Recent market action signaled a shift in focus from risk to rate expectations. As previously noted, this was first observed on December 4th when a better than expected non farm payroll report was released sending the USD higher.
A Very Tight Rope
Central banks around the world are walking a very tight rope, balancing a fragile recovery on the one hand and looming inflation on the other. This is an uncomfortable situation with wide political implications: hike rates too soon and you risk a lagging economy and prolonged, high unemployment. Raise rates too late and you will have unleashed a monster inflation. Either scenario is a losing proposition for any administration but the prospect of hyper inflation is by far worse with much broader implications to the economy.
As Mr. Greenspan will probably tell you, maintaining low rates for a long time will eventually result in market distortions in the form of asset bubbles and/or inflation . This is when one nation keeps its rates low - but what happens when the world's leading economies slash rates in an unprecedented, coordinated move? We've yet to find out, but we do know that there's just a lot more money out there, and isn't that the definition of inflation?
Do You Speak Fedish?
Even on a week filled with economic data fanfare, the FOMC is guaranteed to give the best show in town. Higher than expected reading of PPI and CPI in the US and UK respectively sharpened global focus on the possibility of future rate hike. The Fed is highly unlikely to announce rate increases any time soon. However, with the release of the FOMC minutes, scores of commentators all over the media will immediately begin the amusing process of translating the minutes from Fedish to English. Traders, investors and economists alike will scan through the release with a fine-toothed comb in effort to discern even the slightest change in sentiment in order to glean even the faintest hint regarding where rates are headed.
So what to look for? The Fed is unlikely to raise rates before other emergency measures such as the TARP, TALF, and bond purchasing, are wound down. Therefore it is important to look for any signaling or intention to remove these measures. In addition, it is important to pay attention to any changes in sentiment regarding the recovery and comments regarding the prospects of inflation.
In my free time, I took some Fedish lessons, call it Fedish 101. I was able to discern, with moderate certainty that by repeating the point of a "jobless recovery", Mr. Bernanke is setting the stage for rate hikes prior to any noticeable improvement in employment numbers - a move that, unless gently delivered, can deal a blow to a market struggling with a new breed of consumers who simply spend less.
Showing posts with label Interest rates. Show all posts
Showing posts with label Interest rates. Show all posts
Tuesday, December 15, 2009
Wednesday, December 9, 2009
Excuse me, sir, this Yen is a little overdone!
Can you believe it? it's been almost ten years since we welcomed the new millennium. Ah, the year 2000.... the year that brought us such great excitement of a bright and promising future was also the year that brought us the wrath of the burst of the dot com bubble. It was also the year that brought us what is possibly the greatest carry trade ever - the Yen carry trade. With interest rates effectively at zero, the Yen became the vehicle of choice for funding carry trades against other higher yielding currencies such as the Aussie, Kiwi, and the Euro. It was a smooth sail for carry traders that lasted the good part of a decade - a time of (what then seemed to be) risk free, free money. Investors raked it in hand over fist, collecting interest payments while their higher yielding assets kept appreciating relentlessly. As the world economy recovered from the dot com bust, sending interest rates higher everywhere but Japan, the carry trade became self-propelled. Even a rising Japanese equities market accompanied by moderate rate hikes as of July of 2006 did almost nothing to cool the red-hot carry trade.
Then came Bear Sterns, then Lehman, then....a series of global rate cuts as legions of talking heads on CNBC declared the end of the world was finally here. The unwinding of the carry trade was fast and furious. Within four months(!!!), the Yen has pared a decade's worth of losses as traders rushed to cover their short positions while many others flocked to the Yen, seeking its relative safety in uncertain times. Even as the carry trade seemed completely unwound, the Yen maintained its safe haven status and readily bounced on any sign of weakness in the global recovery which started on March 9th 2009.
A New Government Steps In
Following an August election, a new government, led by the Democratic Party of Japan, took power in September of 2009. With less than one month in office, the newly appointed finance minister, Mr. Fujii, already managed to cause waves in the foreign exchange markets by talking up a strong Yen. We may never know exactly why did Mr. Fujii made such dubious comments in his first days in office. But the result was obvious, and an already upward moving Yen was pushed even higher.
In November of 2009, the global recovery (or bear rally - you decide) showed signs of fatigue and concerns over the sustainability of the recovery started to arise. On November 15th, Japan's preliminary GDP numbers came in much better then expected. The stronger economic reading for Japan, coupled with a global recovery in question, sent the the Yen on a two week dash that culminated over the Thanksgiving holiday with news of Dubai's impending credit crisis sending tremors throughout the global markets. Even as the dollar advanced against most other currencies, it lost ground to the Yen, reaching low levels not seen in years.
It did not take long for the Japanese government to change its tune as a strong Yen put too much pressure on a very fragile and very export dependent economy. Japanese rhetoric reversed and officials were quick to point out that Yen strength came on the back of a weak dollar without any fundamental basis. Of course, with a struggling economy, aging population, astronomical debt, zero interest rates as far as the eye can see, and loose monetary policy, what fundamental reason is there for the Yen to go higher?
Friday's NFP report shed some light on what could be fueling the Yen's relentless rise - flight to safety. The NFP report, which came in much better than expected sent the Yen on a sharp move down against the USD and other major currencies. The NFP numbers and easing concerns about Dubai (which proved to be short lived) gave the market a glimmer of hope and the Yen's reaction is indicative of its role as a safe haven. Since Friday, dark clouds have gathered once again in the form of credit downgrade in Greece, gloomy outlook in Spain, and lingering concerns regarding Dubai. The result? a stronger Yen.
Waiting for Intervention
Talks about Japanese intervention have surfaced in the media over the last couple of weeks and as of today, it seems a somewhat likely scenario. This is a major shift in paradigm for Mr. Fujii from his remarks back in September. Of course, intervention is an extreme measure and is not guaranteed to work - so whether or not the BoJ will intervene is anyone's guess. What is more likely to happen is for Yen pair to base in the short term, creating an invisible fence to ward of Yen bulls. This line in the sand may provide excellent buying opportunities in some Yen pairs, esp. against strong currencies like the Canadian dollar or the Aussie.
Then came Bear Sterns, then Lehman, then....a series of global rate cuts as legions of talking heads on CNBC declared the end of the world was finally here. The unwinding of the carry trade was fast and furious. Within four months(!!!), the Yen has pared a decade's worth of losses as traders rushed to cover their short positions while many others flocked to the Yen, seeking its relative safety in uncertain times. Even as the carry trade seemed completely unwound, the Yen maintained its safe haven status and readily bounced on any sign of weakness in the global recovery which started on March 9th 2009.
A New Government Steps In
Following an August election, a new government, led by the Democratic Party of Japan, took power in September of 2009. With less than one month in office, the newly appointed finance minister, Mr. Fujii, already managed to cause waves in the foreign exchange markets by talking up a strong Yen. We may never know exactly why did Mr. Fujii made such dubious comments in his first days in office. But the result was obvious, and an already upward moving Yen was pushed even higher.
In November of 2009, the global recovery (or bear rally - you decide) showed signs of fatigue and concerns over the sustainability of the recovery started to arise. On November 15th, Japan's preliminary GDP numbers came in much better then expected. The stronger economic reading for Japan, coupled with a global recovery in question, sent the the Yen on a two week dash that culminated over the Thanksgiving holiday with news of Dubai's impending credit crisis sending tremors throughout the global markets. Even as the dollar advanced against most other currencies, it lost ground to the Yen, reaching low levels not seen in years.
It did not take long for the Japanese government to change its tune as a strong Yen put too much pressure on a very fragile and very export dependent economy. Japanese rhetoric reversed and officials were quick to point out that Yen strength came on the back of a weak dollar without any fundamental basis. Of course, with a struggling economy, aging population, astronomical debt, zero interest rates as far as the eye can see, and loose monetary policy, what fundamental reason is there for the Yen to go higher?
Friday's NFP report shed some light on what could be fueling the Yen's relentless rise - flight to safety. The NFP report, which came in much better than expected sent the Yen on a sharp move down against the USD and other major currencies. The NFP numbers and easing concerns about Dubai (which proved to be short lived) gave the market a glimmer of hope and the Yen's reaction is indicative of its role as a safe haven. Since Friday, dark clouds have gathered once again in the form of credit downgrade in Greece, gloomy outlook in Spain, and lingering concerns regarding Dubai. The result? a stronger Yen.
Waiting for Intervention
Talks about Japanese intervention have surfaced in the media over the last couple of weeks and as of today, it seems a somewhat likely scenario. This is a major shift in paradigm for Mr. Fujii from his remarks back in September. Of course, intervention is an extreme measure and is not guaranteed to work - so whether or not the BoJ will intervene is anyone's guess. What is more likely to happen is for Yen pair to base in the short term, creating an invisible fence to ward of Yen bulls. This line in the sand may provide excellent buying opportunities in some Yen pairs, esp. against strong currencies like the Canadian dollar or the Aussie.
Monday, December 7, 2009
Can You Spare a Buck?
It's been a tough ride for the USD since March, not so much of a roller-coaster as a Double Black Diamond slope. The USD peaked earlier this year due to extreme levels of fear and uncertainty in the global financial markets. The end of the world seemed like a done deal and the all-mighty Dollar was everyone's bet (mostly in the form of US treasuries), in what was dubbed the "risk aversion" trade. Since March, however, the USD declined, in a twisted way, on every piece of good news that would normally make a currency stronger. And thus came about the "risk trade". With historically low interest rates and generous QE, the dollar was left alone and defenseless, surrounded by some very scary bears with their claws sharpened and ready for the attack.
Vociferous pros eulogize the greenback daily on various financial media outlets and foreign governments diversify their reserve holdings with gold (India) and Canadian Dollar (Russia). Indeed, the currency has not been able to stick its head above the 10 EMA (weekly, see below) since May. However, even among the big bears out there, there seems to be a growing consensus that a bear rally is in the cards and Friday's market action could have signaled the opening shot.
Fundamental, meet Technical
Fundamentally speaking, there are two scenarios in which the USD slide can reverse, even if only for a relatively short period, and they are (1) deterioration of financial markets and return to risk aversion or (2) interest rate hike by the Fed. Technically speaking, the DXY (aka dollar index) is entering a support level (see weekly chart below) in the 74.50 to 71.50 range.
It always astonishes me when trend-shifting fundamental news "magically" coincide with major technical levels. Over the past two weeks, the DXY came close to a major weekly support level and, wouldn't you know, we got a taste of both bullish scenarios for the USD.
The first came in the form of financial turmoil in Dubai (risk aversion). The second came a week later in the form of much better than expected NFP numbers, causing markets to expect rate hikes earlier than previously predicted.
Of the two events, Friday's NFP report was much more significant because while the reaction to Dubai World's woes was according to expectations, the reaction to the NFP numbers marked the first time in months when a good economic reading led to a stronger dollar signaling a possible break from the inverse relationship between the dollar and the state of the economy (and the equities marker).
Obviously, it is too early to to tell if the dollar rally will fizzle or sizzle and the dollar bulls should hold off on the champagne - at least until New Year's.
Vociferous pros eulogize the greenback daily on various financial media outlets and foreign governments diversify their reserve holdings with gold (India) and Canadian Dollar (Russia). Indeed, the currency has not been able to stick its head above the 10 EMA (weekly, see below) since May. However, even among the big bears out there, there seems to be a growing consensus that a bear rally is in the cards and Friday's market action could have signaled the opening shot.
Fundamental, meet Technical
Fundamentally speaking, there are two scenarios in which the USD slide can reverse, even if only for a relatively short period, and they are (1) deterioration of financial markets and return to risk aversion or (2) interest rate hike by the Fed. Technically speaking, the DXY (aka dollar index) is entering a support level (see weekly chart below) in the 74.50 to 71.50 range.
It always astonishes me when trend-shifting fundamental news "magically" coincide with major technical levels. Over the past two weeks, the DXY came close to a major weekly support level and, wouldn't you know, we got a taste of both bullish scenarios for the USD.
The first came in the form of financial turmoil in Dubai (risk aversion). The second came a week later in the form of much better than expected NFP numbers, causing markets to expect rate hikes earlier than previously predicted.
Of the two events, Friday's NFP report was much more significant because while the reaction to Dubai World's woes was according to expectations, the reaction to the NFP numbers marked the first time in months when a good economic reading led to a stronger dollar signaling a possible break from the inverse relationship between the dollar and the state of the economy (and the equities marker).
Obviously, it is too early to to tell if the dollar rally will fizzle or sizzle and the dollar bulls should hold off on the champagne - at least until New Year's.
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