Risk and the Euro-Dollar Rate
16 November 2009
AS the world’s major central banks slashed rates to near zero in the aftermath of the failure of Lehman Brothers, the systemic shocks to the financial markets posed by trillion dollar losses among the best and brightest of global finance (even as RBS, Citi, UBS and assorted money centre zombies gone toast) and the swiftest, most vicious economic downturn sicne the 1930’s, the dollar acted as the world’s safe haven currency.
Yet the Federal Reserve’s zero overnight borrowing rate and epic money printing spree, quant easing in the dismal jargon of the dismal science, triggered a new dynamic in the foreign exchange markets. Risk appetites, not interest rate differentials, would determine the mood swings of the euro, swissie, sterling, aussie and even yen against the dollar.
Even though the US Treasury Secretary ritually hisses “strong dollar” with a straight face, it is an open secret that the Obama White House is a cheerleader of the “beggar thy neighbour” depreciation of the dollar. Since March, the US Dollar Index has lost 15 per cent of its value with the burden of adjustment falling disproportionately on the euro, not Americas mercantilist trade partners in the Pacific Rim who manage or peg their currencies, notably the Middle Kingdom (aka China Inc). The euro has soared from 1.26 in January to above 1.49 now, a “disaster” for the eurozone’s fragile recovery, as Sarkozy’s top financial advisor in the Elysee Palace so rightly asserted. Meanwhile, the Chinese continue to wreck havoc in the export markets of the world against the EU and Japanese companies.
The Dallas Fed President Richard Fisher even applauded the dollar’s decline when he pointedly stated that “it was rather orderly depreciation”. The unspoken message to the market’s is that no Louvre Accord sort of response from the Fed or the US Treasury is imminent and the recent G-20 conclave in St. Andrews, Scotland contained no dollar support sweet nothings. The IMF, not exactly immune from Washington’s diktat since the birth of the Bretton Woods twins seven decades ago, even helpfully declared that the dollar is still overvalued on a real effective basis on the eve of the G-20 meeting. At least Governor King at the Bank of England was honest when he welcomed protracted sterling weakness to boost exports as the engine of UK economic growth.
Yet the euro’s strength is hostage to the Chinese reluctance to countenance an appreciation of the Renminbi, the most undervalued major currency in the world. This was the reason the euro dropped 2 points against the dollar after the Peoples Bank of China, or PBOC, made a subtle shift in its currency policy language as Air Force One landed in Tokyo on Obama’s state visit to Asia. Yet will the Chinese revalue? Will the Federal Reserve tighten monetary policy as long as the jobless rate has still not peaked even at 10.2 per cent. No, at least in the next three months. The Fed, the PBOC, the ECB and the Bank of England need to encourage, not restrain, Lord Keynes’s animal spirits of capitalism. The central banks need frothy asset markets, low credit spreads, high risk appetite, monetary reflation to give time for the consumer, companies and banks to heal their balance sheet wounds from 2008-9. A precipitous rise in the dollar, particularly since headline inflation is not a policy dilemma yet, is simply not on the agenda of the central banker eminence grises. This is the real reason why the mother of all carry trades continues.
Yet the short dollar trade, whose DNA is the monstrous asset bubble in commodities and emerging markets, is the most crowded, dangerous money equation in international finance. The risks of a cataclysmic crash in risky asset markets if the financial markets sense that the world’s central bankers will exit their free cash programs or, horror of horrors, hike interest rates, even though the Bernanke Fed will use verbal anesthesia to camouflage its intentions, as the November FOMC proved. When this crash happens, the dollar will again prove the market’s haven de jour, exactly as it proved in September 2008.
Never in the history of modern finance have risk assets (gold, oil CRB commodities index, emerging markets, high yield debt) been so notoriously correlated to each other while the Chicago Volatility Index, or VIX, has plummeted from 80 last October to just above 20 now. In essence, the central banks have given speculators a classic one way bet on risk even as risk metrics no longer remotely reflect real world asset with illusions and delusions of the herd — and VIX at 20 convinces me that the Big Chill is coming even as the financial sirens lull the herds into the touching belief that the world is not so dangerous while they lead them to the slaughter.
Risk is still the dominant zeitgeist in the markets. The October payrolls was a media shocker but the cognoscenti concluded that the loss of 190,000 jobs and a September revision of 91,000 the rise in temp hiring/average hourly earnings and the workweek all compensated for the 10.2 per cent shocker. The euro failed to break 1.4820 so I must remain a nervous long, as the momentum in global equities and even gold is bullish. Yet the Euro-dollar has struggled at the 1.5050 psychological range. In any case, strong US economic data (3.5 per cent GDP growth in third quarter, 55 ISM, Case Schiller, home sales) has been risk positive and so euro-bullish.
Retail sales, PPI, industrial production, leading indicators next week will probably not derail the risk on trade. The euro’s surge above 1.50 can only be derailed by a spike in US money market rates, a sharp drop in global stock market indices and a protest by Jean Claude Trichet against the uber-strong single currency. The path of least resistance argues for 1.52 euro-dollar. I find far more value in strategic cross ideas. So I am long Aussie/Kiwi at 1.22 for a 1.28 target as I believe iron ore trumps sheep, that Stevens at the RBA will hike rates while Bollard at the RBNZ will ease. The euro-Norwegian kroner cross at 8.40 enables me to take advantage of a hawkish Norges Bank, high crude oil prices and the risk on trade. Is a 50 per cent fall in the GCC and emerging markets possible in the next three months? Absolutely. Why? Stay tuned.
16 November 2009
AS the world’s major central banks slashed rates to near zero in the aftermath of the failure of Lehman Brothers, the systemic shocks to the financial markets posed by trillion dollar losses among the best and brightest of global finance (even as RBS, Citi, UBS and assorted money centre zombies gone toast) and the swiftest, most vicious economic downturn sicne the 1930’s, the dollar acted as the world’s safe haven currency.
Yet the Federal Reserve’s zero overnight borrowing rate and epic money printing spree, quant easing in the dismal jargon of the dismal science, triggered a new dynamic in the foreign exchange markets. Risk appetites, not interest rate differentials, would determine the mood swings of the euro, swissie, sterling, aussie and even yen against the dollar.
Even though the US Treasury Secretary ritually hisses “strong dollar” with a straight face, it is an open secret that the Obama White House is a cheerleader of the “beggar thy neighbour” depreciation of the dollar. Since March, the US Dollar Index has lost 15 per cent of its value with the burden of adjustment falling disproportionately on the euro, not Americas mercantilist trade partners in the Pacific Rim who manage or peg their currencies, notably the Middle Kingdom (aka China Inc). The euro has soared from 1.26 in January to above 1.49 now, a “disaster” for the eurozone’s fragile recovery, as Sarkozy’s top financial advisor in the Elysee Palace so rightly asserted. Meanwhile, the Chinese continue to wreck havoc in the export markets of the world against the EU and Japanese companies.
The Dallas Fed President Richard Fisher even applauded the dollar’s decline when he pointedly stated that “it was rather orderly depreciation”. The unspoken message to the market’s is that no Louvre Accord sort of response from the Fed or the US Treasury is imminent and the recent G-20 conclave in St. Andrews, Scotland contained no dollar support sweet nothings. The IMF, not exactly immune from Washington’s diktat since the birth of the Bretton Woods twins seven decades ago, even helpfully declared that the dollar is still overvalued on a real effective basis on the eve of the G-20 meeting. At least Governor King at the Bank of England was honest when he welcomed protracted sterling weakness to boost exports as the engine of UK economic growth.
Yet the euro’s strength is hostage to the Chinese reluctance to countenance an appreciation of the Renminbi, the most undervalued major currency in the world. This was the reason the euro dropped 2 points against the dollar after the Peoples Bank of China, or PBOC, made a subtle shift in its currency policy language as Air Force One landed in Tokyo on Obama’s state visit to Asia. Yet will the Chinese revalue? Will the Federal Reserve tighten monetary policy as long as the jobless rate has still not peaked even at 10.2 per cent. No, at least in the next three months. The Fed, the PBOC, the ECB and the Bank of England need to encourage, not restrain, Lord Keynes’s animal spirits of capitalism. The central banks need frothy asset markets, low credit spreads, high risk appetite, monetary reflation to give time for the consumer, companies and banks to heal their balance sheet wounds from 2008-9. A precipitous rise in the dollar, particularly since headline inflation is not a policy dilemma yet, is simply not on the agenda of the central banker eminence grises. This is the real reason why the mother of all carry trades continues.
Yet the short dollar trade, whose DNA is the monstrous asset bubble in commodities and emerging markets, is the most crowded, dangerous money equation in international finance. The risks of a cataclysmic crash in risky asset markets if the financial markets sense that the world’s central bankers will exit their free cash programs or, horror of horrors, hike interest rates, even though the Bernanke Fed will use verbal anesthesia to camouflage its intentions, as the November FOMC proved. When this crash happens, the dollar will again prove the market’s haven de jour, exactly as it proved in September 2008.
Never in the history of modern finance have risk assets (gold, oil CRB commodities index, emerging markets, high yield debt) been so notoriously correlated to each other while the Chicago Volatility Index, or VIX, has plummeted from 80 last October to just above 20 now. In essence, the central banks have given speculators a classic one way bet on risk even as risk metrics no longer remotely reflect real world asset with illusions and delusions of the herd — and VIX at 20 convinces me that the Big Chill is coming even as the financial sirens lull the herds into the touching belief that the world is not so dangerous while they lead them to the slaughter.
Risk is still the dominant zeitgeist in the markets. The October payrolls was a media shocker but the cognoscenti concluded that the loss of 190,000 jobs and a September revision of 91,000 the rise in temp hiring/average hourly earnings and the workweek all compensated for the 10.2 per cent shocker. The euro failed to break 1.4820 so I must remain a nervous long, as the momentum in global equities and even gold is bullish. Yet the Euro-dollar has struggled at the 1.5050 psychological range. In any case, strong US economic data (3.5 per cent GDP growth in third quarter, 55 ISM, Case Schiller, home sales) has been risk positive and so euro-bullish.
Retail sales, PPI, industrial production, leading indicators next week will probably not derail the risk on trade. The euro’s surge above 1.50 can only be derailed by a spike in US money market rates, a sharp drop in global stock market indices and a protest by Jean Claude Trichet against the uber-strong single currency. The path of least resistance argues for 1.52 euro-dollar. I find far more value in strategic cross ideas. So I am long Aussie/Kiwi at 1.22 for a 1.28 target as I believe iron ore trumps sheep, that Stevens at the RBA will hike rates while Bollard at the RBNZ will ease. The euro-Norwegian kroner cross at 8.40 enables me to take advantage of a hawkish Norges Bank, high crude oil prices and the risk on trade. Is a 50 per cent fall in the GCC and emerging markets possible in the next three months? Absolutely. Why? Stay tuned.