Dollar to Rally in 2010 as Fed Cuts Liquidity, BNP Paribas Says

via Dollar to Rally in 2010 as Fed Cuts Liquidity, BNP Paribas Says – Bloomberg.com.

We got our island reversal so now we need to see if this is truly the beginning of the large C wave we have been anticipating.  Aggressive money should be short the belly of the curve 3s/5s/7s and looking for a spot to get long dollars and short commodities.

In the 1930s many, but not all, major economies imposed draconian constraints on trade which sharply contracted international commerce and almost certainly slowed the global recovery. It was widely understood then that the collapse in international trade would only worsen the crisis, and yet countries, seeking to protect their own positions, collectively engaged in behaviour that left them worse off.

via FT.com / Comment / Opinion – Competitive devaluations threaten a trade war.

There is no shortage of cash rich investors in Asia even amidst the current troubles in Dubai. Indeed, sentiment in the gemstones market is particularly upbeat, with a rare five-carat pink diamond selling for a record HK$84.24 million in Hong Kong. Perhaps this is a good reflection of abundant liquidity and of course wealth in Asia and in particular China, with talk that mainland Chinese investors were strong participants in the diamond auction.

It’s not just diamonds that are selling for record prices; gold hit a fresh high above $1,200 and once again at least part of this is attributable to the appetite of Asian central banks as well as demand from China as the country tries to increase its gold reserves. The rise in gold prices has coincided with a bullish announcement from the world’s top gold producer that it has completely eliminated its market hedges earlier than forecast due to the positive outlook on prices and waning supply.

The correlation between gold prices and the USD remains very strong at -0.88 over the last 3-months, with firmer gold prices, implying further USD weakness. In fact, the gold / USD correlation has been consistently strong over the past few months and is showing little sign of diminishing.

Over the past 6-months the correlation has been -0.91 and over the past 1-month it was -0.75.  Assuming that anything above 0.70 can be considered statistically significant, the relationship shows that USD weakness has been well correlated with gold strength and that despite talk of a breakdown in the relationship it appears to remain solid. 

As long as the bullish trend in gold continues, the pressure on the USD will remain in place.  Adding to this pressure is the fact that risk is back on for now. Markets took the news of a fall in the ISM manufacturing index and in particular the drop in the employment component in its stride even though it supports the view of a weaker than consensus drop in payrolls in November when it is published on Friday.

There are still plenty of reasons to be cautious in the weeks ahead and although we appear to be back in a “risk on” environment markets are likely to gyrate between “risk on” and “risk off” over coming weeks. At least for now, the USD looks to remain under pressure but if risk aversion creeps back up as I suspect it may then the USD will see a bit more resilience into year end. 

Moreover, central banks globally are reaching the limits of their tolerance of USD weakness and will be tested once again, with EUR/USD back above 1.5000, EUR/CHF moving back below 1.5100 and the USD/JPY set to re-test 85.00 following the relatively benign measures announced by the BoJ in which the Bank did little to stem deflationary pressure or weaken the JPY.

Dollar/won and yen/won

One thing to remember is that the USD/KRW rate is also the CNY/KRW rate. The Chinese yuan is pegged to the greenback, of course. Korean export advantage can be seen here insofar as Korean firms rival Japanese firms.  So the won is still in pretty good shape for Korea to slip through the sweet spot so to speak.

And see how much weaker the won is compared to both dollar and yen back in 2007.  And here with Chinese yuan:

Chinese yuan vs Korean won

Amazing how Korea has managed to devalue. Now while others argue about who gets to have cheaper currency, the won can slowly appreciate while remaining undervalued from a long-term perspective.

Of course there’s a downside to a cheap won and that’s expensive capital goods and commodities necessary from other currency zones. And energy is a real issue here, especially the potential threat of peak oil and commodity price spikes. Korea has apparently seen the problem, and as one of the most energy inefficient countries has embarked on a green campaign. I believe 75% of the financial crisis fiscal stimulus in Korea went to “green” projects.

CARBON CREDITS COULD BECOME A CURRENCY ISSUE

The weak won will become a liability in any international carbon credit scheme, as credits would be that much more expensive with a weak won. This is a second incentive for Korea to move to alternative energy quickly. More broadly we can ask ourselves how an international carbon credits system would account for various currencies, and also what effect if any the cap and trade markets would have on exchange rates.  In what currency would an international carbon allowance price be set? In the IMF’s Special Drawing Rights are an obvious candidate, but countries might also wish to only enter agreements in local currencies.

Also, the EU-Korea Free Trade Agreement and an upcoming negotiation about one with the US will make South Korea want to show its nice side and not impose too-stringent currency controls. In many ways Korea seems to have had nearly perfect luck so far with its currency since the beginning of the recession in December 2007, and also lucky to have had a Fed nearby sensibly ready to help with Korean banks’  short-term debt financing turmoil at the worst of the financial collapse.

The start of this week looks somewhat better compared to the end of last week. Although nervousness will remain amidst thinning liquidity, news that the UAE central bank “stands behind” local and foreign banks and will lend, albeit at a rate of 0.5% above the 3-month benchmark rate, will reassure investors that banks have sufficient liquidity in the wake of any losses suffered due to the Dubai Holdings debacle. This will see some improvement in risk appetite.

The news will unlikely prevent stock markets in the UAE, which open today following Eid holidays, from sliding, however. Attention will turn to the suspended Sukuk bonds and also to the extent of support (and any strings attached) provided by Abu Dhabi to Dubai. The support from the central bank will help markets outside of the UAE regain a little composure and limit demand for safe haven assets but the rally may prove limited until there is greater transparency.

Nonetheless, even if there is some relief at the beginning of this week due to some containment of the problems in Dubai nerves are likely to fray going into the end of the year, with the multi-month trend of improving risk appetite faltering. There have been plenty of reasons for markets to worry lately including concerns about the shape of economic recovery in the months to come as well as renewed banking sector concerns and these will not be allayed quickly.

Data this week in the US is unlikely to help to dampen growth concerns. The main event is the US November jobs report and although the magnitude of job losses is set to decrease the unemployment rate is set to remain stubbornly high around 10.2%. In addition to an expected decline in the November ISM manufacturing index suggests that growth concerns will intensify rather than lessen. This in turn highlights that any improvement in risk appetite this week will prove limited.

The other key events this week include interest rate decisions in Europe and Australia. Although the ECB is widely expected to leave rates on hold on Thursday, there will be plenty of attention on any details of the Bank’s “gradual” exit strategy. Whether the ECB offers new loans to banks at a variable interest relative to the current fixed rate will be taken as an important sign on the path of liquidity withdrawal. We believe the Bank will stick with a fixed rate. The RBA will take a step further and announce a 25bps interest rate hike tomorrow.

FX markets are likely to be buffeted by the gyrations in risk appetite but at least at the beginning of the week the USD is set to give up its recent gains, with EUR/USD likely to try and hold above 1.5000 as markets digest the better news coming from the UAE. The JPY will be a particular focus given the growing attention of the authorities in Japan. Finance Minister Fujii is quoted in the Japanese press that they won’t intervene in the FX market, which appears to give the green light to further JPY strength though I suspect that if USD/JPY drops below 85.00 again there will plenty of FX intervention speculation and in any case these comments have since been denied.

The yen dropped against higher- yielding currencies after the United Arab Emirates’ central bank said it “stands behind” the country’s banks, easing concerns about a possible default by state-owned Dubai World.

The euro gained for the first time in five days against the yen after the Abu Dhabi-based central bank of the U.A.E. said lenders will be able to borrow using a special facility tied to their current accounts. The Australian and New Zealand dollars rallied as demand rose for riskier assets after concerns eased over credit losses in the Middle East.

Asian stock markets were higher Monday as markets reacted to reassuring news over the weekend that suggested contagion from Dubai World’s debt crisis will be limited.

Financial stocks were rebounding in Australia, Korea and Japan after last week’s sharp selloff on the Dubai news.

Here is a snapshot of the Markets at 11:00am (GMT+8  ):

Changes from last Friday:

Euro: +0.60%

JPY: –0.24%

GBP: +0.66%

AUD: 1.11%

NZD: 1.56%

The dollar wobbled against other major currencies on Friday, giving back some of its Thanksgiving Day gains in quiet trading. Stocks withstood early selling pressure brought on by the Dubai debt debacle, fueling some of the risk appetite that drove the dollar to yearly lows this week.

The buck slipped back to 1.4966 (high 1.5017 – low 1.4827) versus the euro, down a penny from its early highs. With the retreat, the buck stayed near its 16-month low of 1.5143 set on Wednesday.

A day plunging though support to hit a 1995 low of 84.80 yen, the dollar fetched 86.56 against its surging Japanese counterpart.

The dollar jumped to 1.6270 versus the sterling, but tailed off to finish the trade at 1.6470 later in the day. Still, the dollar has picked up more than 4 cents from a 3-month low set earlier in November.

Commodity prices stabilized as the shock of Dubai’s debt predicament waned. The dollar gave back its early gains versus resource-backed currencies, slipping to $1.0612 against Canada’s loonie.

Here is the snapshot of the Forex market at closing session:

(CFD.net.au – Contract for Difference, Share, Forex, ETFs, Commodities Traders) –

At 12:00 (AEDT), the dollar was trading at $US0.9221/25, down 0.64 per cent from yesterday’s close of $US0.9280/83.

During the morning session, the local currency moved between $US0.9215 and $US0.9257.

Royal Bank of Scotland foreign exchange strategist Greg Gibbs said weaker equity markets lowered demand for currencies such as the dollar.

Wall Street closed lower overnight on disappointing housing data, which was weaker than forecast.

Housing starts in the US rose by 0.5 per cent to 590,000 in September, below market expectations of a 610,000 increase.

The Dow Jones Industrial Average closed down 0.50 per cent.

The share market followed the weak theme, with the benchmark S&P/ASX200 index down 0.27 per cent by 12:00.

“It has come off a bit offshore inline with most commodity currencies that weakened offshore,” Mr Gibbs said.

“You could put it down to a softer Equity market in the US may have provided some support for the US dollar.”

Equity markets had rallied consistently over recent weeks on stronger-than expected earnings reports, but had subsided this week.

“It’s run out of juice on the upside, and hence it has corrected a little bit.”

Mr Gibbs said comments from a noted watcher of the Reserve Bank of Australia (RBA) that the central bank may reverse its recent rate rise if the economy weakens in time had some impact on the local currency.

The RBA lifted the overnight cash rate by 25 basis points to 3.25 per cent on October 6, its first tightening of monetary policy since March 2008.

“It may have come off a bit after journalist reports on possible policy moves by the RBA,” he said.

“That could be weighing on the currency.”

Source: Australian dollar lower at noon | Business Breaking News | News.com.au

Dubai Shows Limits of Government Rescues, Roubini’s Das Says

via Dubai Shows Limits of Government Rescues, Roubini’s Das Says – Bloomberg.com.

Yen Strengthens to 14-Year High on Risk Aversion, Stock Losses

via Yen Strengthens to 14-Year High on Risk Aversion, Stock Losses – Bloomberg.com.

Yen Strengthens to 14-Year High on Risk Aversion, Stock Losses

via Yen Strengthens to 14-Year High on Risk Aversion, Stock Losses – Bloomberg.com.

Dubai’s bolt out of the blue is hitting markets globally, with the aftershock made worse by the thin liquidity conditions in the wake of the US Thanksgiving holiday and Eid holidays in the Middle East.  The sell off followed news by government owned Dubai Holdings of a six month debt freeze.  Estimates of exposure to Dubai vary considerably, with European banks estimated to have around $40 billion in exposure though what part of this is at risk is another question. 

The lack of information surrounding the Dubai announcement made matters worse.  The aftermath is likely to continue to be felt over the short term, with further selling of risk assets likely.  Indeed, there is still a lot of uncertainty surrounding international exposure to Dubai or what risk there is to this exposure and until there is further clarity stocks look likely to face another drubbing.

The most sensitive currencies with risk aversion over the past month have been the JPY, and USD index, which benefit from rising risk aversion whilst on the other side of the coin, most Asian currencies especially the THB and KRW as well as the ZAR, and AUD look vulnerable to any rise in risk aversion.  JPY crosses look to be under most pressure, with the likes of AUD/JPY dropping sharply and these currencies are likely to drop further amidst rising risk aversion. 

The rise in the JPY has been particularly dramatic and has prompted a wave of comments from Japanese officials attempting to talk the JPY lower including comments by Finance Minister Fujii that he “will contact US and Europe on currencies if needed”.  So far, these comments have had little effect, with USD/JPY falling briefly through the key psychological level of 85.00, marking a major rally in the JPY from a high of 89.19 at the beginning of the week.  Unless markets believe there is a real threat of FX intervention by Japan the official comments will continue to be ignored.

It’s not all about risk aversion for the JPY, with interest rate differential playing a key role in the downward move in USD/JPY over recent weeks.  USD/JPY has had a high 0.79 correlation with interest rate differentials over the past month.  The US / Japan rate differential narrowed sharply (ie lower US rate premium to Japan) to just around 4.5bps from around 100bps at the beginning of August.  With both interest rate differentials and risk aversion playing for a stronger JPY the strong JPY bias is set to continue over the short term.

Is this the beginning of a new rout in global markets?  It is more likely another bump on the road to recovery, with the impact all the larger due to the surprise factor of Duba’s announcement as it was widely thought that Dubai was on the road to recovery.  The fact that the news took place on a US holiday made matters worse whilst the weight of long risk trades suggests an exaggerated fall out over the short term.

Macro

The Sick Chinese

China is set to become the next Asian super-economy after Japan, but do not be tempeted into making too many direct comparisons. Culturally, the two countries could not be more different and these characteristics seem to, somewhat superficially, manifest themselves within the political arena too. As a cultural tourist in Asia, I’ve often felt that (controversially, perhaps) Japan comes across more culturally socialistic than even communist China. In China, healthy aspirations for wealth, risk-taking and a lustful speculative urge combined with materialism and deep-rooted superstition are potentially lethal ingredients for a central government devoted to focusing the individual whims of 1.3 billion people on more economically constructive activity. I’ve said before; it may be that communism in China is needed as much as it is desired, to quell the destructive elements of ravenous capitalism lurking beneath. A controversial generalization, some might say, but it is just an opinion which helps me to differentiate investment attributes in a macroeconomic sense. I have a couple of questions: why does young Macau already generate more gambling revenues than even Las Vegas and why do you think gambling is banned on mainland China?

These Chinese superstitions are forged from a culture with huge populations without basic support systems (like the safety nets of financial and health infrastructure), thus “luck” was a major factor in how one’s life turned out. Hence the superstitions surrounding names and numbers (the number 8 is considered to mark good prosperity, for example) and the number of business establishments in Hong Kong with the word “lucky” in the title! These highlight similar reasons why Chinese do not consume as much as their Western counterparts. When analyzing this consumption conservatism, many point to the cultural differences and wrongfully compare China to Japan in this respect. I think it has more to do with the lack of support system which forces people to hoard cash as a “bad luck hedge”. If one loses a job or a family member gets sick, one has the ability to pay for a solution or buy time. But there is catch-22 to this predicament the developing World knows all too well; in order to afford the infrastructure and expertise one needs to grow, but in order to achieve balanced, sustainable growth one needs the infrastructure.

Many people unfamiliar with Asian culture also wrongly extrapolate China’s growth trajectory down the same track as Japan’s. This is a common mistake. The cultural differences alone (never mind physical, demographic, geographical, political, historic, environmental, economic etc) suggest to me that China’s pattern will be far different. For one, there is a trend I find very interesting in the service industry – it’s growing. Much like London and New York, Chinese Cities like Hong Kong and Shanghai will become the commercial centres of Asia (see that PwC table I sent on 23rd November). People communicate with the Chinese partly because they simply have to and partly because, culturally, Chinese people tend to be much less socially conservative than their Japanese counterparts – one striking example to me is readiness the Chinese have to adopt parts of Western culture over their own traditional habits.

This degree of extroversion reminds me of American culture and lends itself well to applications in the service industry – especially with the World’s most ferocious economic growth engine powering beneath you. The service industry is a sector I feel the, relatively isolated, North Pacific Island of Japan could not develop with the same penetration - as it requires a degree communicative involvement not inherent to Japanese history or indeed its geographic location. Let me put it another way, a ubiquitous language is an extremely powerful lubricant for economic expansion. Many people look to learn English for example, as many major modern global influences (not just political or economically but also even industries like media, software development, entertainment) are from English speaking origins. Now think about this: 3 times as many people know how to speak Chinese as English. It’s not just China; many of China’s neighbouring countries have dialects descended or mutated from Putonghua (the main Chinese dialect) so communication, a vital component of trade, is relatively easy. There is a strong sense that other Asian nations (and increasingly non-Asian nations!) look to China as the “economic playmaker”, quarterbacking the economic strategy for the region as a whole.

In particular, I noticed the following piece in The Daily Reckoning: Five Reasons China Is Not a Bubble By Romeo Dator, Co-manager, China Region Fund. Here is an excerpt.

 We’re seeing a transition to a service-related economy. The service industry is the fastest-growing sector (roughly 20 percent faster than construction) and now accounts for one-third of China’s workforce.

Source: Daily Reckoning

In general, the size of the service sector is directly correlated to the amount of goods and services an economy consumes. This is why the government has spent such a large amount of the stimulus on areas that benefit the domestic market – that’s where it thinks the economy is headed.

In order for China to succeed in managing a maturing manufacturing base, while keeping inflation and social stability in check, she needs to take the next crucial step towards a more balanced economy. The misguided “savings glut alliance” say that the Chinese need to consume more – as if it were a switch one could just flick. But for reasons I have highlighted, it is just not as easy as that. It’s difficult, indeed irresponsible, for the state to convince individuals to consume when it has provided no support structure to replace the “bad luck hedge” safety net Chinese savers currently hold. Although I do find it interesting that the Chinese Government is openly encouraging savers to hold Gold to preserve their wealth!

One step at a time; first, China needs to reform… sorry, I mean, China needs to form its financial system (in particular its pension system) to give consumers a sense of certainty regarding their personal economic future. Also, China desperately needs to confront the healthcare challenges which await. You think The West has an ageing population problem? Magnify that by a number of times and you have a sense of the scale of this challenge, an entire generation born into a strictly enforced one-child policy in the World’s most populous nation sets the scene for the demographic monster lying in wait for China over the next 20 years.  Healthcare in China has been a niggling thorn in my side when trying to understand what the future holds for the region as a whole.

It first occurred to me, when gawping at an hour-long queue for Pizza Hut in Xian (yes, a queue for a Pizza Hut), I realized the extent to which just nutritional balance alone had changed for literally hundreds of millions of Chinese in the space of less than one generation. The trend is not limited to Western Food, I noticed, but, for newly urbanized workers, used to struggling for calorific intake, the local Macdonald’s-equivalent or fast-food look-alikes are a tempting substitute.

On a more sinister note, though, Diabetes and Heart Disease are not the only diseases exploding in China. A healthcare journalist pointed out this South China Morning Post article to me, while also reminding me that products of the prostitution trade like: syphilis, hepatitis and HIV are practically on exponential trajectories. All this is occurring at a time when repercussions from an industrial-led growth boom are all too apparent. Be it in Air, Soil, Water, Ecology of the Middle Kingdom, the environmental toll is so large it is almost impossible to quantify. How many people in Guangzhou will die from lung cancer or respiratory disorders as a result of poisonous Air pollution – in many cases multiples above the WHO guideline? Some say that the national figure approaches half a million premature deaths a year. I have no idea, but I’m inclined to be bid on that number and these are only a fraction of the health issues coming due.

But an emerging behemoth of a Chinese middle class, with higher standards and an emerging tendency toward lifestyle benchmarks in the developed World, will demand answers and, most urgently, the infrastructure when the time comes. And the time is now – which is why I find it interesting that China announced it will Cut Emissions Gases by 45% ove the next 10 years, there will be more to come from China over the next decade for one reason: there simply has to be. The new-found attentiveness toward environmental issues in The East is long overdue, if China does not take care, very soon its economic aspirations will be cut short by the unviable social and environmental consequences.

How do we invest profitably from all this? Well, I’m still trying to figure that one out. In many respects China is behind the curve, the seeds for a problematic future have already been sown. Perhaps I should set up a fitness gym in Shanghai!

On a separate note, I find it amusing that, after I talked about how China was using currency policy to control inflation on 25th November, Vietnam devalued its currency, the Dong (the name always makes me chuckle), to “control inflation”. Bizarre statement, given that a devaluation would actually increase import prices. I think this move to devalue the currency, while simultaneously hiking interest rates, was more about managing currency outflows and trying to prevent the economy from destabilizing. To quote from the Bloomberg Article on the subject:

“The State Bank of Vietnam wants to control inflation and the trade deficit, but by devaluing the dong, higher import prices will put pressure on inflation,” said Nguyen Van Hoang, chief investment officer at Saigon Asset Management in Ho Chi Minh City. “They might not get what they expected.”

It’s an interesting move in a World where everyone is calling for undervalued Asian currencies to appreciate, not depreciate, against the Dollar.

Macro Data to Watch:

• Expecting a quiet day after the US still is digesting its turkey!
• Japanese jobs data – already out – roughly in line but CPI shows deflation is still entrenched at -2.5% YoY
• Eurozone Consumer Confidence
• Swedish GDP 

Markets

Well the Dollar got spanked yesterday. But has managed a bit of a rebound off the lows. There continue to be volatile moves in the Yen, graph of the day shows how the Dollar-Yen crashed through the lows over the last 48 hours.

The banks got crushed yesterday as Dubai looked precariously close to defaulting on its debt after they delayed debt payments to investors – see the FT article. European Banks are now feeling each other out, trying to decipher who has the most exposure. But despite a bad day in the office for all stocks, the volatility index (VIX) barely budged an inch.

Japanese 5 year interest swap rates hit another low.

Global Stocks to Watch:

• All the banks – especially HSBC in Hong Kong (stock led the drop in London)
• Still watching this B-share market in Shanghai

Today is US Thanksgiving.  Happy Thanksgiving to all my US friends! 

And a nod to the markets (that were open) as well.  With much of North America closed for the holiday, I still managed a decent gain today as the Canadian dollar was trading somewhere, and it took a beating.  On the news that Dubai might blow up.  Not as in terrorist blow up;  but as in I-can’t-meet-my-payments blow up.  Who would have thought?  A year or two ago Dubai was the great new happening place – the new jewel of the Middle East, and now its the new Argentina of a decade ago.  That spooked the Asian markets overnight, but really spooked the European markets later on in the day.  The big ones all closed down over 3%.   This sent commodities down, (except for natural gas, go figure), currencies down (against the dollar), and appears to have set up a potentially nasty morning for U.S. Thanksgiving revellers – especially with potentially thin (probably thicker now) trading tomorrow.  It will be worth watching Asia tonight.

I’m covered; still have lots of short ETFs.  To me, equities and oil have have had a decidly soggy tone over the past couple of weeks despite trading near the rally high, and I’ve had the sense that any bad news out of left field could pop this balloon.  This Dubai thing might be it.  Real-estate and unemployment are still major boat anchors, and I don’t think it will take too much more weight (a feather perhaps?) to push this market down again.  This rally has felt surreal all along.  It’s been long, powerful, and persistent, but against a backdrop of such bizarre economic dysfunction.

But, whatever.  We’ll trade what comes.  And speaking of trading …

I sold the HNU because I missed a signal early last week, and this kind of evens everything out.  A bit more cash in the kitty if we go down, but lots of shares left to get profitable fast if we go up.

It’s interesting that my co-Scouter Steve’s best friend Brian, who flew 777’s for Emirates Airlines and was based in Dubai, left and came back to Canada a couple of weeks ago.  His decision may have been fortuitous in retrospect.  (I’m now trying to recruit him into Scouts; from the cockpit to the fire pit, as it were.)

Again, Happy Thanksgiving and a hearty Du-bye bye …

Cheers,
Allocator
a.k.a. George Parkanyi

L'euro sur la barre de 1,51 dollar

via L’euro sur la barre de 1,51 dollar.

The euro surged to its best level in more than a year against the dollar as the US currency weakened broadly against other majors.

In the Eurozone, German consumer confidence for December unexpectedly dropped for a second month as economic and income expectations dropped moderately on an expected rise in unemployment.

European Central Bank President Jean-Claude Trichet said the ECB has avoided the materialization of deflationary risks thanks to its solid anchoring of inflation expectations.

The euro leveled off at a 15-month high versus the U.S. dollar, rising as high as 1.5094. The European currency rose above a Resistance level with the rally.