AUD’s relative softness (its is the second worst performing currency on the session so far overall versus the USD) looks a little odd; the AUD did make a new marginal new high for the current move up (highest spot level since September 2008) initially on the remarks but the rally stalled below 0.85 (and high/low resistance just above at 0.8515). A sharp fall in Chinese stocks has perhaps overshadowed RBA policy prospects to some degree and tempered risk-seeking plays for the moment.
While the market has started to price in sharp rate increases for Australia over the course of the next year, note that in real terms, yield spreads are not an obvious draw for any of the major currencies, with real yields currently clustered in the 1-2% range and, for the most part among the major currencies, largely moving in synch. That might not stop investors from continuing to push the AUD higher moving forward – despite today’s softness, the AUD has performed well on the week – but it is perhaps telling that the JPY has been the strongest currency on the session so far, suggesting little or no interest to bump up carry trade exposure today purely on the back of the rather hawkish RBA comments. This might just reflect short term positioning but the JPY looks in a good position to extend this week’s gains versus the USD; technically, USD/JPY is poised to put in a big weekly reversal and next week, a heavy round of US government coupon payments and bond redemptions (estimates of up to USD80 bn) suggest some flows back to Japan given larger institutional investors’ bias to reduce exposure to US Treasury debt. The Nikkei reports today that larger Japanese exporters – electronics and auto makers – are reducing their own internal assumptions for USD/JPY for the current quarter. Short JPY positions may be facing a bit of a squeeze in the next few days if the technical signals and potential redemption-related flows are any guide.
Given the market’s focus on Reserve Bank of Australia Governor Stevens’ comments overnight – which boosted expectations that Australian interest rates are very unlikely to fall further and may well rise before the end of this year if the economy holds up – the AUD’s relative softness (its is the second worst performing currency on the session so far overall versus the USD) looks a little odd; the AUD did make a new marginal new high for the current move up (highest spot level since September 2008) initially on the remarks but the rally stalled below 0.85 (and high/low resistance just above at 0.8515). A sharp fall in Chinese stocks has perhaps overshadowed RBA policy prospects to some degree and tempered risk-seeking plays for the moment.
While the market has started to price in sharp rate increases for Australia over the course of the next year, note that in real terms, yield spreads are not an obvious draw for any of the major currencies, with real yields currently clustered in the 1-2% range and, for the most part among the major currencies, largely moving in synch. That might not stop investors from continuing to push the AUD higher moving forward – despite today’s softness, the AUD has performed well on the week – but it is perhaps telling that the JPY has been the strongest currency on the session so far, suggesting little or no interest to bump up carry trade exposure today purely on the back of the rather hawkish RBA comments. This might just reflect short term positioning but the JPY looks in a good position to extend this week’s gains versus the USD; technically, USD/JPY is poised to put in a big weekly reversal and next week, a heavy round of US government coupon payments and bond redemptions (estimates of up to USD80 bn) suggest some flows back to Japan given larger institutional investors’ bias to reduce exposure to US Treasury debt. The Nikkei reports today that larger Japanese exporters – electronics and auto makers – are reducing their own internal assumptions for USD/JPY for the current quarter. Short JPY positions may be facing a bit of a squeeze in the next few days if the technical signals and potential redemption-related flows are any guide.
Wednesday, August 12, 2009
Market Event Risk - FOMC Interest Rate Decision (August): 11 August 2009
August 11th, 2009
The next instalment of the Federal Open Market Committee (FOMC) interest rate decision will be delivered on August 12. However, as has been the case in the past, with the Fed explicitly committing itself to keeping interest rates “exceptionally low” for an extended period of time, the actual interest rate announcement is unlikely to attract much attention. Instead, the focus will undoubtedly be on the tone and content of the statement. In terms of the economic and inflation outlook, analysts expect the economic assessment to perhaps offer some acknowledgement of the improvement in the economic outlook, and maybe note that the economy may be stabilising, despite the continued weakness in the labour market. The inflation outlook is likely to remain virtually intact. In terms of the Fed’s monetary policy stance, this meeting is likely to be pivotal for the FOMC, as the Fed will likely decide on whether to increase the size of its Treasury purchase program given that the allocated funds for the program will likely be exhausted before the next meeting.
Foreign Exchange: The biggest issue for the currency markets is whether the Fed pulls a surprise like the Bank of England last week and unexpectedly pumps up its asset purchases. However, that’s unlikely to be the case as the Fed has some ways to go with its Treasury purchases, and has an even longer way to go when factoring in its total asset purchase plans, so there’s no need at this point to make any changes. The second issue will be the tone of the statement, which should be a little more positive than that last as we’ve seen further improvement (or at least less deterioration) in the weeks since the last FOMC meeting. But with unchanged asset purchases being USD-supportive and a more optimistic tone being USD-negative (assuming the risk-on/USD-negative relationship continues to hold), there may not be much net USD reaction.
Fixed Income: The Fed rate decision should trump all other economic releases tomorrow, and one continues to highlight the risk of a bond bearish outcome. This is motivated by several factors. First, the bond market has sold off after the prior two Fed decisions. Second, it’s expected that the economic and credit assessment to be notably improved. Third, the Treasury purchase plan is unlikely to be extended despite recent Bank of England precedent to the contrary, and based upon the fumbling of an announcement today, there is at least a slim chance that the Treasury purchase plan could be halted altogether effective tomorrow (this is highly speculative, but worth noting since it would prompt a sharp bond selloff) The only thing tempering this view is that no exit strategy should be offered given that it has already been discussed ad nauseum in other forums. Still, the overall assessment is that Treasuries should sell off in response to this report.
The next instalment of the Federal Open Market Committee (FOMC) interest rate decision will be delivered on August 12. However, as has been the case in the past, with the Fed explicitly committing itself to keeping interest rates “exceptionally low” for an extended period of time, the actual interest rate announcement is unlikely to attract much attention. Instead, the focus will undoubtedly be on the tone and content of the statement. In terms of the economic and inflation outlook, analysts expect the economic assessment to perhaps offer some acknowledgement of the improvement in the economic outlook, and maybe note that the economy may be stabilising, despite the continued weakness in the labour market. The inflation outlook is likely to remain virtually intact. In terms of the Fed’s monetary policy stance, this meeting is likely to be pivotal for the FOMC, as the Fed will likely decide on whether to increase the size of its Treasury purchase program given that the allocated funds for the program will likely be exhausted before the next meeting.
Foreign Exchange: The biggest issue for the currency markets is whether the Fed pulls a surprise like the Bank of England last week and unexpectedly pumps up its asset purchases. However, that’s unlikely to be the case as the Fed has some ways to go with its Treasury purchases, and has an even longer way to go when factoring in its total asset purchase plans, so there’s no need at this point to make any changes. The second issue will be the tone of the statement, which should be a little more positive than that last as we’ve seen further improvement (or at least less deterioration) in the weeks since the last FOMC meeting. But with unchanged asset purchases being USD-supportive and a more optimistic tone being USD-negative (assuming the risk-on/USD-negative relationship continues to hold), there may not be much net USD reaction.
Fixed Income: The Fed rate decision should trump all other economic releases tomorrow, and one continues to highlight the risk of a bond bearish outcome. This is motivated by several factors. First, the bond market has sold off after the prior two Fed decisions. Second, it’s expected that the economic and credit assessment to be notably improved. Third, the Treasury purchase plan is unlikely to be extended despite recent Bank of England precedent to the contrary, and based upon the fumbling of an announcement today, there is at least a slim chance that the Treasury purchase plan could be halted altogether effective tomorrow (this is highly speculative, but worth noting since it would prompt a sharp bond selloff) The only thing tempering this view is that no exit strategy should be offered given that it has already been discussed ad nauseum in other forums. Still, the overall assessment is that Treasuries should sell off in response to this report.
USD/CAD Morning Comments
August 12th, 2009
Comments from Canadian officials earlier today in China have not had much impact on the CAD. Finance Minister Flaherty said that the government “has always expressed concerns with respect to rapid fluctuations” in the CAD but in discussions with Chinese officials, both parties agreed that international currency issues should “take a back seat” until the global economy was back on its feet. While that might give the impression of downplaying Canada’s recent concerns about currencies, it perhaps suggests more accurately that policy makers will continue to focus on currency issues as they relate to domestic – rather than international – considerations; China can maintain its CNY policy and Canada can still fire off the odd verbal shots at the FX markets if the CAD gets too strong. For the moment, the recent run up in the CAD appears to have turned and although the CAD has softened in the past week or so more or less as quickly as it appreciated in late July, this sort of “rapid (downward) fluctuation” is unlikely to attract the attention of local policy makers. Concerns that the global recovery could stall (Asian equities fell in overnight trade, though Europe has held up relatively well) have trimmed commodity prices a little in the past few days and that has helped trim appetite for the CAD though some still think the CAD looks fundamentally attractive (structurally sounder economy, financial system more robust) and some expect losses to remain limited in the short term and for the CAD to continue to appreciate in the medium term. Trade data may provide a little support for the CAD – the market is looking for a modest narrowing in June over the May deficit but the risk is for a very small surplus. The important short term support for USD/CAD is at 1.0990/1.1010 – below here and we should see USD/CAD drop back quite quickly – while there is a band of short, medium and long term resistance above the 1.11 level, suggesting that modest CAD losses from here should represent a decent risk/reward medium term buying opportunity.
Comments from Canadian officials earlier today in China have not had much impact on the CAD. Finance Minister Flaherty said that the government “has always expressed concerns with respect to rapid fluctuations” in the CAD but in discussions with Chinese officials, both parties agreed that international currency issues should “take a back seat” until the global economy was back on its feet. While that might give the impression of downplaying Canada’s recent concerns about currencies, it perhaps suggests more accurately that policy makers will continue to focus on currency issues as they relate to domestic – rather than international – considerations; China can maintain its CNY policy and Canada can still fire off the odd verbal shots at the FX markets if the CAD gets too strong. For the moment, the recent run up in the CAD appears to have turned and although the CAD has softened in the past week or so more or less as quickly as it appreciated in late July, this sort of “rapid (downward) fluctuation” is unlikely to attract the attention of local policy makers. Concerns that the global recovery could stall (Asian equities fell in overnight trade, though Europe has held up relatively well) have trimmed commodity prices a little in the past few days and that has helped trim appetite for the CAD though some still think the CAD looks fundamentally attractive (structurally sounder economy, financial system more robust) and some expect losses to remain limited in the short term and for the CAD to continue to appreciate in the medium term. Trade data may provide a little support for the CAD – the market is looking for a modest narrowing in June over the May deficit but the risk is for a very small surplus. The important short term support for USD/CAD is at 1.0990/1.1010 – below here and we should see USD/CAD drop back quite quickly – while there is a band of short, medium and long term resistance above the 1.11 level, suggesting that modest CAD losses from here should represent a decent risk/reward medium term buying opportunity.
Monday, June 29, 2009
LAST WEEK’S CURRENCY TRADING REVIEW
The Dollar managed to stall the recent losses against the Euro but lost more ground against riskier currencies as stock markets tested highs around the world. The break above 10000 on the Nikkei helped most Yen crosses to test fresh year highs. US retail sales were at expectations of 0.5% in May. Also June Consumer Sentiment increased to 69 vs. 68.7 previously. Oil broke above $70 a barrel for the first time this year. The Euro couldn’t muster fresh gains this week as the USD received broad support from its status as reserve currency around the world. Multiple Finance minister have offered there support both for the USD and US bonds in the past week. Industrial Production (April) dropped 1.9% vs. -1.4% previously. The EUR/USD gained 0.33% closing at 1.4016, after opening the week at 1.3970.
The Japanese Yen couldn’t break past 99 Yen but did mange new highs on the AUD/JPY and GBP/JPY as the carry trade roared back on commodity gains. Final Q1 GDP was upgraded to -3.8%. The GBP rebounded well after Political concerns faded. EUR/GBP traded at fresh year lows. Manufacturing Production gained 0.2% vs. -0.1% forecast.GBP/USD gained 2.82% closing at 1.6442 after opening at 1.5978. The AUD surged ahead as Unemployment numbers of -1.7K beat forecasts of -30k and commodities rallied. Consumer Confidence surged the most in 22 years up 12.7%. The AUD/USD closed up 2.36% at 0.8122 after opening at 0.7930.
The forex trading week preview
In the States; on Monday, TIC Flows (April) previously at 23.2BN. On Tuesday, PPI (May) forecast at 0.6% m/m. Also released, May Housing starts are forecast at 485K whilst building permits (May) is forecast at 500K. May Industrial Production is forecast at -0.9% vs. -0.5% previously. On Wednesday CPI (May) are forecast at -0.9% vs. -0.7%. On Thursday, weekly Jobless Claims are forecast at 610K vs. 601K previously. We will provide our previews and reviews of these data releases in the daily summary.
In the Eurozone; On Tuesday, German Zew Survey forecast at 35 vs. 31 previously. On Wednesday, Trade Balance is forecast at -1.5Bn in April. On Friday, German PPI (May) is forecast flat vs. -1.4% previously m/m. In the UK; On Tuesday, CPI (May) is forecast at 2.0% y/y vs. 2.3% previously. On Wednesday, BOE minutes released along with ILO Unemployment Rate (April) forecast at 7.35 vs. 7.1% previously. On Thursday, Retail Sales (May) forecast at 0.3% vs. 0.95 previously. We will provide our previews and reviews of these data releases in the daily summary.
In Japan;
On Tuesday, BOJ meet and are forecast to hold at 0.1%.On Friday, BOJ minutes form the meeting released. We will provide our previews and reviews of these data releases in the daily summary.
In Australia;
Euro – 1.3970
Initial support at 1.3793 (May 28 low) followed by 1.3728 (May 21 low). Initial resistance is now located at 1.4178 (Jun 11 high) followed by 1.4267 (Jun 5 high)
Yen – 98.15
Initial support is located at 97.09 (Jun 5 low) followed by 96.52 (Jun 2 low). Initial resistance is now at 98.89 (May 7 high) followed by 99.74 (April 13 high).
Pound – 1.6380
Initial support at 1.6242 (Jun 10 low) followed by 1.6041 (Nov 6 low). Initial resistance is now at 1.6662 (Jun 3 high) followed by 1.6739 (61.8% retrace).
Australian Dollar – 0.8075
Initial support at 0.7968 (Jun 8 low) followed by the 0.7828 (Jun 10 low). Initial resistance is now at 0.8263 (Jun 3 high) followed by 0.8378 (Sept 26 high).
Gold – 937
Initial support at 936 (May 21 low) followed by 925 (May 20 low). Initial resistance is now at 965 (Jun 5 high) followed by 983 (June 3 high).
Wednesday, June 10, 2009
Last week’s currency trading review
The Dollar continued to be sold off in a broad based fashion after key levels on multiple currencies was breached. South Korean state pension fund exacerbated the negative mood stating that it was planning to reduce exposure to US treasuries. Also hurting was talk that the next BRIC meeting of the world’s biggest commodity bloc will consider de-dollarization as part of its agenda. Q1 GDP was revised lower to -5.7% vs. -6.1%. The Euro broke above 1.4000 and held the gains well into the weekend. Risk appetite and USD weakness the main catalyst in the move higher with EUR/JPY enjoyed good gains. German IFO improved to 84.2 vs. 83.7 previously and CPI came in flat 0.0% y/y in May. The EUR/USD gained 1.15% closing at 1.4159, after opening the week at 1.3996.
The Japanese Yen was even weaker than the USD as stock market gains helped encourage investors to sell the low yielding Yen. Jumps in Long term US interest rates help to keep the pair buoyant as did fresh gains on most of the crosses with GBP/JPY touching new year highs above 150 Yen. The USD/JPY gained 0.46% closing at 95.21 after opening at 94.77. The GBP continued higher against the dollar but also made fresh lows against the Euro as the riskier currency got more support during the week. A break of 0.8500 in the EUR/GBP could provide fresh selling towards 0.8000. GBP/USD gained 1.61% closing at 1.6188 after opening at 1.5927. The AUD broke above the key psychological level of 0.8000 as the pair received support form heavy AUD/JPY gains and commodity markets continued to surge. Q1 Capex fell -8.9% vs. -6.0% forecast. The AUD/USD closed up 2.31% at 0.8010 after opening at 0.7825.
The forex trading week preview
In the States; big data week with Nonfarm Payrolls on Friday the Highlight. On Wednesday, ADP Unemployment Report forecast at -530K vs. -491k previously. Also on Wednesday, Non-manufacturing ISM forecast at 45 vs. 43.7 previously. On Friday, Non Farm Payrolls are forecast at -530K vs. -539K previously. Unemployment Rate is forecast at 9.2% vs. 8.9%. We will provide our previews and reviews of these data releases in the daily summary.
In the Eurozone; On Wednesday, EUGDP is forecast to unrevised at -2.5% in Q1. EU PPI is forecast at -0.8% m/m in April. On Thursday the ECB meet and are forecast to hold at 1.00% although the market will be listening to Trichet closely in the press conference afterwards.
In the UK; On Wednesday, PMI services are forecast at 49.4 vs. 48.7. On Thursday, BOE rate announcement widely expected to hold at 0.5%. Last meeting they did expand the QE program with negative implication for the GBP. We will provide our previews and reviews of these data releases in the daily summary.
In Japan; Q1 Capex is forecast at -27.1% vs. -17.3% previously. We will provide our previews and reviews of these data releases in the daily summary.
In Australia; RBA meeting on Tuesday forecast to hold at 3.0% and Q1 GDP forecast at 0.2% vs. -0.5% previously. We will provide our previews and reviews of these data releases in the daily summary.
TECHNICAL COMMENTARY
Euro – 1.4170
Initial support at 1.3926 (May 29 low) followed by 1.3793 (May 28 low). Initial resistance is now located at 1.4364 (Dec 29 high) followed by 1.4621 ()
Yen – 96.40
Initial support is located at 94.43 (Mar 25 low) followed by 93.52 (Mar 19 low). Initial resistance is now at 97.24 (May 28 high) followed by 98.82 (May 11 high).
Pound – 1.6455
Initial support at 1.5855 (May 28 low) followed by 1.5757 (May 22 low). Initial resistance is now at 1.6497 (June 1 high) followed by 1.6672 (Oct 30 high).
Australian Dollar – 0.8105
Initial support at 0.7803 (May 26 low) followed by the 0.7703 (May 29 low). Initial resistance is now at 0.8152 (76.4% retrace 0.8814 to 0.6009) followed by 0.8378 (Sep 26 high).
Gold – 976
Initial support at 959 (May 29 low) followed by 941 (May 26 low). Initial resistance is now at 1006 (Feb 20 high) followed by 1032 (Mar 17 high).
Tuesday, June 2, 2009
Forex Trading Articles
How Interest Rates Play a Role in the Currency Markets
Interest rates play the foremost important role in moving the prices of currencies in the Forex market. As the institutions that set interest rates, central banks are therefore the most influential factors. Interest rates dictate flows of investment. Since the currencies are representations of a country’s economy, differences in interest rates affect the relative worth of currencies in relation to one another. When central banks change interest rates they cause the Forex market to experience movement and volatility. In the realm of Forex trading, accurate speculation of central banks’ actions can enhance the trader's chances for a successful trade.
An increase in interest rates encourages traders to invest within that market and causes the demand for the currency to rise. As demand rises, the currency becomes scarcer and consequently more valuable. Investors are drawn to the currency, causing it to appreciate, because they will gain a higher yield on their investments, as in the Jane example. In order to purchase the country's assets (stocks or bonds), Jane will have to convert her domestic currency to the target country's currency also increasing demand. Conversely, a fall in interest rates discourage investors from purchasing assets in that particular economy, as the return on their investment is now smaller. The economy's currency will depreciate as a result of the weaker demand.
Thursday, May 28, 2009
Forex overview
What is Forex? Forex is an abbreviation of Foreign Exchange (also referred to as FX) and it is the largest financial market in the world.
The Forex market is the place where currencies are traded (currencies are money that is used as an exchange medium). In other words, it is the place where currencies are being sold and bought. In the Forex market all currencies are traded in real time.
Trading with currencies always means that there are two simultaneous transactions taking place. If a currency is being bought, it is also being sold. To better understand this notion, think of currencies as both the goods you are buying AND the method with which you're paying for the goods.
Since the Forex market is the place where currencies are traded in real time, people may trade one currency for another and make a profit off of this transaction. Profits are made when one is able to determine which currency's value will increase by the end of a pre-determined time period (such time periods may be short or long). The Forex market is open 24 hours a day, five days a week and it is based in four major cities: New York, London, Sydney, and Tokyo. The Forex market is open to individuals over the age of eighteen.
While Forex trading may sound daunting, it really isn’t. It can be easily comprehended and understood without prior experience in finance or economy. It is challenging and exciting, thought provoking and manageable, stimulating and filled with opportunities.
Some Forex Basics:
- The first currency listed in a currency pair is called the "base currency".
- The “base currency” is usually the U.S. Dollar. Traders will generally trade the U.S. Dollar against another currency, which is called the “counter currency”.
- Currencies are quoted in pairs. For example: The pair U.S. Dollar and JPY will be quoted in the following way: USD/JPY equals to 2.5 (This means that 1 U.S. Dollar can buy 2.5 JPY).
- When a quote increases, it means that the “base currency” has risen in value and the “counter currency” has weakened in value. For example: If the USD/JPY quote used to be equal to 2.5 but is now equal to 2.6, then this means that the dollar has strengthened (because 1 U.S. Dollar can now buy 2.6 JPY as opposed to the mere 2.5 JPY it could buy beforehand.)
FX Market Update - the pound takes the center stage to play improved risk appetite
May 27th, 2009 ·
Euro/dollar has been unable to repeat its Memorial Day weekend foray over 1.4000 as the pound has taken center stage in the risk appetite venture, over 1.6000 for the first time since early November. Traders note some downside risk to German inflation outlook, since some German regional CPI’s have come in weak, and the ECB’s Liikanen said the ECB hasn’t set an interest rate floor, Euro negative. Technicals suggest Euro upside is limited since it failed to close over 1.4000 and it’s a sell with support at 1.3830 and 1.3721. Fundamentals are Euro supportive, but perhaps not just yet, given divergence in data: 1) 1Q GDP shows investment crashing 16% but consumer spending +.5%; 2) IFO’s current conditions are low but expectations are higher, near pre-Lehman levels; 3) indicators show Q2 is likely still contracting, but a (shaky) pick-up is expected in Q3. Traders note press reports about Eurozone banks still needing assistance, compared with the UK, where the “heavy lifting” has been launched in QE and disappointing bank announcements. Sterling hence seems the way to play improved risk appetite. Reserve diversification to Euro is also diminishing as a theme, an S&P official having said diversification is a long process and Euro not ready to replace the USD as a reserve currency. Even China said the USD remains the dominant currency, and its replacement by SDR isn’t likely. Elsewhere, Sweden’s plan to borrow SEK100 bio in currency to replenish reserves hit the SEK, and EUR/SEK hit a 7 day high.
US existing home sales today rose slightly more than expected, +2.9%, risk positive after yesterday’s ginormous jump in consumer confidence, biggest gain in 6 years, signaled consumers think the worst is over and the economy will recover later this year. AUD is hence comfortably over .7800, helped by rising CRB, and USD/CAD under 1.1200 as oil is over $63 for the first time since November. WTI futures broke over the 200-day moving average, opening the way for $76. Important USD/CAD support points are under pressure still this morning even though the strong outperformance of the commodity bloc over the past few weeks (AUD up a little more than 10% against the USD while the CAD and NZD are up by just under 10% over the past month) is a little less obvious as a group on the day, with the Kiwi under performing. The CAD was unfazed by yesterday’s budget news from Ottawa and while the sharp downward revision to the budget deficit may be an embarrassment for the government, the news still leaves Canada looking relatively strong against its major currency peers in the US and Europe in particular where deficit and debt are climbing sharply. The relatively sounder government finances in Canada plus the BoC’s reluctance to embark on CE/QE policies mean there is more upside still in the CAD in the medium term. In addition, oil prices continue to climb, with crude prices above the 200-day MA for the first time since September last year. That should give the CAD additional support in the short term at least and help offset short term worries about a GM bankruptcy (which seems to be largely factored into the markets). Technically, key medium term support points are the 200-week MA at 1.1155 and 1.1104, trend/channel support drawn off of the November 2007 low); decent buying has been seen off the lows overnight but short term charts also suggest very strong resistance now at 1.1190/00. Look for the 1.11 area to remain under pressure today; below here, there is little notable support until the 1.08/1.10 area.
Wednesday, May 27, 2009
Forex Glossary
Ask (Offer) — price of the offer, the price you buy for.
Aussie — a Forex slang name for the Australian dollar.
Bank Rate — the percentage rate at which central bank of a country lends money to the country's commercial banks.
Bid — price of the demand, the price you sell for.
Broker — the market participating body which serves as the middleman between retail traders and larger commercial institutions.
Cable — a Forex traders slang word GBP/USD currency pair.
Carry Trade — in Forex, holding a position with a positive overnight interest return in hope of gaining profits, without closing the position, just for the central banks interest rates difference.
CFD — a Contract for Difference — special trading instrument that allows financial speculation on stocks, commodities and other instruments without actually buying.
Commission — broker commissions for operation handling.
CPI — consumer price index the statistical measure of inflation based upon changes of prices of a specified set of goods.
EA (Expert Advisor) — an automated script which is used by the trading platform software to manage positions and orders automatically without (or with little) manual control.
ECN Broker — a type of Forex brokerage firm that provide its clients direct access to other Forex market participants. ECN brokers don't discourage scalping, don't trade against the client, don't charge spread (low spread is defined by current market prices) but charge commissions for every order.
ECB (European Central Bank) — the main regulatory body of the European Union financial system.
Fed (Federal Reserve) — the main regulatory body of the United States of America financial system, which division — FOMC (Federal Open Market Committee) — regulates, among other things, federal interest rates.
Fibonacci Retracements — the levels with a high probability of trend break or bounce, calculated as the 23.6%, 32.8%, 50% and 61.8% of the trend range.
Flat (Square) — neutral state when all your positions are closed.
Fundamental Analysis — the analysis based only on news, economic indicators and global events.
GDP (Gross Domestic Product) — is a measure of the national income and output for the country's economy; it's one of the most important Forex indicators.
GTC (Good Till Cancelled) — order to buy or sell of a currency with a fixed price or worse. The order is alive (good) until execution or cancellation.
Hedging — maintaining a market position which secures the existing open positions in the opposite direction.
Jobber — a slang word for a trader which is aimed toward fast but small and short-term profit from an intra-day trading. Jobber rarely leaves open positions overnight.
Kiwi — a Forex slang name for the New Zealand currency — New Zealand dollar.
Leading Indicators — a composite index (year 1992 = 100%) of ten most important macroeconomic indicators that predicts future (6-9 months) economic activity.
Limit Order — order for a broker to buy the lot for fixed or lesser price or sell the lot for fixed or better price. Such price is called limit price.
Liquidity — the measure of markets which describes relationship between the trading volume and the price change.
Long — the position which is in a Buy direction. In Forex, the primary currency when bought is long and another is short.
Loss — the loss from closing long position at lower rate than opening or short position with higher rate than opening, or if the profit from a position closing was lower than broker commission on it.
Lot — definite amount of units or amount of money accepted for operations handling (usually it is a multiple of 100).
Margin — money, the investor needs to keep at broker account to execute trades. It supplies the possible losses which may occur in margin trading.
Margin Account — account which is used to hold investor's deposited money for FOREX trading.
Margin Call — demand of a broker to deposit more margin money to the margin account when the amount in it falls below certain minimum.
Market Order — order to buy or sell a lot for a current market price.
Market Price — the current price for which the currency is traded for on the market.
Momentum — the measure of the currency's ability to move in the given direction.
Moving Average (MA) — one of the most basic technical indicators. It shows the average rate calculated over a series of time periods. Exponential Moving Average (EMA), Weighted Moving Average (WMA) etc. are just the ways of weighing the rates and the periods.
Offer (Ask) — price of the offer, the price you buy for.
Open Position (Trade) — position on buying (long) or selling (short) for a currency pair.
Order — order for a broker to buy or sell the currency with a certain rate.
Pivot Point — the primary support/resistance point calculated basing on the previous trend's High, Low and Close prices.
Pip (Point) — the last digit in the rate (e.g. for EUR/USD 1 point = 0.0001).
Profit (Gain) — positive amount of money gained for closing the position.
Principal Value — the initial amount of money of the invested.
Realized Profit/Loss — gain/loss for already closed positions.
Resistance — price level for which the intensive selling can lead to price increasing (up-trend).
Scalping — a style of trading notable by many positions that are opened for extremely small and short-term profits.
Settled (Closed) Position — closed positions for which all needed transactions has been made.
Slippage — execution of order for a price different than expected (ordered), main reasons for slippage are — "fast" market, low liquidity and low broker's ability to execute orders.
Spread — difference between ask and bid prices for a currency pair.
Standard Lot — 100,000 units of the base currency of the currency pair, which you are buying or selling.
Stop-Limit Order — order to sell or buy a lot for a certain price or worse.
Stop-Loss Order — order to sell or buy a lot when the market reaches certain price. It is used to avoid extra losses when market moves in the opposite direction. Usually is a combination of stop-order and limit-order.
Support — price level for which intensive buying can lead to the price decreasing (down-trend).
Swap — overnight payment for holding your position. Since you are not physically receiving the
currency you buy, your broker should pay you the interest rate difference between the two currencies of the pair. It can be negative or positive.
Technical Analysis — the analysis based only on the technical market data (quotes) with the help of various technical indicators.
Trend — direction of market which has been established with influence of different factors.
Unrealized (Floating) Profit/Loss — a profit/loss for your non-closed positions.
Useable Margin — amount of money in the account that can be used for trading.
Used Margin — amount of money in the account already used to hold open positions open.
Volatility — a statistical measure of the number of price changes for a given currency pair in a given period of time.
VPS (Virtual Private Server) — virtual environment hosted on the dedicated server, which can be used to run the programs independent on the user's PC. Forex traders use VPS to host trading platforms and run expert advisors without unexpected interruptions.
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Forex Market - Risk Appetite Improving
The markets are in a happier place (sentiment wise) generally this morning though the huge swings of the past couple of days in FX in particular has left a lot of blood on the streets which will leave investors even less inclined to get “married” to any particular view of position than they were before. For the moment, however, higher equities and lower risk signals suggest that risk appetite is on the rise; equities have been encouraged by reports that some of the large US banks are looking to repay TARP money. In addition, positive comments from RBA Governor Stevens, suggesting the global economy may start to show signs of recovery towards the end of the year and a better than expected ZEW report from Germany earlier today helped the general mood. Reports that the UK government exploring sales of partially nationalized banks has added to the buoyancy in risk appetite and helped propel the GBP sharply higher; officials have, however, cautioned that it was too soon to speculate about sales. Meanwhile, LIBOR rates continue to fall (three-month USD LIBOR was fixed at a record low of 0.7525 today) and the “TED spread” has dipped to its lowest level since 2007.
With risk appetite improving, the USD and the JPY have slipped back since late last week. The move in the JPY has especially sharp yesterday, with positioning (market was long JPY on a number of fronts), verbal intervention from the MoF indicating discomfort with the JPY’s recent gains, and a move to align Japan’s foreign and local current debt rating yesterday (to Aa2) all combining to produce a hefty sell off. Note though that despite the huge rally in USD/JPY (as well as other cross/JPY markets), USD/JPY has done little more than test the technical breakdown point in the upper 96s; if resistance at 96.75 continues to hold, we should expect another assault on the downside (we still target a test of 89). Note, however, that Japanese GDP data is released tonight and is not expected to be pretty. Elsewhere, the USD is suffering and after the dust from last week’s moves has settled, it is apparent that many of the longer term USD-sell signals held up to a fairly stiff test. EUR/USD bounced from a more or less pinpoint retest of the 200-day MA at 1.3420 yesterday (ditto NZD/USD). Reports today that China and Brazil are discussing ways of avoiding the USD in trade transactions and news reports from Russia that the EUR share of central bank reserves had overtaken that of the USD (47.5% and 41.5% respectively) will add to the rather morose tone of the USD. Look for a renewed test of the low 1.37 area fairly quickly.
Market Outlook - May 2009
EUR/USD
The dollar hit its weakest level against a basket of currencies today, prodded lower by gains in the euro as rising share prices stoked demand for currencies to be higher risk. The euro gained against the dollar, following a half percent rise in US stock markets, as well as rhetoric that a stronger euro will not hurt the euro zone.
GBP/USD
Sterling rose to a fresh five month high against the dollar today, quickly reversing brief losses on relief that the Bank of England minutes contained no big surprise. Gilts pared losses meanwhile after the minutes revealed the BoE voted unanimously to extend the asset purchase program by 50 billion pounds earlier this month and also discussed the possibility of a 75 billion pound extension.
USD/CHF
The Swiss franc clung on to recent gains against the dollar on Wednesday as the greenback was under pressure due to investors more optimistic view on the economic outlook. The franc was little changed against the US currency after having gained around one percent over the last two days. The SNB officials said the central bank would fight a rise in the franc.
AUD/USD
The Australian dollar retreated from a 7-1/2 month high on Wednesday as weak economic data at home and abroad cooled optimism for a speedy world economic recovery, hitting demand for risky assets. The Aussie had dipped after data showed a key measure of Australian consumer confidence fell in May, hurt by last week’s debt-fuelled government budget and by worries about job losses.
The dollar hit its weakest level against a basket of currencies today, prodded lower by gains in the euro as rising share prices stoked demand for currencies to be higher risk. The euro gained against the dollar, following a half percent rise in US stock markets, as well as rhetoric that a stronger euro will not hurt the euro zone.
GBP/USD
Sterling rose to a fresh five month high against the dollar today, quickly reversing brief losses on relief that the Bank of England minutes contained no big surprise. Gilts pared losses meanwhile after the minutes revealed the BoE voted unanimously to extend the asset purchase program by 50 billion pounds earlier this month and also discussed the possibility of a 75 billion pound extension.
USD/CHF
The Swiss franc clung on to recent gains against the dollar on Wednesday as the greenback was under pressure due to investors more optimistic view on the economic outlook. The franc was little changed against the US currency after having gained around one percent over the last two days. The SNB officials said the central bank would fight a rise in the franc.
AUD/USD
The Australian dollar retreated from a 7-1/2 month high on Wednesday as weak economic data at home and abroad cooled optimism for a speedy world economic recovery, hitting demand for risky assets. The Aussie had dipped after data showed a key measure of Australian consumer confidence fell in May, hurt by last week’s debt-fuelled government budget and by worries about job losses.
USD/MXN
Mexico’s peso soared to a six month high on Tuesday and stocks climbed to their highest in over seven months, boosted by optimism about US banks and bets the global economy has already seen the worst. The peso firmed 1.35 percent while the IPC index rose 1.71 percent. The peso has soared nearly 20 percent against the dollar from a 16 year low hit on March 9th, while stocks are up almost 4 percent from March lows.
USD/JPY
Japan’s economy shrank a record 4.0 percent in the first quarter (-15.2% annualized) as domestic demand and investment buckled, threatening to crush an anticipated export led rebound in the second half. Any recovery depends on whether Japanese exporters who have begun replenished depleted inventory, see demand picking up in Western markets, and whether Tokyo’s $160 billion stimulus plan can pull consumption at home back from the brink.
USD/BRL
Brazil’s currency closed at its highest level against the dollar in more than seven months on Tuesday, boosted by growing investment inflows on optimism about a rebound in Latin America’s largest economy. The Sao Paulo stock market ended slightly lower after a choppy day’s trading, dragged down near the close by a retreat in US stocks. The real surged 2 percent to its strongest level since Oct. 2, 2008
USD/CAD
The Loonie strengthened against its US counterpart as global equity markets and commodities continued to soar. The currency pair fell from an earlier high as European stocks traded firmer on the back of better than forecasted business sentiment from Germany as well as reports that a number of US banks are planning to return TARP funds to the US government.
USD/KRW
The South Korean won steadied against the dollar on Wednesday after choppy trade as importers chased the US currency for settlements, offsetting higher local shares. Investors were also wary of potential dollar buying intervention by the foreign exchange authorities despite the finance minister shrugging off concerns about the won’s fast recent rise.
USD/CNY
The yuan ended steady against the dollar on Wednesday and is poised to trade narrowly in the near term – a prospect that pushed offshore one year volatilities to their lowest in nearly a year. The fall in volatilities indicates that the market has become more unified in expecting a stable yuan in coming months.
USD/INR
The Indian rupee dropped on Wednesday as a stronger dollar overseas and expectation of a fall in domestic shares weighed, after it had jumped 4.3 percent over three days. The rupee’s rise this week followed a comfortable victory for the ruling coalition that boosted hopes for economic reforms and boosted the stock market 17.5 percent in two days.
Forex Outlook
The USD has found a bit of life early this week, after getting completely decimated last week on fears of an eventual downgrade to its AAA credit rating. A lot of the press today and over the weekend was devoted to the USD and its outlook. This morning’s FT discussed how China stuck in a “dollar trap”, since given the size of its USD-denominated reserves it has no choice but to keep buying US assets. An
anonymous official said that the Chinese FX administration has not fundamentally changed its strategy of allocating the bulk of its reserves to US securities (although it has shifted towards buying shorter-term securities), but that it is “verynegative” on sterling, while it is neutral on the euro and bullish on the Australian dollar.
One of the most interesting aspects of last week’s USD selloff was that it came at the same time as flat/weaker equities and increasing volatility, as the dip in the VIX below 30 was short-lived, and it bounced back above 32 late last week. USD’srelationship with risk aversion was at risk itself, and it looks like the breakdown could finally be materializing. This is a development that traders will be watching
closely, since that means that weak US economic data no longer automatically leads to USD buying.
anonymous official said that the Chinese FX administration has not fundamentally changed its strategy of allocating the bulk of its reserves to US securities (although it has shifted towards buying shorter-term securities), but that it is “verynegative” on sterling, while it is neutral on the euro and bullish on the Australian dollar.
One of the most interesting aspects of last week’s USD selloff was that it came at the same time as flat/weaker equities and increasing volatility, as the dip in the VIX below 30 was short-lived, and it bounced back above 32 late last week. USD’srelationship with risk aversion was at risk itself, and it looks like the breakdown could finally be materializing. This is a development that traders will be watching
closely, since that means that weak US economic data no longer automatically leads to USD buying.
Over the weekend we heard from a couple of FOMC members, who also seemed to be concerned about the US fiscal situation, and specifically how it relates to the Fed. Vice Chairman Kohn that the central bank needs insulation from political pressure, and that point was repeated by Dallas Fed President Fisher, who was interviewed by the Wall Street Journal. Fisher said “I think the trick here is to assist the functioning of the private markets without signalling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program.” He also mentioned that during his recent trip to Asia, he was “grilled” by senior Chinese government officials on whether or not the Fed was going to monetize the massive budget deficits.
Today is an extremely quiet day with both the US and UK on holiday, but later this week the focus will probably back on the USD, with a large amount of Treasury supply, starting tomorrow. If any of this week’s three note auctions go poorly, we could certainly see another leg of USD selling.
Other things to watch for this week will be the Japanese trade and industrial production data for April, which will tell us if the improvements in March were just a blip or if the BoJ and Japanese government are correct in sounding more optimistic, and the US housing and durable goods data for April.
Tuesday, May 26, 2009
May, 2009
Archive for May, 2009
Euro Rises Despite EU Economic Malaise
May. 25th 2009
Their is no way to sugarcoat it; the EU economy is in poor shape, and is steadily worsening. In the most recent quarter, it contracted by 2.5%, most in at least 13 years. [It very well could have been the worst quarter in 50 years, but Eurozone economic data was only compiled beginning in 1996].
Germany’s economy is leading the pack (downwards), having contracted by 3.8% in the most recent quarter, and by 7% since the recession officially began. Compared to similar declines in other economies, “The 1.2% fall in France, large by any normal standards, almost counts as a boom,” quipped The Economist. It turns out that many of the EU’s headline economies were especially dependent on exports and/or housing to drive growth, both of which have been annihilated by the credit crisis. “One of the ironies of this downturn is that it was caused by global housing and credit busts, and yet the economies that have suffered most, such as Germany and Japan, sat out the credit boom.”
Still, some economists continue to wear rose-tinted glasses: “Hopes rose…that the worst could be over for Germany’s economy as a closely-watched index measuring the confidence of financial market players rose to a near three-year high in May, its seventh consecutive monthly gain.” Added Axel Weber, a member of the ECB’s governing council, “‘There is definitely hope that the euro zone economy will gradually stabilise in the later part of 2009.” A more realistic analyst responds: “That points not to a revival but rather to a slower rate of GDP decline in the present quarter (it could scarcely get worse).” To prove that economists truly create their own reality, another confidence indicator that was released on the same day fell to a six-year low.
Other analysts have found solace in EU labor markets, which remain relatively buoyant due to a lack of flexibility in hiring and firing. In fact, “Unemployment in the United States has risen to European averages, and seems likely to pass them when international data for April is calculated.” While this might be good news for workers, however, it negatively impacts GDP growth by preventing the economy from returning to a stable production base
May. 25th 2009
Their is no way to sugarcoat it; the EU economy is in poor shape, and is steadily worsening. In the most recent quarter, it contracted by 2.5%, most in at least 13 years. [It very well could have been the worst quarter in 50 years, but Eurozone economic data was only compiled beginning in 1996].
Germany’s economy is leading the pack (downwards), having contracted by 3.8% in the most recent quarter, and by 7% since the recession officially began. Compared to similar declines in other economies, “The 1.2% fall in France, large by any normal standards, almost counts as a boom,” quipped The Economist. It turns out that many of the EU’s headline economies were especially dependent on exports and/or housing to drive growth, both of which have been annihilated by the credit crisis. “One of the ironies of this downturn is that it was caused by global housing and credit busts, and yet the economies that have suffered most, such as Germany and Japan, sat out the credit boom.”
Still, some economists continue to wear rose-tinted glasses: “Hopes rose…that the worst could be over for Germany’s economy as a closely-watched index measuring the confidence of financial market players rose to a near three-year high in May, its seventh consecutive monthly gain.” Added Axel Weber, a member of the ECB’s governing council, “‘There is definitely hope that the euro zone economy will gradually stabilise in the later part of 2009.” A more realistic analyst responds: “That points not to a revival but rather to a slower rate of GDP decline in the present quarter (it could scarcely get worse).” To prove that economists truly create their own reality, another confidence indicator that was released on the same day fell to a six-year low.
Other analysts have found solace in EU labor markets, which remain relatively buoyant due to a lack of flexibility in hiring and firing. In fact, “Unemployment in the United States has risen to European averages, and seems likely to pass them when international data for April is calculated.” While this might be good news for workers, however, it negatively impacts GDP growth by preventing the economy from returning to a stable production base
The Euro, meanwhile, has never been stronger. It has risen over 10% since touching a low against the Dollar on March 10, and recently broke through an important psychological barrier of $1.40. There are couple of explanations for this “contradiction.” The first is simply an application of the risk-aversion narrative. Simply put, “the euro is generally considered a risky bet on currency markets and therefore gains at times when there is greater perceived economic stability.” Recent trends suggest that financial market stability is more important than economic stability in the eyes of investors, but the idea is the same.
The other explanation concerns inflation, or rather the lack thereof. The European Central Bank’s response to the credit crisis has been much more restrained than its counterparts, most of which are pumping money into credit markets with little concern about the future implications. Sure, the ECB has authorized a program to extend low-interest loans to member banks, and plans to purchase up to $80 Billion in corporate bonds, but these measures pale in comparison to what the Fed and BOE have announced.
The ECB has also opted not to cut rates all the way to 0%, electing instead to hold its benchmark at 1%. Jean-Claude Trichet, head of the ECB, recently underscored that the role of the ECB is primarily to guard against inflation, rather than stimulate economic growth. “We are there to deliver price stability and price stability in the medium term is a crucial element in activating confidence,” he said. While there is certainly room for the debate as to whether this is economically sensible, Euro bulls can rest assured that their currency is being actively protected.
The other explanation concerns inflation, or rather the lack thereof. The European Central Bank’s response to the credit crisis has been much more restrained than its counterparts, most of which are pumping money into credit markets with little concern about the future implications. Sure, the ECB has authorized a program to extend low-interest loans to member banks, and plans to purchase up to $80 Billion in corporate bonds, but these measures pale in comparison to what the Fed and BOE have announced.
The ECB has also opted not to cut rates all the way to 0%, electing instead to hold its benchmark at 1%. Jean-Claude Trichet, head of the ECB, recently underscored that the role of the ECB is primarily to guard against inflation, rather than stimulate economic growth. “We are there to deliver price stability and price stability in the medium term is a crucial element in activating confidence,” he said. While there is certainly room for the debate as to whether this is economically sensible, Euro bulls can rest assured that their currency is being actively protected.
US Trade Deficit Nears 10 Year Low; Good News for USD?
May. 24th 2009
Over the last year, declines in imports and commodity prices have contributed to a veritable collapse in the US trade imbalance. While the deficit increased to $27 Billion last month, the general trend is definitely still downwards.
Since the inception of the credit crisis, US imports have fallen by a record 40%, on an annualized basis. In March, “Imports decreased 1 percent to $151.2 billion, the fewest since September 2004. Demand fell for industrial supplies such as natural gas and steel and for capital goods such as engines and machinery, reflecting the slump in U.S. business investment.” Lower commodity prices have also played a role on the imports side of the equation. In fact, if not for a slight uptick in energy prices, the deficit probably would have declined further this month.
May. 24th 2009
Over the last year, declines in imports and commodity prices have contributed to a veritable collapse in the US trade imbalance. While the deficit increased to $27 Billion last month, the general trend is definitely still downwards.
Since the inception of the credit crisis, US imports have fallen by a record 40%, on an annualized basis. In March, “Imports decreased 1 percent to $151.2 billion, the fewest since September 2004. Demand fell for industrial supplies such as natural gas and steel and for capital goods such as engines and machinery, reflecting the slump in U.S. business investment.” Lower commodity prices have also played a role on the imports side of the equation. In fact, if not for a slight uptick in energy prices, the deficit probably would have declined further this month.
Exports are also falling, but at a slower pace, such than the net effect is a more positive US balance of trade. “The 2.4% monthly fall in exports in March more than reversed the 1.5% rise the month before. But even that 2.4% drop compares well with the monthly declines of 6% plus that had become the norm since last September,” explains one economist. In other words, worldwide demand (as symbolized by US exports), is stabilizing.
Economists remain divided as to whether the trade deficit will continue to decline: “The low-hanging fruit has been achieved, and it will be difficult to narrow the trade deficit by much more going forward, especially if the vicious downturn in the economy seen in the fourth quarter and first quarter has begun to abate…..Once the economy begins to return to health in earnest (mainly a 2010 story), the trade deficit will likely begin to re-widen.” But a competing view expects “drooping consumer demand to weigh on imports and keep the trade deficit on a narrowing trend in the coming months,” in which case the deficit could fall to $350 Billion by the end of the year. Compared this to the record $788 Billion deficit of 2006!
While the balance of trade doesn’t figure directly into GDP (although it confusingly is incorporated into the expenditure method), a declining trade balance is generally reflective of a healthier economy. It implies that either exports are growing relatively faster than imports, and/or consumers are diverting more of their relative spending towards domestic consumption, both of which should contribute positively to GDP. Summarizes one economist, “If the current account did move towards balance, then it would allow the U. S. economy to probably grow at a more sustainable rate in the long term.”
The idea of sustainability (not in the environmental sense, unfortunately) is also connected to the US Dollar. Generally speaking, it is the Dollar’s role as the world’s reserve currency which has enabled the US to run a trade imbalance almost continuously for the last 30 years. In other words, trade surplus economies are willing to accept Dollars because they can be stably and profitably invested in the US. In this regard, one commentator hit the nail right on the head: “When it comes to the U.S. trade gap, how many refrigerators the U.S. sells overseas is far less important than how many dollars the rest of the world wants.”
Note: Both Charts courtesy of International Business Times.
Asian Currencies Rally for Third Straight Month
May. 22nd 2009
According to a recent Reuters poll, investors are increasingly bullish on emerging market Asian currencies, including the Taiwan dollar, Indonesian rupiah, Singapore dollar, Malaysian ringgit, Philippine peso, South Korean won, and Indian rupee. The Thai Baht wasn’t covered by the poll, but given its strong performance over the last few months, it seems safe to include it in the bunch.
This uptick in sentiment is somewhat unspectacular, since “The Bloomberg-JPMorgan Asia Dollar Index, which tracks the 10 most-active regional currencies,” has now risen for almost three consecutive months [See chart below]. Leading the pack are the Taiwan Dollar and South Korean Won, which recently touched five-month and seven-month highs, respectively. “The Korean currency has climbed 28 percent since reaching an 11-year low of 1,597.45 in March.”
Investors are now pouring money back into Asia at rapid clip. “Asia ex-Japan received $933 million in the week ended May 20, the most among emerging-market stock funds, bringing the total this year to $6.9 billion.” Meanwhile, the “The MSCI Asia Pacific Index of regional stocks climbed 22 percent this quarter” while Chinese stocks are up 45% since the beginning of 2009.
But it’s unclear - doubtful is a better word - whether this rally is supported by economic fundamentals. One commentator summarized this contradiction as follows: “Improved sentiment has led to a massive resurgence in flows to emerging markets, irrespective of the underlying data, which remains weak. Investors are going out of dollars to riskier markets, riskier currencies.”
Let’s drill down into some of the data. Chinese exports fell 15% in April. Japan’s economy contracted 15% in the most recent quarter. Singapore’s exports are down 20% on an annualized basis. The South Korean economy is projected to shrink by 2% this year. The Central Bank of Thailand just cut its benchmark interest rate to an unbelievable 1%. The only bright spot economically is Taiwan, which is benefiting both from improved economic ties with China and a healthy current account surplus. I suppose everything is relative, as “developing Asian economies will grow 4.8 percent in 2009, even as the world economy contracts 1.3 percent” according to the International Monetary Fund.
The notion that the rally is not rooted in fundamentals is shared by the region’s Central Banks, which clearly realize that economic recovery will be much more difficult in the face of currency appreciation. One analyst argues that, “Until the signs of global economic recovery become more convincing, central banks will unlikely tolerate significant currency appreciation.” The Central Banks of South Korea, Taiwan, and Indonesia have already actively intervened to hold their currencies down, while Malaysia and Singapore (discussed in a Forexblog post last week) have also intervened for the sake of stability.
As a result, this rally could soon begin to lose steam. “A ‘correction’ in regional currencies is ‘appropriate’ following recent gains,” said one analyst. Another has called the rally “overdone.” Still, Central Banks and economic data pale in comparison to capital flows and risk/reward analysis. In short, these currencies (and other investments) will continue to find buyers for as long as there are those hungry for risk. Citigroup, whose “Asia-Pacific foreign-exchange volume may rise about 10 percent from the first quarter,” is bullish. A representative of the firm declared: “Fund managers are still ’sitting on lots and lots of cash’ so the pickup in volumes will continue.”
Euro Continues to Rise, but Technical Obstacles Exist
May. 20th 2009
Over the last couple months, the Euro has thoroughly outperformed the Dollar, which recently fell to a five-month low on a trade-weighted basis. Over the same period, global stock and commodity prices have also risen quickly, which is not a coincidence.
In other words, investors are allocating capital on the basis of risk, rather than in accordance with (economic) fundamentals. For example, “ICE’s Dollar Index and crude oil have a correlation of minus 0.61 in the past two months, compared with minus 0.26 since the start of the year,” as rising oil prices and the declining Dollar feed back into each other.
Meanwhile, “Implied volatility on major currencies, which reflects investors’ expectations of currency swings, fell to 13.96 percent yesterday, from…17.22 percent at the end of March. A drop in volatility tends to signal less demand for options to protect investors from currency swings.” This indicator is now at its lowest level since the days preceding the Lehman Brothers bankruptcy and subsequent stock market collapse. One would normally expect a correlation between risk and return, but in this case, rising returns have been accompanied by lower risk.
Even more unbelievable is that this decline in risk is taking place against the backdrop of declining economic fundamentals. “Risk appetite in the currency market is nothing short of impressive considering the fact that the Fed reduced their growth forecasts,” said one analyst. However, “The euro-area economy will contract 4.2 percent this year, according to the International Monetary Fund, more than the projected 2.8 percent contraction in the U.S. and 4.1 percent slump in the U.K.” If investors were focusing on this divergence in economic growth, one would expect the Euro would be falling.
One hypothesis is that inflation-conscious traders are flocking to the Euro, since the ECB remains vigilant about fighting inflation, even in the face of declining prices and aggregate demand. After cutting rates to a record low 1% earlier this month, the ECB unveiled its own version of a quantitative easing plan, involving the purchase of 60 billion euros worth of low risk securities. But this is a pittance, both relative to the size of the EU economy (it represents a mere .6% of GDP) and compared to the Trillion Dollar Fed program. This led one analyst to call the ECB’s plan “chicken feed.” While all of this is noteworthy, it’s unlikely that this is having a meaningful effect on forex markets, which still remain focused on (avoiding) deflation.
If the Euro is to continue rising, it must overcome some technical obstacles. “The euro could hit a ceiling if the recent resilience of U.S. stock markets faces headwinds. ‘At some point…stronger nongovernment growth has to show up to sustain and justify these moves in equities.’ ” It’s interesting that the fear of Euro bulls is not that the EU economy won’t recover, but rather that US stock prices are overvalued. Given recent market movements, however, their concerns are reasonable, and “any disappointment [in corporate fundamentals] could provide an excuse to take profit [this] week — benefiting the dollar.”
Meanwhile, “Implied volatility on major currencies, which reflects investors’ expectations of currency swings, fell to 13.96 percent yesterday, from…17.22 percent at the end of March. A drop in volatility tends to signal less demand for options to protect investors from currency swings.” This indicator is now at its lowest level since the days preceding the Lehman Brothers bankruptcy and subsequent stock market collapse. One would normally expect a correlation between risk and return, but in this case, rising returns have been accompanied by lower risk.
Even more unbelievable is that this decline in risk is taking place against the backdrop of declining economic fundamentals. “Risk appetite in the currency market is nothing short of impressive considering the fact that the Fed reduced their growth forecasts,” said one analyst. However, “The euro-area economy will contract 4.2 percent this year, according to the International Monetary Fund, more than the projected 2.8 percent contraction in the U.S. and 4.1 percent slump in the U.K.” If investors were focusing on this divergence in economic growth, one would expect the Euro would be falling.
One hypothesis is that inflation-conscious traders are flocking to the Euro, since the ECB remains vigilant about fighting inflation, even in the face of declining prices and aggregate demand. After cutting rates to a record low 1% earlier this month, the ECB unveiled its own version of a quantitative easing plan, involving the purchase of 60 billion euros worth of low risk securities. But this is a pittance, both relative to the size of the EU economy (it represents a mere .6% of GDP) and compared to the Trillion Dollar Fed program. This led one analyst to call the ECB’s plan “chicken feed.” While all of this is noteworthy, it’s unlikely that this is having a meaningful effect on forex markets, which still remain focused on (avoiding) deflation.
If the Euro is to continue rising, it must overcome some technical obstacles. “The euro could hit a ceiling if the recent resilience of U.S. stock markets faces headwinds. ‘At some point…stronger nongovernment growth has to show up to sustain and justify these moves in equities.’ ” It’s interesting that the fear of Euro bulls is not that the EU economy won’t recover, but rather that US stock prices are overvalued. Given recent market movements, however, their concerns are reasonable, and “any disappointment [in corporate fundamentals] could provide an excuse to take profit [this] week — benefiting the dollar.”
Outlook is Positive for Australia, but Less so for Australian Dollar
May. 19th 2009
The economic outlook continues to improve for Australia. Most recently, both the government and the Central Bank released five-year growth forecasts, both of which show a modest recovery in 2010. “By 2011-12, the commodity-rich economy will again be firing on all cylinders with growth of 4.5%, well above the long-term growth rate of around 3%.”
This positive development coincided with the release of similarly upbeat economic data: “Retail sales surged 2.2 percent in March from the previous month, four times as much as economists forecast. Home-loan approvals jumped 4.9 percent, the sixth consecutive gain.” Meanwhile, unemployment shrank for the first time in months, and consumer confidence is once again rising. While the economy is forecast to shrink by .75% in the current fiscal year, this compares favorably with other industrialized countries.
The sudden turnaround can be attributed to a couple factors. First of all, the pickup in China’s economy is stimulating demand for natural resources, which had been slack for the last year. If not for simultaneously falling commodity prices, Australia might have even achieved positive economic growth for the year.
The government’s stimulus plan and spending initiatives have also played a role, although the extent cannot be measured accurately for a few months. “The government claims that measures in its budget will inject a further A$8.8 billion into the economy in 2009-10, adding to around A$50 billion in fiscal measures already announced since October 2008.”
The outlook for the Australian Dollar, meanwhile, is not so rosy. The 425 basis points in cumulative rate cuts that the Royal Bank of Australia (RBA) effected over the last year have lowered the interest rate differential with other industrialized countries. While the RBA has indicated that it will pause before cutting rates further, interest rate futures reflect the expectation that rates will be lower twelve months from now. “Economists say the RBA is open to cutting interest rates again if consumer and business confidence appear threatened, but for now it is content to let monetary and fiscal stimulus measures take hold.”
To be sure, the uptick in risk tolerance has been good for the Australian Dollar, igniting a 25% rise since March. The currency now stands at a 7-month high against the US Dollar. But the increasingly modest differential is now causing some analysts to question whether it is a reasonable risk to take, especially against the backdrop of volatility and a high correlation with global stock prices. “What’s the point of picking up a 3 percent interest-rate differential by being long Aussie and short Japan in a world where the exchange rate can move by that much in two days?” Asks One analyst rhetorically.
This same analyst is actually recommending investors to use the Australian Dollar as a funding currency, and go long on higher-yielding currencies, such as the Brazilian Real. This particular trade would have netted a respectable 5.9% return in 2009. How quickly the roles have reversed!
Deflation: Worst-Case Scenario or Already Here?
May. 18th 2009
In following up on last week’s post (”Inflation or Stimulus: An In-depth Look At the Fed’s Response to the Credit Crisis“) on the possibility of inflation, I want to focus today’s post on the opposite phenomenon: deflation.
As evidenced by the huge expansion of government borrowing and Fed Quantitative easing, it is deflation which is currently the paramount concern of policymakers. While falling prices would seem to represent an ideal solution to the current economic downturn, deflation is actually quite pernicious if left unchecked. To elaborate: “When prices fall across the board, businesses and consumers postpone purchases because they expect lower prices later, or worry their incomes will decline or don’t want to acquire assets that will fall in value. Shrinking demand forces sellers to cut prices further, triggering a vicious cycle.” Deflation is also detrimental to consumers with liabilities, which remain the same even as incomes are falling.
Now that we understand what deflation looks like, let’s examine its likelihood. In fact, the current economic environment represents a perfect breeding ground for deflation. For example, both consumers and businesses are using stimulus and bailout checks to pay down debt, rather to increase spending. In addition, businesses are selling out of inventory rather than ramping up production, due to uncertainty for the future. Bond yields are rising, making it more expensive - and hence less likely - for companies to borrow and invest.
And what about the data? The Retail Price Index, “RPI - which turned negative for the first time in almost 50 years in March - is expected to fall from minus 0.4% to minus 1% in April.” The Consumer Price Index, meanwhile, “declined by 0.7 percent year-over-year in April, the largest 12-month drop since 1955.” It’s hard to take this data seriously, however, given the “seasonal adjustments” and “stripping of so-called volatile energy prices, and using the dubious ” ‘owners equivalent rent,’ OER, to measure consumer housing expenses” in order to conceal the actual decline in property values. In short, the actual decline is probably much worse, especiall given the steep drop in commodities from 2008. At least Fed Chairman Ben Bernanke is satisfied, and was most recently quoted for his belief that “the risks of deflation were receding.” Bernanke remains committed to pumping money into the economy via its purchases of government bonds. It still has a ways to go in making good on its promise to buy more than $1 Trillion in securities.
While it’s easy to blame the Fed, it’s also hard not to begrudge it some sympathy for having to toe a very thin line between deflation and hyperinflation. In the event that its successful in forestalling a decline in prices, it will have just enough time to catch its breath before drawing all of the new money out of the economy so as to prevent inflation from taking hold and another bubble from forming in asset prices.
Carry Trade Lifts Hungarian Forint
May. 17th 2009
The rally in emerging markets and accompanying revival of the carry trade can be seen clearly in the Hungarian Forint, which can now claim the distinction of being the world’s best performing currency. You’re probably scratching your head and/or rolling your eyes, but bear with me.
Beginning last July, shortly before the peak of the credit crisis, the Forint began to fall rapidly. It quickly lost more than half of its value against the Dollar, but then again so did a bunch of other currencies. The more relevant comparison is with the Euro, against which the Hungarian currency also fared quite poorly. Despite a 13% rally over the last two months, the Forint is still down 27% from its high last summer.
May. 17th 2009
The rally in emerging markets and accompanying revival of the carry trade can be seen clearly in the Hungarian Forint, which can now claim the distinction of being the world’s best performing currency. You’re probably scratching your head and/or rolling your eyes, but bear with me.
Beginning last July, shortly before the peak of the credit crisis, the Forint began to fall rapidly. It quickly lost more than half of its value against the Dollar, but then again so did a bunch of other currencies. The more relevant comparison is with the Euro, against which the Hungarian currency also fared quite poorly. Despite a 13% rally over the last two months, the Forint is still down 27% from its high last summer.
This is understandable, since Hungarian economic fundamenals are commensurately poor. “Household consumption is shrinking due to a drop in wages and narrower borrowing opportunities, while investments are hit by a lack of funds and a global economic downturn.” Factor in an 18.7% annualized decline in exports, and the result is a 6.4% decline in GDP for the most recent quarter.
Hungary’s economic woes have not gone unnoticed. “The International Monetary Fund, the EU and the World Bank have pledged 20 billion euros ($27 billion) of emergency loans to support Hungary, the biggest aid package for a European nation alongside Romania.” While financial markets have stabilized, credit default swap rates indicate investors are still concerned about the possibility of default. Meanwhile, Hungary has now been officially rejected (for the second time) by the European Monetary Union, such that its doubtful that Forint will ever be absorbed into the Euro.
Why, then, is the Forint rallying? The answer is simple: high interest rates. The benchmark Hungarian interest rate is a lofty 9.5%. While other Central Banks have been busy lowering rates to try to boost economic growth, “The Monetary Council of the central bank voted unanimously on April 20 to keep rates on hold at 9.50 percent.” Given the precarious financial situation, its economic policymakers are concerned that a drop in interest rates could precipitate capital flight and a currency crisis.
An exasperated Deputy Central Bank Governor explained to reporters, “As long as Hungary is considered such a vulnerable country, our interest rates cannot be lower than South Africa’s or Turkey’s; it’s not the Czech Republic, Slovakia or Poland you should compare us to.” She has clearly been paying monitoring the forex markets and knows that now is not the time to gamble with investors’ sudden return to Hungary.
Analysts remain divided over whether the upward trend in the Forint is sustainable. For its part, “Deutsche Bank recommends investors sell the euro against the forint on bets the rate difference will help the Hungarian currency gain 10 percent to 260 per euro in two to three months from 286.55 today.” However, it will be difficult for the economy to stage a serious economy for as long as the currency is rallying, which is why a survey of analysts revealed a median forecast of a medium-term decline in the Forint.
The Sucker’s Rally and the Dollar
May. 14th 2009
“The Dow Jones Industrial Average has bounced an astounding 30% from its March 9 low of 6547. Is this the dawn of a new era? Are we off to the races again?” Asks Andy Kessler provocatively in a recent Op-Ed for the Wall Street Journal.
This is an important question not only for stock market investors, but also for forex traders. By no coincidence, the stock market rally has coincided with a steady decline in the Dollar, which recently broke through a key level of resistance and touched a four-month low against a basket of currencies, and is similarly nearing a four-month low against its chief rival, the Euro. ”
Experts” point to a decline in risk aversion as the chief driver of the rally; when investors become more comfortable with risk, they buy stocks, which in turn causes investors to become even more complacent with risk. Hence, a 30% rally only six months after stocks recorded their worst day and worst week ever.
In this case, however, the experts are not in complete agreement. Economic fundamentals, for example, remain relatively weak, and corporate profits are still anemic. Andy Kessler blames the Fed for distorting “asset allocation formulas” by dropping yields to zero and for its quantitative easing program, which “gets money into the economy the fastest — basically by cranking the handle of the printing press and flooding the market with dollars (in reality, with additional bank credit). Since these dollars are not going into home building, coal-fired electric plants or auto factories, they end up in the stock market.”
Sure enough, trading data suggests that in fact this rally is being driven by retail investors, as opposed to institutions. Says Lou Ritholz, ” ‘The ‘dumb’ retail money is leading the gains. ‘In this type of environment, the market is guilty until proven innocent. We have to assume this remains a bear market until we see a more normalized economy.’ ” In short, it looks like analysts have confused the chicken with egg, by emphasizing the decline in risk aversion, rather than the self-fulfilling nature of the rally.
If the rally does end, it will almost certainly be good news for the Dollar, at least in the short-term. There has emerged a strong correlation between global stock prices and emerging market currencies, for example, which virtually ensures an outflow of capital from emerging markets. One professional idiot- err investor- Jim Rogers has prognosticated an end both to the stock market rally and the Dollar rally. Credit Rogers for his long-term thinking, but he seems to have impugned a direct relationship, when recent trends suggest it is actually inverse.
I agree with Kessler, and abide by the same maxim “Only a fool predicts the stock market…” My point here is not to convince you that the market rally is unsustainable, but rather to emphasize the importance of knowing where you stand. I’m personally quite bearish on the Dollar in the long-term (food for a future post), but a damper in the stock rally would almost certainly be positive for the Dollar.
Central Bank Mulls Intervention to Hold Down Singapore Dollar
May. 13th 2009
While the Singapore Dollar hasn’t been punished to the same extent as its counterparts, the currency was nonetheless dealt a strong blow by the credit crisis, falling 20% in a matter of months, after peaking in 2008. For its part, the Monetary Authority of Singapore (MAS)- which functions as the Central Bank- couldn’t have been happier. The currency had fallen just enough to almost completely offset its rise during the leadup to the crisis.
Now, with a global stock market rally underway and a modest economic recovery taking shape on the horizon, the Singapore Dollar has quickly erased almost half of its slide. The Central Bank naturally, is alarmed, and is threatening to intervene. While the MAS, itself, has thus far denied such a possibility, insiders suggested that “The Monetary Authority of Singapore will buy the U.S. dollar “‘f it falls below S$1.4700, around S$1.4690…’ [which] roughly equates with the strong end of the undisclosed trade-weighted band that the MAS uses to guide the Singapore currency.” Curiously enough, the Singapore Dollar beat a retreat this week, after rising all the way to $1.45.
The Singapore Dollar is generally considered a bellweather for the currencies of neighboring countries. Singapore is seen as having a model economic policy, and the Singapore Dollar is somewhat immune from the shocks that affect other currencies because its fluctuation is controlled via a loose band by the city-state’s Monetary Authority. The exchange rate is basically used in lieu of conventional monetary policy ( i.e. adjusting interest rates), although market supply/demand plays a significant role. You can think of the MAS as performing a sort of smoothing function.
In this way, the MAS is acting similarly to the Swiss National Bank, which professes to manipulate its exchange rate in order to prevent deflation- not to increase the competitiveness of exporters. According to a top MAS official, “We keep our monetary policy [based] on the medium-term inflation outlook and taking into account growth prospects. We don’t use the currency for competitiveness because it is not sustainable to align currencies just for competitiveness.” This is somewhat plausible as the MAS intervened similarly during the last downturn, in order to forestall a systemic drop in prices.
As always, the line between maintaining price stability and increasing demand is thin, since the latter is in fact used to bring about the former. This is especially true with Singapore, whose economy is largely dependent on exports to drive growth, and hence has been hit especially hard by the downturn. “In the first quarter of 2009, calculated on an annualized basis, Singapore’s economy contracted at a record rate of 11.5 percent from a year earlier, and 19.7 percent from the previous quarter.” [See Chart] As a powerful symbol of just how bad things are, the New York Times recently reported that over 700 cargo ships are docked near and around Singapore, idling as a result of slackened trade. Maybe the MAS noticed…
The Singapore Dollar is generally considered a bellweather for the currencies of neighboring countries. Singapore is seen as having a model economic policy, and the Singapore Dollar is somewhat immune from the shocks that affect other currencies because its fluctuation is controlled via a loose band by the city-state’s Monetary Authority. The exchange rate is basically used in lieu of conventional monetary policy ( i.e. adjusting interest rates), although market supply/demand plays a significant role. You can think of the MAS as performing a sort of smoothing function.
In this way, the MAS is acting similarly to the Swiss National Bank, which professes to manipulate its exchange rate in order to prevent deflation- not to increase the competitiveness of exporters. According to a top MAS official, “We keep our monetary policy [based] on the medium-term inflation outlook and taking into account growth prospects. We don’t use the currency for competitiveness because it is not sustainable to align currencies just for competitiveness.” This is somewhat plausible as the MAS intervened similarly during the last downturn, in order to forestall a systemic drop in prices.
As always, the line between maintaining price stability and increasing demand is thin, since the latter is in fact used to bring about the former. This is especially true with Singapore, whose economy is largely dependent on exports to drive growth, and hence has been hit especially hard by the downturn. “In the first quarter of 2009, calculated on an annualized basis, Singapore’s economy contracted at a record rate of 11.5 percent from a year earlier, and 19.7 percent from the previous quarter.” [See Chart] As a powerful symbol of just how bad things are, the New York Times recently reported that over 700 cargo ships are docked near and around Singapore, idling as a result of slackened trade. Maybe the MAS noticed…
Inflation or Stimulus: An In-depth Look At the Fed’s Response to the Credit Crisis
May. 12th 2009
These days, The Federal Reserve Bank seems to have very few supporters. A recent poll showed that “Twenty-six percent of Americans said they were ‘a lot less’ confident in the Fed…now than five years ago.” Some people think the Fed is doing too much in responding to the economic downturn, others accuse it of doing too little, and everyone agrees the Fed is culpable for lax regulatory efforts under Alan Greenspan. One of the biggest criticisms being levied at the Fed is that its current policies are sure to generate massive inflation in the medium-term, as a result of the massive liquidity being pumped into the financial system now. In this post, I will attempt to provide some clarity on this aspect.
Sure enough, the US monetary base (represented by M1) has exploded since the inception of the credit crisis, rising more than 15% to more than $1.5 Trillion. Plus, given that there is a slight lag in the release of data, these figures don’t necessarily include the effects of the Fed’s expansion in its quantitative easing program, announced on March 18. One commentator explains that, “Of all the Fed’s moves, this ‘quantitative easing’ gets money into the economy the fastest — basically by cranking the handle of the printing press and flooding the market with dollars (in reality, with additional bank credit). Since these dollars are not going into home building, coal-fired electric plants or auto factories, they end up in the stock market.” In the short-term, then, QE has probably contributed only to asset-price inflation, rather than the more serious consumer price inflation.
What about the charge that the Fed is dangerously reaching its tentacles into every corner of the financial markets? As you can see from the chart below, there is certainly a huge degree of truth to this claim. Since January 2008, the Fed has “diversified” its portfolio away from relatively benign Treasury securities, into at least 20 different types of securities and loans. In the process, its balance sheet exploded from approximately $800 Billion to $2.2 Trillion, and could expand further as the next phase of quantitative easing is implemented.
This portfolio’s makeup is indeed becoming increasingly risky. For example, “The Federal Reserve took on more than $74 billion in subprime mortgages, depreciating commercial leases and other assets after Bear Stearns Cos. and American International Group Inc. collapsed.” Despite writing down almost $10 Billion from this portion alone, however, the Fed continues to turn consistent profits. “Last year the central bank reported a whopping $43 billion in operating income. That was more or less the same level as in 2007, but meanwhile short-term interest rates had plummeted, ending the year near zero.” The assertions of conspiracy theorists, notwithstanding, the majority of this profit was transferred to the US Treasury. [Chart courtesy of The Economist].
Fortunately, most of the (non-esoteric) securities are highly liquid, and can theoretically be sold to investors if and when it becomes appropriate to do so. “The Fed, for example, is required by law to end some when the need is no longer urgent. It charges a penalty for some programmes so that borrowers will return to private markets once these have healed.” The Commercial Paper Funding Facility (CPFF) and Term Auction Facility (TAF) programs, which together account for over $650 Billion of the Fed’s portfolio, moreover, can be quickly undone. “The maturity of the outstanding [TAF] loans is 84 days at a maximum, ” while CPPF “deals in short-term money market instruments and can also be phased out, if desired, in a short period of time.”
The $400 Billion in swap lines, on the other hand, are slightly more problematic, both because of the longer time frame and because foreign banks “are now heavily dependent on the Fed for dollars.” Then there is the Term Asset-Backed Securities Loan Facility (TALF), which is not yet operational. While this program is also designed to be temporary, “the multi-year maturities of the loans and the potential size of the program—up to $1 trillion—make the impact on the monetary base more persistent than for some of the other liquidity programs.”
In short, inflation isn’t yet on the radar screen, as economists and bankers must first combat disinflation, and perhaps even deflation. Of course, there is always the (very serious) risk that the Fed either won’t be able to, or simply won’t be diligent enough in removing this cash from the money supply when the time comes. There is also a moral hazard component of the Fed’s QE, whereby “governments could come to rely on such purchases to finance budget deficits.” In my opinion, this kind of scenario would be much more likely to engender inflation, but it would be primarily the fault of the government (as opposed to the Fed), and hence beyond the scope of this post.
The $400 Billion in swap lines, on the other hand, are slightly more problematic, both because of the longer time frame and because foreign banks “are now heavily dependent on the Fed for dollars.” Then there is the Term Asset-Backed Securities Loan Facility (TALF), which is not yet operational. While this program is also designed to be temporary, “the multi-year maturities of the loans and the potential size of the program—up to $1 trillion—make the impact on the monetary base more persistent than for some of the other liquidity programs.”
In short, inflation isn’t yet on the radar screen, as economists and bankers must first combat disinflation, and perhaps even deflation. Of course, there is always the (very serious) risk that the Fed either won’t be able to, or simply won’t be diligent enough in removing this cash from the money supply when the time comes. There is also a moral hazard component of the Fed’s QE, whereby “governments could come to rely on such purchases to finance budget deficits.” In my opinion, this kind of scenario would be much more likely to engender inflation, but it would be primarily the fault of the government (as opposed to the Fed), and hence beyond the scope of this post.
Pound Sterling Trends Downward as BOE Expands QE
May. 11th 2009
The Pound is holding its own against the USD, even touching a four-month high last week. But against other major currencies, the story is just the opposite. While managing to avoid parity against the Euro, for example, the Pound has nonetheless remained range-bound against the common currency. The Australian Dollar, meanwhile, has risen to $2 against the Pound for the first time in 13 years.
How to explain the stagnation of the Pound? It depends on which currency pair you look at. Against the Dollar, the narrative remains one of risk aversion; when stocks rise, so usually does the Pound. “The U.K. pound is joining other currencies in beating up on the dollar,” announced one analyst on a day that stocks and commodities rallied broadly. The Pound has also been able to hold its own against the Dollar because both currencies’ Central banks have embarked on similar quantitative easing plans, which could prove equally inflationary in the long run. [Chart courtesy of Economist].
In fact, the Bank of England just announced a huge expansion in its program, increasing total debt buying (i.e. money printing) by $50 Billion. One analyst summarized the impact of this announcement on forex markets as follows: “The Bank of England’s aggressive stance with regard to quantitative easing is adding to concern about the economy and that is negative for sterling.” Not much nuance there….
In fact, this is especially bad for the Pound against the Euro, where a juxtaposition of the Central Banks’ respective approaches to the credit crisis reveals stark differences: “The weakness in the pound suggests the market is drawing a contrast between the ECB, which seems to be dragging its legs on quantitative easing, and the BOE, which is still ‘full-steam ahead.’ ” Where the ECB is providing liquidity indirectly in the form of swaps and guarantees, the BOE is printing money and injecting it right into capital markets.
“Mervyn King, governor of the Bank of England, has said the exit strategy will be dictated by the outlook for inflation and that central banks should not support markets that cannot survive on their own,” but investors remain skeptical and for good reason. “Britain will sell a record 220 billion pounds of gilts this fiscal year, 50 percent more than last year.” Based on the fact that yields have risen for four straight weeks (against the backdrop of the first “failed” auction ever for UK government bonds), there is doubt that the government can finance its deficits.
The BOE continues to be roundly smacked with criticism, for its role in fomenting the credit crisis and in not adequately responding to it: “It happens that in the early years of inflation targeting, it did produce a stable economy. But I think it’s now clear that it can’t, by itself, produce a stable economy,” argued one commentator. Unemployment rates in the UK remain at frighteningly high levels. The government’s own economists (which are more optimistic than third-party forecasts) forecast GDP at -3.5% for 2009, with a modest recovery in 2010. Of course, these forecasts should be taken with a grain of salt, as they hinge on the crucial assumption that the BOE’s interest rate cuts and quantitative easing plan will soon trickle down through the economy, proof of which has still not been observed.
As a result, I’m personally between neutral and bearish for the UK Pound. For as long as stocks continue to rally, investors will remain Adistracted. If and when the rally loses steam (I am skeptical that the rally is sustainable), they will quickly turn their attention to comparative economic and monetary conditions; suffice it to say that Pound won’t stack up well.
WisdomTree Unveils New Multi-Currency ETF
May. 9th 2009
On Wednesday, the latest addition the Wisdom Tree family of currency ETFs officially debuted, and in its first two days of trading, the Emerging Currency Fund (CEW) returned an impressive 2.2%. It’s not worth annualizing this figure, but suffice it to say that its performance is already turning heads.
According to the prospectus, CEW “is an actively managed exchange-traded fund that seeks to provide the investor with a liquid, broad-based exposure to money market rates and currency movements within emerging market countries.” Investors will gain exposure both to the currencies themselves and to their respective short-term interest rates, via “short-term U.S. money market securities and forward currency contracts and swaps of the constituent currencies…designed to create a position economically similar to a money market security denominated in each of the selected currencies.”
Chosen from three regions (Latin America, Africa/Europe/Middle East, and Asia), the inaugural 11 currencies are as follows: Brazilian real, Chinese yuan, Chilean peso, Indian rupee, Israeli shekel, Mexican peso, Polish zloty, South African rand, South Korean won, Taiwanese dollar and Turkish new lira. According to WisdomTree, these currencies were selected not necessarily for economic reasons, but rather because of their relatively high liquidity and low correlation with each other. In addition, “The selected currencies are equally weighted in terms of dollar value at each currency assessment date and after each quarterly re-balancing,” to reflect fluctuations in exchange rates. Naturally, WisdomTree reserves the right to rejigger the portfolio in terms of constituent makeup, but this would probably only be effected to improve overall liquidity, rather to replace an under-performing currency.
The advantage of CEW lies in its automatic diversification, such that investors gain access to a variety of currencies but only have to transact in the fund itself. WisdomTree also points out that, “Emerging market currencies often move independently of domestic stock, bond and money market investments…[and] exhibit low correlations to other alternative asset classes, such as commodities and gold.” The chart below [courtesy of CEW promotional materials] makes this point indirectly, and it probably comes as a surprise that US stocks are collectively more volatile than individual emerging market currencies. “Incorporating a 10% allocation of emerging currency into balanced portfolio mixes of the domestic stocks and domestic bonds over the last ten years…raised annual returns by an average of 0.66%, while lowering overall portfolio volatility” in a hypothetical exercise.
“In terms of taxation, WisdomTree says normal capital gains rules will apply to the sales of fund shares. However, income from the portion of the fund invested in U.S. money market securities usually will be taxed as ordinary income, while the tax treatment of the local currency forward contracts could vary with the situation.” The fund’s expense ratio, meanwhile, is .55%.
If the preceding paragraphs read like a sales pitch, I apologize, as that was not my intention. At the same time, I’m personally quite positive about CEW (as well as ETFS in general, for that matter), since it provides quick and easy exposure to a bunch of quality currencies, eliminating the need to buy them separately. Not to mention that this fund is debuting right when both the carry trade and emerging markets (and their currencies) are coming back in vogue.
I’m not sure if the timing was deliberate, but it could certainly have been worse. It’s tough to say whether the market rally of the last two months is sustainable, but if the decline in risk aversion that ignited the rally continues to obtain, it will be good for CEW.
Swiss National Bank Renews Threat of Intervention
May. 7th 2009
When the Swiss National Bank (SNB) announced oln March 12 that it would intervene in forex markets for the first time since 1994, the Franc immediately plummeted up to 5% against select currencies. Since then, the currency has largely clawed back some of its losses, prompting talk of round two: “Speculation about an imminent intervention in the foreign-exchange markets was rife…after the euro fell to CHF1.5031, the lowest level seen since March 12 when the SNB began selling Swiss francs against euros.”
If the preceding paragraphs read like a sales pitch, I apologize, as that was not my intention. At the same time, I’m personally quite positive about CEW (as well as ETFS in general, for that matter), since it provides quick and easy exposure to a bunch of quality currencies, eliminating the need to buy them separately. Not to mention that this fund is debuting right when both the carry trade and emerging markets (and their currencies) are coming back in vogue.
I’m not sure if the timing was deliberate, but it could certainly have been worse. It’s tough to say whether the market rally of the last two months is sustainable, but if the decline in risk aversion that ignited the rally continues to obtain, it will be good for CEW.
Swiss National Bank Renews Threat of Intervention
May. 7th 2009
When the Swiss National Bank (SNB) announced oln March 12 that it would intervene in forex markets for the first time since 1994, the Franc immediately plummeted up to 5% against select currencies. Since then, the currency has largely clawed back some of its losses, prompting talk of round two: “Speculation about an imminent intervention in the foreign-exchange markets was rife…after the euro fell to CHF1.5031, the lowest level seen since March 12 when the SNB began selling Swiss francs against euros.”
It was unclear whether the Central Bank had chosen a magic threshold, such that a rise by the Franc above which would trigger a sale of Francs in the open market. Earlier in the week, one analyst asserted, “With the euro/franc exchange rate almost at pre-intervention levels - the euro jumped to a level above CHF1.52 after the SNB intervention in March from CHF1.4843 before the announcement - the stage is set for the SNB to either put up or shut up.”
Sure enough, both the Chairman of the SNB as well as a board member both announced yesterday that the campaign to hold down the the Franc is still in effect, and will soon enter a new phase. Thus far, the Bank has relied on various forms of quantitative easing to deflate its currency, both through direct currency transactions and purchases of bonds. The goal of such quantitative easing is only proximately to deflate the Franc; the ultimate goal is to ward off deflation. Given that the Bank had already lowered its benchmark interest rate close to zero, manipulating its currency was/is one of its few remaining options. “As long as the environment does not improve and as long as deflation risks are visible in our monetary policy concept, we will stick to this insurance strategy resolutely,” said Chairman Jean-Pierre Roth.
As the economic recession takes hold, the Swiss economy is forecast to contract 3% in 2009, but to grow in 2010. Consumer sentiment has fallen to the lowest level since 2003. Inflation, meanwhile is projected at -0.5%; deflation, in other words. Still, Switzerland maintains that its motivation is not to boost the economy, but only to increase monetary stability. National Bank governing board member Thomas Jordan “reiterated the interventions have nothing to do with a beggar-thy-neighbor policy, a strategy to weaken a country’s currency to improve the situation for domestic exporters.”
Given that forex intervention is usually doomed to failure, the SNB must rely on a combination of luck and improved fundamentals to keep the Franc down. Thus, when the next round of intervention was announced yesterday, the Franc fell by a modest .75% against the Euro, as investors largely shrugged of the news. Fortunately, the initial pledge to intervene coincided with a pickup in investor sentiment, and decline in risk aversion. This has reduced demand for the Swiss Franc, which had previously been bid up as a so-called “safe haven” currency. As long as the stock market rally continues, investors will stick to higher-yielding currencies and the Franc should be “safe.”
Australian, New Zealand Currencies Benefit from Risk Aversion
May. 6th 2009
Against each other, the New Zealand Kiwi and Australian Dollar have traded in a pretty tight range for the last year (except for a “blip” in the fall of 2008). This makes sense, as both currencies rise and fall in accordance with exports and interest rates.
Against other currencies, meanwhile, both have torn upwards in the last couple months. Despite steep interest rate cuts, both currencies have maintained their interest rate advantages against other industrialized currencies. This has not gone unnoticed, and the return of the carry trade has been kind. “The current improvement in sentiment is providing an underpinning of support and while that remains the case - and that may be until midyear - the New Zealand dollar is going to remain well-supported,” said one economist.
The correlation between the New Zealand Kiwi, specifically, with the US stock market has become remarkably cut-and-dried of late, which you can see from the chart below. For carry traders, therefore, it probably makes more sense to follow stock market commentary than to track New Zealand economic data. The same economist, for example, warned “that the equities rally, which has seen the broad U.S. Standard & Poor’s 500 index climb 36% from its March low after rising another 3.4% Monday to its highest since Jan. 8, may be dissipating.
The correlation between the New Zealand Kiwi, specifically, with the US stock market has become remarkably cut-and-dried of late, which you can see from the chart below. For carry traders, therefore, it probably makes more sense to follow stock market commentary than to track New Zealand economic data. The same economist, for example, warned “that the equities rally, which has seen the broad U.S. Standard & Poor’s 500 index climb 36% from its March low after rising another 3.4% Monday to its highest since Jan. 8, may be dissipating.
”Besides, given the deteriorating economics in both countries, lower interest rates are probably inevitable: “We think this case for further cuts will be made in the second half of this year…we think it will be very difficult, no matter what the global economy is doing, for the RBA to ignore rapidly rising unemployment,” offered one analyst who predicted that rates would be cut to a “trough of 2%.” In such a scenario, the interest rate spread would still remain healthy, but perhaps not enough to offset the additional risk.Australian home prices are falling at a rapid clip, the labor market is sagging. In New Zealand, meanwhile, a decline in sentiment and consumer spending has corresponded with a 1% contraction in GDP in the quarter ended March 31. Tourism is down, although net exports are increasing. The current account deficit continues to expand, but this is mostly a product of an investment balance - perhaps related to the carry trade.
For now, forex traders remain optimistic, albeit slightly less so than before: “The difference in the number of wagers by hedge funds and other large speculators on an advance in the Australian dollar compared with those on a drop — so-called net longs — was 16,692 on April 28, compared with net longs of 17,250 a week earlier.”
Despite “Reality,” Fed Optimistic about the Economy
May. 5th 2009
Last week, the Fed opted to maintain its benchmark Federal Funds Rate close to zero, and indicated in its press release that it “anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” [Chart courtesy of CNN].
Nonetheless, the Fed made a point of emphasizing that the economy seems to be stabilizing: “Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower.” I suppose everything is relative, but it’s a bit perplexing as to where the Fed is getting its data from, given that “Gross domestic product, the broadest measure of economic activity, fell at an annual rate of 6.1% in the first quarter of 2009 after a 6.3% drop in the last three months of 2008.” This exceeded analysts’ expectations for a 4.7% decline, and if anything, would seem to suggest that the economy is worsening. Granted, consumer spending rose slightly and inventories declined, but the aggregate picture paints an unequivocal picture of an economy in deep recession.
Bernanke, apparently, is unconvinced. ” ‘We continue to expect economic activity to bottom out, then to turn up later this year,’ Mr. Bernanke told the congressional Joint Economic Committee.” Meanwhile, the unemployment rate is currently 8.5% and falling. Business investment is still abysmal, as companies implement hiring freezes and hold off on all non-essential capital purchases.
Bernanke is especially optimistic about the state of the US financial system, noting that “conditions in credit markets have revived slightly in recent weeks. Homeowners are refinancing mortgages at a rapid clip, and financial institutions have stepped up their sale of securities backed by of credit card loans, automobile debt and student loans.” However, mortgage refinancing is a red herring, and frees up very little cash for consumption. Meanwhile, debt securitization is well below 2007 levels, and some experts predict that credit card loans represent the next catastrophe. “Fitch’s Prime Credit Card Delinquency Index measures credit card debt more than 60 days late. Through January 2009 that index surged to a record 4.04 percent.”
Bernanke also hinted that the results from the bank stress-tests, scheduled to be released today, are largely positive. As part of this program, “The government plans to divide banks into three categories, based on the adequacy of their capital reserves to absorb projected losses,” if the recession were to worsen. If Bernanke’s assertions are to be believed, then the tests will show that their capital reserves are sufficient, and they will not need additional capital infusions.
Bernanke’s testimony and the Fed Statement have been greeted positively by investors, “contributed to improving sentiment and boosted risk appetite, easing demand for then yen and greenback as safehavens.” Nonetheless, everything he says should be taken with a grain of salt. Even with the best rose-tinted glasses money can buy, it’s hard to draw such optimistic conclusions from an objective interpretation of the data. Either Bernanke is basing his assessment off of the stock market rally (which is circularly based on such economic optimism), or he is trying to deliberately distort reality in order to try to make a recovery self-fulfilling by disingenuously telling people that everything is okay. Personally, I don’t think he’s worth taking seriously.
Bernanke, apparently, is unconvinced. ” ‘We continue to expect economic activity to bottom out, then to turn up later this year,’ Mr. Bernanke told the congressional Joint Economic Committee.” Meanwhile, the unemployment rate is currently 8.5% and falling. Business investment is still abysmal, as companies implement hiring freezes and hold off on all non-essential capital purchases.
Bernanke is especially optimistic about the state of the US financial system, noting that “conditions in credit markets have revived slightly in recent weeks. Homeowners are refinancing mortgages at a rapid clip, and financial institutions have stepped up their sale of securities backed by of credit card loans, automobile debt and student loans.” However, mortgage refinancing is a red herring, and frees up very little cash for consumption. Meanwhile, debt securitization is well below 2007 levels, and some experts predict that credit card loans represent the next catastrophe. “Fitch’s Prime Credit Card Delinquency Index measures credit card debt more than 60 days late. Through January 2009 that index surged to a record 4.04 percent.”
Bernanke also hinted that the results from the bank stress-tests, scheduled to be released today, are largely positive. As part of this program, “The government plans to divide banks into three categories, based on the adequacy of their capital reserves to absorb projected losses,” if the recession were to worsen. If Bernanke’s assertions are to be believed, then the tests will show that their capital reserves are sufficient, and they will not need additional capital infusions.
Bernanke’s testimony and the Fed Statement have been greeted positively by investors, “contributed to improving sentiment and boosted risk appetite, easing demand for then yen and greenback as safehavens.” Nonetheless, everything he says should be taken with a grain of salt. Even with the best rose-tinted glasses money can buy, it’s hard to draw such optimistic conclusions from an objective interpretation of the data. Either Bernanke is basing his assessment off of the stock market rally (which is circularly based on such economic optimism), or he is trying to deliberately distort reality in order to try to make a recovery self-fulfilling by disingenuously telling people that everything is okay. Personally, I don’t think he’s worth taking seriously.
Spike in Treasury Yields is Good News for US Dollar Bulls
May. 4th 2009
By no coincidence, the Dollar’s best day in April was a mirror image of its worst day in March. Recall what happened when the Fed initially announced its quantitative easing program: “The dollar plunged a record 3.4 percent against the euro on March 18 as traders speculated the Fed’s purchase Treasuries would debase the currency.” On April 29, meanwhile, “The dollar rose the most against the yen this month after the Federal Reserve refrained from increasing purchases of Treasuries and mortgage securities.”
The implication is that as risk aversion has dropped, investors have turned their gaze towards interest rates. Previously, this phenomenon would have worked against the Dollar, as both short-term and long-term interest rates are generally lower in the the US than they are abroad. On the short end of the curve, this is a product of a low Federal Funds Rate, as guided by the Fed. On the long end, this is a function of high demand for US Treasury securities, which keeps prices high and rates proportionately low.
However, this trend is very quickly reversing itself. Aside from a few hiccups (including a big one on March 18!), Treasury yields have risen continuously since touching an all-time low in January. Since then, the yield on the 10-year note, for example, has risen from 2.2% to nearly 3.2%. The impetus for higher rates is coming both from a decline in risk aversion (which is leading investors to seek alternatives to Treasuries) as well as a concern that the Fed will not be as active in buying US bonds as it had initially intimated.
A decline in demand for Treasury securities is making some investors understandably nervous that the government will not be able to fund its deficits (projected at 10% of GDP in 2009). Writes one columnist, “We cannot take it for granted that the global bond markets will prove deep enough to fund the $6 trillion or so needed for the Obama fiscal package, US-European bank bailouts, and ballooning deficits almost everywhere.” The fear is that the government will turn to the Fed, which will stoke inflation by printing money, and induce a devaluation of the Dollar.
If the Fed limits its purchase of Treasuries, by extension, not only will this limit inflation, but also it will lead to higher interest rates on US government bonds, which should help prop up investor demand. One currency strategist observed that “The dollar-yen is very closely correlated with the back end of the yield spread.” In other words, as US long-term yields rise, so may the Dollar.
If the Fed limits its purchase of Treasuries, by extension, not only will this limit inflation, but also it will lead to higher interest rates on US government bonds, which should help prop up investor demand. One currency strategist observed that “The dollar-yen is very closely correlated with the back end of the yield spread.” In other words, as US long-term yields rise, so may the Dollar.
Of course, the key is to strike a balance between too much demand and not enough. If investors got really spooked by the fact that “The Congressional Budget Office expects interest payments to more than quadruple in the next decade as Washington borrows and spends, to $806 billion by 2019 from $172 billion next year,” then it could lead to a skyrocketing of interest rates as investors beat a mass retreat away from Treasuries, which would certainly entail a devaluation of the Dollar. To apply Alan Greenspan’s famous analogy, has anyone coined the term “Goldilocks Treasury Yields” yet?
South Africa Hikes Rates, but Interest Rate Differential is Preserved
May. 1st 2009
Yesterday, the South African Reserve Bank (SARB) lowered its benchmark interest rate by 100 basis points to 8.5%. Since December, the Central Bank has now cut rates by 3.5%, from a high of 12%. [As an aside, the SARB uses a repo rate to conduct policy, as opposed to a discount rate. In theory, a repo rate is slightly unique in that it reflects the rate at which the Central Bank will repurchase government securities from commercial banks. The Federal Funds Rate, in contrast, "is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions." In practice, both rates function as modulators of liquidity in the financial system.]
“The outlook for domestic economic growth remains subdued, with no indications of a quick recovery,” offered the SARB as a rationale for the rate cuts. Activity in manufacturing and mining, two of the cornerstones of the South African economy, have plummeted since the inception of the credit crisis, along with exports and retail sales. As a result, “Central bank Governor Tito Mboweni said April 7 he would ‘not be surprised‘ if the nation’s economy shrank for a second consecutive quarter in the three months through March, following a 1.8 percent contraction in the fourth quarter.” Meanwhile, South Africa’s producer price index (PPI) has declined for seven consecutive months. Coupled with a moderation in food and energy prices, inflation is no longer perceived as a serious problem.
The South African Rand actually rose on the news of the rate cut, as part of a trend that has seen the currency rise nearly 40% since touching a low of 11.7 Rand/Dollar in October. In April alone, “South Africa’s rand, the laggard of 27 major world and emerging-market currencies last year, rallied 12 percent against the dollar.”
This reversal of fortune is due largely to the recovery of risk appetite and consequent return of investors to the carry trade.
South Africa is especially poised to benefit from this trend for a couple reasons. Primarily, the Rand’s advantage lies in in interest rate differentials. Even if the SARB hews to economists’ predictions and cuts its repo rate by another 100 basis points, the differential will still be tremendous, as virtually every industrialized country has lowered rates close to zero. In addition, South Africa is perceived as a relatively safe place to invest, especially relative to interest rate levels. According to one trader, “We’re seeing a re-assessment of the rand’s relative value because of the fact that South Africa’s economy and financial system are relatively more sound than is the case in many other countries.”
As Bloomberg News summarized, you can’t stand in front of a freight train: “Emerging-market stocks are poised for their best month in 20 years as evidence the global recession is easing spurs investor demand for higher-yielding assets.”
In the end, you can’t fool the markets and carry traders ignore fundamentals at their peril. The recent election of Jacob Zuma as South African Prime Minister “hardly adds to confidence in the South African economy.” In addition, South Africa continues to maintain a sizable current account imbalance, “at 7.4 percent of gross domestic product last year.” Despite declines in February and March, the deficit touched a “record 17.380 billion rand deficit in January” and the markets are “expecting large deficits to persist this year as exports come under pressure.”
South Africa is especially poised to benefit from this trend for a couple reasons. Primarily, the Rand’s advantage lies in in interest rate differentials. Even if the SARB hews to economists’ predictions and cuts its repo rate by another 100 basis points, the differential will still be tremendous, as virtually every industrialized country has lowered rates close to zero. In addition, South Africa is perceived as a relatively safe place to invest, especially relative to interest rate levels. According to one trader, “We’re seeing a re-assessment of the rand’s relative value because of the fact that South Africa’s economy and financial system are relatively more sound than is the case in many other countries.”
As Bloomberg News summarized, you can’t stand in front of a freight train: “Emerging-market stocks are poised for their best month in 20 years as evidence the global recession is easing spurs investor demand for higher-yielding assets.”
In the end, you can’t fool the markets and carry traders ignore fundamentals at their peril. The recent election of Jacob Zuma as South African Prime Minister “hardly adds to confidence in the South African economy.” In addition, South Africa continues to maintain a sizable current account imbalance, “at 7.4 percent of gross domestic product last year.” Despite declines in February and March, the deficit touched a “record 17.380 billion rand deficit in January” and the markets are “expecting large deficits to persist this year as exports come under pressure.”
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