Nothing charges the volatility of the currency markets like an unexpected result for a well watched economic statistic.
A decade ago, the United States International Trade Balance caused violent gyrations in the Forex market, so much so that traders referred to those Friday morning sessions as “New York Fridays” naming and fearing the dangerous market after the trade balance release. Only a few other American statistics, unemployment, GNP (as GDP was then called) and CPI could, on occasion, provide a similar charge. For most traders the US statistical regime was limited to these major national statistics collected by the US government.
Then, as now, these statistics were released and dominated trading once a month. For the rest of the time, markets were moved by trading flows and speculative interest. Second and third tier economic statistics did not draw market attention. Ten years ago no one was betting their P/L on the Chicago Purchasers Index or Housing Starts; the Institute of Supply Management (ISM)) Non-Manufacturing Index was wholly unnoticed.
Over the past several years, market participants and the financial media have substantially widened their statistical focus. Many second and third tier measures now garner the type of interest and comment that used to be reserved for GDP or Non Farm Payrolls. The US economy has over 50 (or 60, or 1000, I am not sure anyone has counted) publicly reported economic statistics. There are easily enough PPI, Industrial Production, Consumer Sentiment, Durable Goods, Retail Sales, ISM, NAPM, TICS, NAHB and Redbook numbers reported each month to keep an army of analysts busy. How can traders judge which statistics deserve attention and which are of cursory or cumulative interest?
Aside from the few well known economy wide measures already mentioned, most statistics record activity in a specific industry or economic sector or for a limited time period. The usefulness and predictive ability of the majority of these indicators is strongest when they are combined with other measures or when part of a trend.
As a general guide to trading value, I have divided indicators into three groups: trend, situational and headline, distinguished by the quality of their information and the type of influence they exert over the current market.
Trend statistics, not surprisingly, are most valuable when they are trending. Because these indicators depict conditions in a relatively restricted area of the economy or for a short amount of time individual releases can be misleading or simply outliers. It is risky to base an economic assessment or trade on the return of a single trend statistic.
Different indicators from the same sector can give an accurate glimpse of that particular economic sector but not necessarily of the economy as a whole. Even when different monthly statistics point in a similar direction, only several months of releases can establish a trend.
A drop in the monthly capacity utilization figure or a rise in the Conference Board Consumer Sentiment measure by itself provides limited information for the trader. But if in the space of a week Consumer Sentiment, Factory Orders and ISM all gain you have the makings of a tradable move. When properly utilized, these trend or secondary statistics can supply invaluable clues to economic strength and to the timing and direction of currency moves but their greatest value lies in combination with other similar indicators.
Situational statistics are indicators elevated in importance by particular circumstances. One could also call these central bank or crisis indicators. These numbers are important because they are used by central banks in their own economic analysis or because they depict conditions in a crucial economic sector. These statistics can change over time. As bankers change and crises come and go, newly favored or newly crucial measures will replace the ones currently popular.
Chairman Bernanke has been particularly frank about using the PCE Deflator for measuring inflation. The ECB’s favored inflation statistics are the Harmonized Index of Consumer Prices (HICP), and the M3 Money Supply. Earlier leaders of these institutions preferred different measures or refused to say what measures they considered important.
The collapse of the American housing market has given all statistics associated with housing and home construction substantial import. But the housing crisis will not last forever and as it ebbs so will the importance and influence of its indicators.
Headline statistics are economy wide numbers that give the broadest picture of economic conditions. Non Farm Payrolls and GDP are the best current American examples.
These statistics have a history of volatility and of defying market predictions but they also carry pertinent information about the overall economy. The NFP number in particular relates directly to the dominate percentage of the American economy derived from consumer spending and thus to overall economic health.
There is however, another reason for the volatility that often accompanies the release of these figures. These statistics are the basis for large amounts of speculative positioning, both prior to release and immediately after.
The larger the difference between the expected number and the actual statistic, the greater the volatility as traders adjust their position to the new parameter. Even when a headline number is as predicted it can produce violent reactions as those positions based on the expected number take profit.
Headline numbers go in and out of fashion. Ten years ago the trade balance produced volatility even greater than NFP does today. But twenty years of ever worsening numbers have drained the suspense and traders have noted that the dire predictions for the American economy from permanent trade deficits have amounted to very little.
Today’s global economy is an entirely different creature than it was twenty years ago. Instantaneous global financial flows, international manufacture and trade and a 24 hour media have spread the potential and danger of trading markets to every corner of the world economy.
The speed with which the bankruptcy of Lehman Brothers undermined financial markets around the world was simply unprecedented but should not have been unexpected.
Are there indicators that better reflect the new global economy and that could become the new trading instigators? Prediction is hazardous but my nominee for the US is the Treasury International Capital System Report (TICS) of the Treasury Department. This statistic tracks foreign investment in the American economy, the purchases of American stocks bonds and Treasuries. With the Federal deficit largely funded by foreign capital what could be more important?
Joseph Trevisani
Thursday, October 8, 2009
Tuesday, September 22, 2009
Market Direction
When yields on the 10 Year Treasury note were climbing to 4.0% last spring bond traders fears were focused three items: the Federal Reserve’s liquidity provisions, the Obama administration’s ten year deficit projections and the inflationary potential of both programs. The collapse in Treasury prices prompted the Fed’s entry into the Treasury market. Its $300 billon program to purchase government debt led to suspicions that the US Government had embarked on direct monetization of its debt, printing dollars to make up for the revenues it no longer had. As the Treasury began to auction its debentures these fears undermined confidence that investors would accept the new issuance at market rates.
China and Russian were the most vocal about the danger to their American investments from a collapsing dollar but the risk applied to all holders of US notes. The Chinese and the Russians outlined their concerns in clear and unsusually plain language. Chinese officials warned the US government to be mindful of its status as the world's largest holder of US debt and cautioned Washington to act as a careful custodian of its currency. The Russian were blunter, calling for a new world reserve currency to replace the dollar.
If the debt markets did not readily buy American notes because of worries about the US dollar, American bond rates would be forced higher dragging mortgage and other US rates with them. The US government’s efforts to limit the economic damage of the financial crisis and recession would be far less effective with higher mortgage and credit card rates. Few economists and officials then thought the American economy could tolerate a substantial rise in rates.
But rhetoric aside, the Chinese had reasons of their own to fear what would have been a dangerous fall in the Treasury markets and the consequent rise in American interest rates.
China depends on the world’s economy to buy her exports. If the US Treasury markets had cratered in the spring the effect on the US economy and the world could have been catastrophic. In the frightened atmosphere last spring that risk was very high.
At the very least a collapse in the Treasury market would have heightened the sense of disaster that was just beginning to ebb, seriously deepened the recession and hastened the decline in world trade. In that febrile atmosphere a Chinese withdrawal from the US Treasury markets would have had global effects.
Chinese exports contracted dramatically in the late fall, winter and early spring. Factories closed, millions of migrant workers to the cities were thrown out of work bringing with them the specter of civil unrest which is never far from the minds of the rulers in Beijing.
When the US began its Treasury auctions China’s immediate self interest kept her actively involved. As the most visible of the world’s governments participating in the Treasury market any sign of actual withdrawal, as opposed to theoretical criticism, would have had a dire effect on the worldwide appetite for US debt.
China clearly had and has a present interest in keeping the US Treasury market from sinking and in keeping US rates low and the US economy on track for the strongest recovery possible. But there is also a long term Chinese interest in fostering the US debt binge.
The Obama administration has embarked on the largest expansion of US debt in history. Its legislative plans include the greatest addition to government services since the Depression. Such a program cannot be accomplished without the cooperation of the world’s credit markets; the leading buyers of US debt are other governments with China paramount. If China does not acquiesce to the increase in US debt the administration will have a much harder time enacting its plans. The most likely political result in Washington would be a curtailment of US Government spending and a drop in the amount of debt that the Treasury would have to issue.
But if the administration is able to complete its economic agenda the result will be an enormous increase of US debt and eventually higher taxes to pay for those programs and the debt.
The exaction that this debt will take from the US economy in lower productivity and economic growth will permanently alter the position of the US economy in the world. If the administration completes its agenda then the dollar will decline, slowly but inexorably, as the US economy slips from its position as the most vibrant mature industrial economy and loses it position as the world's largest national economy.
The possibility for a devaluation of Chinese dollar holding is very real but perhaps Beijing considers it a down payment on the future. Would it not be a worthy price to pay for assisting the self-imposed crippling of her greatest economic competitor?
Joseph Trevisani
China and Russian were the most vocal about the danger to their American investments from a collapsing dollar but the risk applied to all holders of US notes. The Chinese and the Russians outlined their concerns in clear and unsusually plain language. Chinese officials warned the US government to be mindful of its status as the world's largest holder of US debt and cautioned Washington to act as a careful custodian of its currency. The Russian were blunter, calling for a new world reserve currency to replace the dollar.
If the debt markets did not readily buy American notes because of worries about the US dollar, American bond rates would be forced higher dragging mortgage and other US rates with them. The US government’s efforts to limit the economic damage of the financial crisis and recession would be far less effective with higher mortgage and credit card rates. Few economists and officials then thought the American economy could tolerate a substantial rise in rates.
But rhetoric aside, the Chinese had reasons of their own to fear what would have been a dangerous fall in the Treasury markets and the consequent rise in American interest rates.
China depends on the world’s economy to buy her exports. If the US Treasury markets had cratered in the spring the effect on the US economy and the world could have been catastrophic. In the frightened atmosphere last spring that risk was very high.
At the very least a collapse in the Treasury market would have heightened the sense of disaster that was just beginning to ebb, seriously deepened the recession and hastened the decline in world trade. In that febrile atmosphere a Chinese withdrawal from the US Treasury markets would have had global effects.
Chinese exports contracted dramatically in the late fall, winter and early spring. Factories closed, millions of migrant workers to the cities were thrown out of work bringing with them the specter of civil unrest which is never far from the minds of the rulers in Beijing.
When the US began its Treasury auctions China’s immediate self interest kept her actively involved. As the most visible of the world’s governments participating in the Treasury market any sign of actual withdrawal, as opposed to theoretical criticism, would have had a dire effect on the worldwide appetite for US debt.
China clearly had and has a present interest in keeping the US Treasury market from sinking and in keeping US rates low and the US economy on track for the strongest recovery possible. But there is also a long term Chinese interest in fostering the US debt binge.
The Obama administration has embarked on the largest expansion of US debt in history. Its legislative plans include the greatest addition to government services since the Depression. Such a program cannot be accomplished without the cooperation of the world’s credit markets; the leading buyers of US debt are other governments with China paramount. If China does not acquiesce to the increase in US debt the administration will have a much harder time enacting its plans. The most likely political result in Washington would be a curtailment of US Government spending and a drop in the amount of debt that the Treasury would have to issue.
But if the administration is able to complete its economic agenda the result will be an enormous increase of US debt and eventually higher taxes to pay for those programs and the debt.
The exaction that this debt will take from the US economy in lower productivity and economic growth will permanently alter the position of the US economy in the world. If the administration completes its agenda then the dollar will decline, slowly but inexorably, as the US economy slips from its position as the most vibrant mature industrial economy and loses it position as the world's largest national economy.
The possibility for a devaluation of Chinese dollar holding is very real but perhaps Beijing considers it a down payment on the future. Would it not be a worthy price to pay for assisting the self-imposed crippling of her greatest economic competitor?
Joseph Trevisani
Tuesday, September 15, 2009
Market Direction
The yen carry trade was one of the great runs in modern currency history. A long position opened in late in late 2003 and held until mid-2007 appreciated over 30% in capital and could have earned upwards of 7% a year on the interest rate spread. At the trade’s height from mid-2005 until the summer of 2007 the trajectory of yen crosses rose with barely a correction.
Japanese rates in that period never rose above 0.5%. The worldwide lure of yen funding was not only the extremely low cost of money but the knowledge that the Bank of Japan (BOJ) could not raise rates.
Interest rates in the United States are the equivalent of the zero rate policy in Japan. If the Fed cannot raise rates because of anemic US economic growth will the dollar replace the yen as the world funding currency?
The extended period of effective zero interest rates in Japan was the financial rationale for the carry trade. But low interest rates alone did not account for the longevity of the yen carry trade. Long positioning in the carry returned the rate differential and trading interest and easy credit for speculators kept the crosses moving higher. But equally important was the trap that the Japanese economy held for the BOJ. The Japanese central bank could not raise rates. The performance of the Japanese economy since 1989 and her political reality precluded it. Currency traders enjoyed a more than reasonable conviction that whatever BOJ officials might say Japanese rates would stay low.
Japan’s lost decade began in late 1989 when the Bank of Japan sharply raised interest rates to combat a credit fueled bubble in the property and stock markets. Both markets crashed. Twenty years later neither have regained the prices of that decade. But having engineered the calamity the Japanese government did not insist on the rationalization of insolvent banks and industrial companies. Banks were kept alive with government aid and falling companies were supported by bank loans and subsidies. Economic growth ground to a halt.
From 1995 onward the main Japanese interest rate set by the Bank of Japan was never higher than 0.5%. But the extremely low rates did not spur economic growth. The zero rate policy which the bank began in 2001 to counter price deflation and foster economic activity accomplished neither goal.
It was the boom years of the world economy in the middle part of this decade and the external demand for Japanese goods that dragged the export dominated Japanese economy out of its self-inflicted doldrums. With the collapse in world demand last year the Japanese economy was again trapped by its export model. Fifteen years of massive government spending and little economic reform has only succeeded in raising the Japanese debt level to the highest in the industrial world without building a solid domestic base of consumption. Japan’s lost decade could well become permanent if world demand for Japanese products does not recover
In order for the dollar to become the world’s long term funding currency, as the yen was for the better part of the decade, low interest rates are not sufficient. Markets must also become convinced that US rates will stay low for a prolonged period; that period is probably well beyond the horizon currently implied by Fed Chairman Bernanke. Whatever the problems of the American economy markets are far from convinced that a ten year Japanese economic morass awaits the United States.
The currency reaction to the financial crisis and its logic has been well documented. Overnight the dollar and the United States Government became the repository of much of the world’s portable risk capital. The majority of that temporary capital infusion has now left the US seeking investment elsewhere in the world.
The Federal Reserve response to the sub-prime housing problem began two years ago in September 2007 when it cut rates 0.5%. Since then the Fed has taken US rates effectively to zero and supplied enormous amounts of liquidity to the economy, initially to stave off economic collapse and subsequently to secure economic growth.
But the US economy, despite massive losses in property and equities and continuing job destruction, is not facing the economic stasis of Japan’s lost decade
The US economy is larger and more diverse than Japan's. Exports do not dominate the economy. The US population is growing and domestic consumption is the bulk of GDP. The US financial and economic system is far less controlled by the central government and economic rationalization of banks and companies is taking place. The US will probably not have a large number of companies kept alive with permanent government subsidies. In short the US economy is still expected to recover and to grow next year. The Fed will not have to keep rates below 0.5% for a decade. Far more likely is a Fed rate hike cycle beginning in late 2010 or 2011.
The dollar will not become the new world funding currency as long as the US economy performs within a range of its historical potential. If traders thought there was a good chance that the Fed would be forced to emulate the BOJ zero rate policy for a decade then the dollar would already have seen far heavier losses than it has.
Traders are not yet betting on a lost decade in the US. Until they do the dollar will be a funding currency only until the Fed first hints at higher rates The world will borrow cheaply in the US as long as it can, but there will be no five year carry trade punishing the dollar, at least not yet.
Joseph Trevisani
Japanese rates in that period never rose above 0.5%. The worldwide lure of yen funding was not only the extremely low cost of money but the knowledge that the Bank of Japan (BOJ) could not raise rates.
Interest rates in the United States are the equivalent of the zero rate policy in Japan. If the Fed cannot raise rates because of anemic US economic growth will the dollar replace the yen as the world funding currency?
The extended period of effective zero interest rates in Japan was the financial rationale for the carry trade. But low interest rates alone did not account for the longevity of the yen carry trade. Long positioning in the carry returned the rate differential and trading interest and easy credit for speculators kept the crosses moving higher. But equally important was the trap that the Japanese economy held for the BOJ. The Japanese central bank could not raise rates. The performance of the Japanese economy since 1989 and her political reality precluded it. Currency traders enjoyed a more than reasonable conviction that whatever BOJ officials might say Japanese rates would stay low.
Japan’s lost decade began in late 1989 when the Bank of Japan sharply raised interest rates to combat a credit fueled bubble in the property and stock markets. Both markets crashed. Twenty years later neither have regained the prices of that decade. But having engineered the calamity the Japanese government did not insist on the rationalization of insolvent banks and industrial companies. Banks were kept alive with government aid and falling companies were supported by bank loans and subsidies. Economic growth ground to a halt.
From 1995 onward the main Japanese interest rate set by the Bank of Japan was never higher than 0.5%. But the extremely low rates did not spur economic growth. The zero rate policy which the bank began in 2001 to counter price deflation and foster economic activity accomplished neither goal.
It was the boom years of the world economy in the middle part of this decade and the external demand for Japanese goods that dragged the export dominated Japanese economy out of its self-inflicted doldrums. With the collapse in world demand last year the Japanese economy was again trapped by its export model. Fifteen years of massive government spending and little economic reform has only succeeded in raising the Japanese debt level to the highest in the industrial world without building a solid domestic base of consumption. Japan’s lost decade could well become permanent if world demand for Japanese products does not recover
In order for the dollar to become the world’s long term funding currency, as the yen was for the better part of the decade, low interest rates are not sufficient. Markets must also become convinced that US rates will stay low for a prolonged period; that period is probably well beyond the horizon currently implied by Fed Chairman Bernanke. Whatever the problems of the American economy markets are far from convinced that a ten year Japanese economic morass awaits the United States.
The currency reaction to the financial crisis and its logic has been well documented. Overnight the dollar and the United States Government became the repository of much of the world’s portable risk capital. The majority of that temporary capital infusion has now left the US seeking investment elsewhere in the world.
The Federal Reserve response to the sub-prime housing problem began two years ago in September 2007 when it cut rates 0.5%. Since then the Fed has taken US rates effectively to zero and supplied enormous amounts of liquidity to the economy, initially to stave off economic collapse and subsequently to secure economic growth.
But the US economy, despite massive losses in property and equities and continuing job destruction, is not facing the economic stasis of Japan’s lost decade
The US economy is larger and more diverse than Japan's. Exports do not dominate the economy. The US population is growing and domestic consumption is the bulk of GDP. The US financial and economic system is far less controlled by the central government and economic rationalization of banks and companies is taking place. The US will probably not have a large number of companies kept alive with permanent government subsidies. In short the US economy is still expected to recover and to grow next year. The Fed will not have to keep rates below 0.5% for a decade. Far more likely is a Fed rate hike cycle beginning in late 2010 or 2011.
The dollar will not become the new world funding currency as long as the US economy performs within a range of its historical potential. If traders thought there was a good chance that the Fed would be forced to emulate the BOJ zero rate policy for a decade then the dollar would already have seen far heavier losses than it has.
Traders are not yet betting on a lost decade in the US. Until they do the dollar will be a funding currency only until the Fed first hints at higher rates The world will borrow cheaply in the US as long as it can, but there will be no five year carry trade punishing the dollar, at least not yet.
Joseph Trevisani
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