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Showing posts with label Forex. Show all posts
Showing posts with label Forex. Show all posts
Tuesday, May 10, 2016
Thursday, November 26, 2009
Market Direction
The Dollar Index (DXY) is usually considered a trading equivalent of the spot currencies on which it is based. But despite its firmly speculative nature, the index has been no more volatile than its currency components over the past year and in specific cases it has been considerably less so.
The DXY is composed of a basket of five currencies, Euro 57.6%, Yen 13.6%, Sterling 11.9%, Canadian Dollar 9.1%, Swedish Krona 4.2%, and Swiss Franc 3.6%. The index, whose futures trade on the Intercontinental Exchange, was originally created in 1973 by JP Morgan. It components have only been rebalanced once for the inception of the Euro.
Indices are private trading vehicles designed to reflect market interest and to be instruments that traders find useful for speculation. They are designed solely to attract trading enthusiasm; they are not necessarily intended to accurately reflect the economic or financial realities of the currency or its country.
DXY 10 Year Chart (Bloomberg)
The DXY does not mirror the United States trade position in the global economy. It is heavily weighted to Europe, undervalues the Canadian Dollar, ignores South Korea Taiwan and by necessity China. A firm cannot settle a trade flow in the DXY nor is it particularly useful as a hedge because of the specific matrix of its components. But because of these non-economic aspects, an index may conceivably reflect speculative currency opinion more accurately than the underlying currencies. Indices are not directly buffeted by trade flows, subject to investment and capital controls, banking regulation and other rules and regulation impinging on currency speculation except as they affect the constituent components of the index. The speculative urge should dominate the index.
For these reasons the DXY and other instruments like it are thought to reflect overall speculative dollar sentiment without the complicating factors of economics and finance. As example if dollar sentiment is negative then it could be more negative in an index because the makeup of open positioning will only be between the overall positive and negative market sentiment for the currency. From a trader’s point of view, the more an index reflects speculative intent the more volatility it is likely to contain and the more it will move. Movement equals profit, or at least potential profits.
Over the past year dollar sentiment has boomed during the acute crisis phase of the financial crisis, from September to early March for most currencies, and then beat a long retreat as the fear of world economic collapse has ebbed. Is this movement reflected in the volatility of the DXY and does it compare to the shifts in its major components?
During the Dollar positive phase of the crisis, the DXY gained 18% (9/22/08-3/4/09). In the same time frame the US Dollar added 16% versus the Euro (9/22/08 to 3/4/09 and 22% from the 7/15/08 low), 26% against the Sterling (9/18/08 to 1/23/09), 8% against the Swiss Franc (9/22/08-3/12/09), and 27% versus the Canadian Dollar. The American Dollar lost 0.5% % against the Yen from September to early April but gained 16% from its December low to its April 4th high.
The Yen is the exception to the general improvement in the Dollar in this period because its valuation was driven by the precipitous fall in the Yen crosses. The Yen crosses had to reach their nadir which the Euro/Yen did on January 21st before the Dollar could begin to trade higher on its own against the Japanese currency.
Since the index reached its crisis high on March 4th of this year it has lost 16% to Friday’s close. In that same period and from its March high the Dollar lost 19% against the Euro, 23% against the Sterling (from 3/11), 12% versus the Yen, 15% against the Swiss Franc and 19% against the Canadian. The Dollar lost more against each component currency except the Yen and the Swiss that it did in the DXY. From a speculative trading perspective, as least during the Dollar retreat, the components were the place to be.
The peculiar conditions of the financial crisis may have played a large part in this unusual volatility in the real rather than the created currency. The salient fact in the first phase of the crisis was the pursuit of safety by any means. The currency flows during this period were a flood into dollar assets and then in the work out phase an even greater flood out. It seems that when these flows were added to the normal speculative positioning in the currencies they added substantially to the volatility in the real rather than the DXY.
The trading advantage of the currencies over the Dollar Index was most pronounced in the Dollar retreat. Once the reasons for the Dollar ascent in the acute phase of the crisis became clear, and it also became evident that the government rescues would succeed, large speculative interest joined the simple reversal of the pro-Dollar risk aversion trade. These speculative positions were all against the Dollar. Once traders had a chance to assay the situation it became obvious that the abnormal piling into Dollar assets would reverse and the market would join in the rout.
In currency trading the advantage for potential profitability between a derivative and its underlying generally lies with the underlying instrument. For the Dollar Index it is no different. Even during the immense dislocation of the financial crisis the greatest potential for profit was in the spot currencies themselves.
Joseph Trevisani
The DXY is composed of a basket of five currencies, Euro 57.6%, Yen 13.6%, Sterling 11.9%, Canadian Dollar 9.1%, Swedish Krona 4.2%, and Swiss Franc 3.6%. The index, whose futures trade on the Intercontinental Exchange, was originally created in 1973 by JP Morgan. It components have only been rebalanced once for the inception of the Euro.
Indices are private trading vehicles designed to reflect market interest and to be instruments that traders find useful for speculation. They are designed solely to attract trading enthusiasm; they are not necessarily intended to accurately reflect the economic or financial realities of the currency or its country.
DXY 10 Year Chart (Bloomberg)
The DXY does not mirror the United States trade position in the global economy. It is heavily weighted to Europe, undervalues the Canadian Dollar, ignores South Korea Taiwan and by necessity China. A firm cannot settle a trade flow in the DXY nor is it particularly useful as a hedge because of the specific matrix of its components. But because of these non-economic aspects, an index may conceivably reflect speculative currency opinion more accurately than the underlying currencies. Indices are not directly buffeted by trade flows, subject to investment and capital controls, banking regulation and other rules and regulation impinging on currency speculation except as they affect the constituent components of the index. The speculative urge should dominate the index.
For these reasons the DXY and other instruments like it are thought to reflect overall speculative dollar sentiment without the complicating factors of economics and finance. As example if dollar sentiment is negative then it could be more negative in an index because the makeup of open positioning will only be between the overall positive and negative market sentiment for the currency. From a trader’s point of view, the more an index reflects speculative intent the more volatility it is likely to contain and the more it will move. Movement equals profit, or at least potential profits.
Over the past year dollar sentiment has boomed during the acute crisis phase of the financial crisis, from September to early March for most currencies, and then beat a long retreat as the fear of world economic collapse has ebbed. Is this movement reflected in the volatility of the DXY and does it compare to the shifts in its major components?
During the Dollar positive phase of the crisis, the DXY gained 18% (9/22/08-3/4/09). In the same time frame the US Dollar added 16% versus the Euro (9/22/08 to 3/4/09 and 22% from the 7/15/08 low), 26% against the Sterling (9/18/08 to 1/23/09), 8% against the Swiss Franc (9/22/08-3/12/09), and 27% versus the Canadian Dollar. The American Dollar lost 0.5% % against the Yen from September to early April but gained 16% from its December low to its April 4th high.
The Yen is the exception to the general improvement in the Dollar in this period because its valuation was driven by the precipitous fall in the Yen crosses. The Yen crosses had to reach their nadir which the Euro/Yen did on January 21st before the Dollar could begin to trade higher on its own against the Japanese currency.
Since the index reached its crisis high on March 4th of this year it has lost 16% to Friday’s close. In that same period and from its March high the Dollar lost 19% against the Euro, 23% against the Sterling (from 3/11), 12% versus the Yen, 15% against the Swiss Franc and 19% against the Canadian. The Dollar lost more against each component currency except the Yen and the Swiss that it did in the DXY. From a speculative trading perspective, as least during the Dollar retreat, the components were the place to be.
The peculiar conditions of the financial crisis may have played a large part in this unusual volatility in the real rather than the created currency. The salient fact in the first phase of the crisis was the pursuit of safety by any means. The currency flows during this period were a flood into dollar assets and then in the work out phase an even greater flood out. It seems that when these flows were added to the normal speculative positioning in the currencies they added substantially to the volatility in the real rather than the DXY.
The trading advantage of the currencies over the Dollar Index was most pronounced in the Dollar retreat. Once the reasons for the Dollar ascent in the acute phase of the crisis became clear, and it also became evident that the government rescues would succeed, large speculative interest joined the simple reversal of the pro-Dollar risk aversion trade. These speculative positions were all against the Dollar. Once traders had a chance to assay the situation it became obvious that the abnormal piling into Dollar assets would reverse and the market would join in the rout.
In currency trading the advantage for potential profitability between a derivative and its underlying generally lies with the underlying instrument. For the Dollar Index it is no different. Even during the immense dislocation of the financial crisis the greatest potential for profit was in the spot currencies themselves.
Joseph Trevisani
Wednesday, November 18, 2009
Market Direction
President Obama’s trip to Asia is one part introduction, one part diplomatic dialogue and eight parts competitive economics. Whatever agreements are met with leaders of Japan, and South Korean or communiqués are issued from the Asia-Pacific Economic Cooperation Conference (APEC) in Singapore, it is the visit to Beijing that matters.
The American President would like China’s cooperation on the Iranian and North Korean nuclear programs, a more flexible currency policy for the yuan, open trade and continued Chinese purchase of American debt. He is likely to obtain only the last, the price for which will be all the others.
China wants unquestioned sovereignty over Tibet, an uncritical acceptance of its internal political and economic policies and reassurance that the United States will honor its debts, rein in deficit spending and prevent a dollar collapse.
The Beijing rulers received assurance on Tibet when Obama refused to see the exiled Tibetan Dali Lama. This administration has not, as in previous terms, harangued China to open its political and economic system. There has been little or no criticism of China from the American political establishment prior to this trip, Treasury Secretary Geithner’s ‘manipulated yuan’ comment before the Senate Finance Committee notwithstanding.
The trade-off will come between the competitive economic agendas of China and the United States. The terms of this agreement have already been set; the China trip simply makes the new status quo plain for all to see.
President Obama will reassure President Hu that Washington takes its debt obligations seriously, that it is about to become serious about controlling Federal spending and that it holds to a strong dollar policy. President Hu will promise not to withdraw Chinese support from the Treasury market. The Chinese will pretend to believe the Americans and the Americans will not press them on any other topic.
The price for China’s continued support of the US debt market and by extension of the administration’s domestic agenda is American acquiescence in all international topics of importance to China. For the Chinese it is an excellent trade, a chance to neuter its greatest international adversary for the price of an investment it would probably have to make anyway. The basic fact of the trade is that China feels it has choices and the United States fears it does not. As long as a Chinese withdrawal from the US debt markets is more frightening to Washington than to Beijing China will have the upper hand in this relationship.
The Chinese currency policy does not just affect its trade with the United States. Because the yuan has been essentially fixed against the dollar since last summer it has depreciated against all other currencies as the dollar has fallen. Terms of trade have worsened for Europe, South Korean, Japan, Taiwan and all of China’s trading partners. Asian central banks have had to spend billions of reserves defending the dollar against their own currencies lest the appreciation become detrimental to their economies. Though the recession has been less severe in Asia it has not skipped over the region. World trade has had a larger percentage drop than the fall in GDP of any individual national economy; the economies that depend most heavily on exports have suffered the most. It does not help that the currency markets have long participated in the positive speculative view of Asian currencies against the dollar.
China’s position as the chief and most important creditor of the United States gives it an influence in the world economy much greater than its relatively fragile political and economic strength warrants. Only the United States has the economic, political and military weight to challenge the Beijing Government’s economic and trade policies. But US opposition is hamstrung by its need to petition the Chinese for more and more money. One cannot ask one’s banker for bigger and bigger loans and then complain about the interest rate.
Beijing’s understanding of the terms of trade that are best for the Chinese economy is encapsulated by its yuan policy. In the long run a currency program that beggars its neighbors does not do China, its trading partners or the world economy any good. After all someone, someplace has to buy Chinese products. Stable economic development for China, as for all others, depends on a domestic economy that absorbs a large portion of the national production. But, at least for the time being China’s rulers have decided that they can obtain a better deal in the global market than the combined opposition of her trading partners led by the United States would have formerly permitted.
President Obama’s visit to Beijing is an acknowledgement of the new status quo in the world economy. China will set the terms of her trade for the world until the United States regains control of its own budget.
Joseph Trevisani
The American President would like China’s cooperation on the Iranian and North Korean nuclear programs, a more flexible currency policy for the yuan, open trade and continued Chinese purchase of American debt. He is likely to obtain only the last, the price for which will be all the others.
China wants unquestioned sovereignty over Tibet, an uncritical acceptance of its internal political and economic policies and reassurance that the United States will honor its debts, rein in deficit spending and prevent a dollar collapse.
The Beijing rulers received assurance on Tibet when Obama refused to see the exiled Tibetan Dali Lama. This administration has not, as in previous terms, harangued China to open its political and economic system. There has been little or no criticism of China from the American political establishment prior to this trip, Treasury Secretary Geithner’s ‘manipulated yuan’ comment before the Senate Finance Committee notwithstanding.
The trade-off will come between the competitive economic agendas of China and the United States. The terms of this agreement have already been set; the China trip simply makes the new status quo plain for all to see.
President Obama will reassure President Hu that Washington takes its debt obligations seriously, that it is about to become serious about controlling Federal spending and that it holds to a strong dollar policy. President Hu will promise not to withdraw Chinese support from the Treasury market. The Chinese will pretend to believe the Americans and the Americans will not press them on any other topic.
The price for China’s continued support of the US debt market and by extension of the administration’s domestic agenda is American acquiescence in all international topics of importance to China. For the Chinese it is an excellent trade, a chance to neuter its greatest international adversary for the price of an investment it would probably have to make anyway. The basic fact of the trade is that China feels it has choices and the United States fears it does not. As long as a Chinese withdrawal from the US debt markets is more frightening to Washington than to Beijing China will have the upper hand in this relationship.
The Chinese currency policy does not just affect its trade with the United States. Because the yuan has been essentially fixed against the dollar since last summer it has depreciated against all other currencies as the dollar has fallen. Terms of trade have worsened for Europe, South Korean, Japan, Taiwan and all of China’s trading partners. Asian central banks have had to spend billions of reserves defending the dollar against their own currencies lest the appreciation become detrimental to their economies. Though the recession has been less severe in Asia it has not skipped over the region. World trade has had a larger percentage drop than the fall in GDP of any individual national economy; the economies that depend most heavily on exports have suffered the most. It does not help that the currency markets have long participated in the positive speculative view of Asian currencies against the dollar.
China’s position as the chief and most important creditor of the United States gives it an influence in the world economy much greater than its relatively fragile political and economic strength warrants. Only the United States has the economic, political and military weight to challenge the Beijing Government’s economic and trade policies. But US opposition is hamstrung by its need to petition the Chinese for more and more money. One cannot ask one’s banker for bigger and bigger loans and then complain about the interest rate.
Beijing’s understanding of the terms of trade that are best for the Chinese economy is encapsulated by its yuan policy. In the long run a currency program that beggars its neighbors does not do China, its trading partners or the world economy any good. After all someone, someplace has to buy Chinese products. Stable economic development for China, as for all others, depends on a domestic economy that absorbs a large portion of the national production. But, at least for the time being China’s rulers have decided that they can obtain a better deal in the global market than the combined opposition of her trading partners led by the United States would have formerly permitted.
President Obama’s visit to Beijing is an acknowledgement of the new status quo in the world economy. China will set the terms of her trade for the world until the United States regains control of its own budget.
Joseph Trevisani
Tuesday, October 13, 2009
Market Direction
The spectacular rise in gold, now hovering in record territory, has been fostered by three very different conceptions: gold as a trader’s choice, gold as a theoretical proof and gold as a historical metaphor.
For the believers in metaphor the ascent of the metal is an augury for the decline of the west; for the theoreticians it is the only secure defense against inflation; for the traders it is a momentum purchase not to be missed. All three groups are buying gold and as yet, none have been proven wrong.
If we translate these speculations into currency terms the traders promise a long position with better returns than any other investment. The theoreticians predict a global currency system ravaged by government inflation and a revolving cast of devalued national scripts. And the third intimates the ultimate end of the dollar as the world reserve currency presumably replaced by the yuan. All three foresee a continued fall in the value of the dollar.
The economic logic of the three groups of gold supporters is currently aligned and all are profiting from the rise in prices. But it would be remarkable if three such disparate scenarios remained in tune for long.
The east may indeed replace the west as the dominant global economic center but it will not do so in time for the ‘metaphorical Spenglerians’ (so named for Oswald Spengler who published The Decline of the West in 1918) to take profit on their investment. Even if true the western decline will be slow and erratic and these position takers will miss their profit levels waiting for the final collapse.
For the theoreticians or monetarists, the second group of ‘gold bugs’, inflation will suddenly spring out of the ground like the product of so many governmental dragons’ teeth. It is inevitable, increase the money supply and inflation follows.
However, with prices in decline in many industrial economies and unemployment at a new and much higher normal, it is hard to see firms extracting higher prices from consumers when cheaper international goods are so readily available. Whatever the theoretical prospect for inflation the current empirical evidence points the other way, toward deflation.
For the third group, the traders, theory and metaphor are irrelevent. The global financial system is under a soothing blanket of liquidity. The central bankers who have warmed the world with cash and who are now (we assume) very aware of the danger of prolonged cheap credit will (we assume), sooner or later, begin to draw back the protecting cover of liquidity. But the reabsorption of liquidity by the banks is wholly conditional on economic recovery. The most forthright of the world’s central bankers, Ben Bernanke of the American Federal Reserve has stated this over and over; there is no reason to doubt his word.
The gold buyers in this group believe the Chairman. Until the central bank begins to tighten credit, excess cash and the pursuit of trading profit determines the price of gold. It does not matter that the bankers say they will tighten credit when the proper time comes, what matters is action. Until the banks actually begin to raise rates and subtract liquidity, for them, gold is a solid buy.
Of the three scenarios the first, the ‘Spenglerian’ is the most impervious to evidence. It exists apart from factual verification or to put it another way, it is always possible to find evidence that the west is declining. It is just a matter of choosing the right statistics. In practical and emotional terms this group will always be long gold, though it is in unsettled times like ours that they do the most buying.
For the monetarists results depend largely on logic and economic equations. If so much liquidity is loosed on financial markets it must over time (duration unspecified) produce inflation. It is a simple monetary equation, a rising pile of cash chasing a much more slowly rising pile of goods and assets. Over time inflation is the end product. But inflation is not solely the product of a balanced equation between cash and goods. Firms must be able to raise prices and consumers must be able to pay those higher prices and those last factors are now very much absent.
Yet economic stagnation and inflation are not mutually exclusive. If returning American economic growth is not sufficient to reduce unemployment what are the chances that the Fed will commence raising rates regardless of the price index? And if on the other side of the world East Asian economic growth takes off and forces commodity and goods prices higher those prices will shortly be felt in the United States. Irrespective of what the US economy is doing the world’s markets can export inflation to the US.
What would prevent the price of oil from climbing as it did last summer if the Chinese, Indian and Brazilian economies accelerate and that third of the world creates its own economic cycle? Will the US be dragged by East Asia into robust recovery? Unknown. But the effect on the overextended American consumer and economy of $100 oil is not unfathomable. There is no certainty that one third of the world economy will be dynamic enough to force prices higher in the US. But if inflation comes in the US it will probably arrive from overseas and US domestic liquidity will have done little to create it.
For the Fed to raise rates and by default defend the dollar US economic growth will have to be robust enough to begin to take down the unemployment rate. This is an entirely unsure prospect.
US consumers are tapped there has been no sign in retails sales or consumer credit that the drivers of US growth have resumed their seats behind the wheel. The effect of a weak dollar on US exports may be pronounced. Shipments may increase enough to substantially reduce the trade deficit. But the US is not an export driven economy nor is its work force widely engaged in manufacturing. Exports may grow appreciably without it having any noticeable effect on American unemployment. Exports might look excellent to economists and free traders without US workers feeling any better or increasing their spending.
Of the three gold buying groups, the monetarists and the traders are most susceptible to Fed policy changes. But the traders are likely to act first. For them the earliest indication of a genuine change in Fed policy will be enough to abandon their long gold positions for profit. Monetarists are likely to wait until they are sure the Fed will act and then wait again until there is proof that the Fed has acted in time to prevent inflation.
And there we have the pernicious effect on the dollar. Until the Federal Reserve reestablishes the link between economic growth and interest rates the logic of the gold buyers is inescapable. Gold is not predicting a decline in the dollar or the inevitable advent of inflation but it is promising that without a vigilant Fed the first will continue and the second creep ever closer.
Joseph Trevisani
For the believers in metaphor the ascent of the metal is an augury for the decline of the west; for the theoreticians it is the only secure defense against inflation; for the traders it is a momentum purchase not to be missed. All three groups are buying gold and as yet, none have been proven wrong.
If we translate these speculations into currency terms the traders promise a long position with better returns than any other investment. The theoreticians predict a global currency system ravaged by government inflation and a revolving cast of devalued national scripts. And the third intimates the ultimate end of the dollar as the world reserve currency presumably replaced by the yuan. All three foresee a continued fall in the value of the dollar.
The economic logic of the three groups of gold supporters is currently aligned and all are profiting from the rise in prices. But it would be remarkable if three such disparate scenarios remained in tune for long.
The east may indeed replace the west as the dominant global economic center but it will not do so in time for the ‘metaphorical Spenglerians’ (so named for Oswald Spengler who published The Decline of the West in 1918) to take profit on their investment. Even if true the western decline will be slow and erratic and these position takers will miss their profit levels waiting for the final collapse.
For the theoreticians or monetarists, the second group of ‘gold bugs’, inflation will suddenly spring out of the ground like the product of so many governmental dragons’ teeth. It is inevitable, increase the money supply and inflation follows.
However, with prices in decline in many industrial economies and unemployment at a new and much higher normal, it is hard to see firms extracting higher prices from consumers when cheaper international goods are so readily available. Whatever the theoretical prospect for inflation the current empirical evidence points the other way, toward deflation.
For the third group, the traders, theory and metaphor are irrelevent. The global financial system is under a soothing blanket of liquidity. The central bankers who have warmed the world with cash and who are now (we assume) very aware of the danger of prolonged cheap credit will (we assume), sooner or later, begin to draw back the protecting cover of liquidity. But the reabsorption of liquidity by the banks is wholly conditional on economic recovery. The most forthright of the world’s central bankers, Ben Bernanke of the American Federal Reserve has stated this over and over; there is no reason to doubt his word.
The gold buyers in this group believe the Chairman. Until the central bank begins to tighten credit, excess cash and the pursuit of trading profit determines the price of gold. It does not matter that the bankers say they will tighten credit when the proper time comes, what matters is action. Until the banks actually begin to raise rates and subtract liquidity, for them, gold is a solid buy.
Of the three scenarios the first, the ‘Spenglerian’ is the most impervious to evidence. It exists apart from factual verification or to put it another way, it is always possible to find evidence that the west is declining. It is just a matter of choosing the right statistics. In practical and emotional terms this group will always be long gold, though it is in unsettled times like ours that they do the most buying.
For the monetarists results depend largely on logic and economic equations. If so much liquidity is loosed on financial markets it must over time (duration unspecified) produce inflation. It is a simple monetary equation, a rising pile of cash chasing a much more slowly rising pile of goods and assets. Over time inflation is the end product. But inflation is not solely the product of a balanced equation between cash and goods. Firms must be able to raise prices and consumers must be able to pay those higher prices and those last factors are now very much absent.
Yet economic stagnation and inflation are not mutually exclusive. If returning American economic growth is not sufficient to reduce unemployment what are the chances that the Fed will commence raising rates regardless of the price index? And if on the other side of the world East Asian economic growth takes off and forces commodity and goods prices higher those prices will shortly be felt in the United States. Irrespective of what the US economy is doing the world’s markets can export inflation to the US.
What would prevent the price of oil from climbing as it did last summer if the Chinese, Indian and Brazilian economies accelerate and that third of the world creates its own economic cycle? Will the US be dragged by East Asia into robust recovery? Unknown. But the effect on the overextended American consumer and economy of $100 oil is not unfathomable. There is no certainty that one third of the world economy will be dynamic enough to force prices higher in the US. But if inflation comes in the US it will probably arrive from overseas and US domestic liquidity will have done little to create it.
For the Fed to raise rates and by default defend the dollar US economic growth will have to be robust enough to begin to take down the unemployment rate. This is an entirely unsure prospect.
US consumers are tapped there has been no sign in retails sales or consumer credit that the drivers of US growth have resumed their seats behind the wheel. The effect of a weak dollar on US exports may be pronounced. Shipments may increase enough to substantially reduce the trade deficit. But the US is not an export driven economy nor is its work force widely engaged in manufacturing. Exports may grow appreciably without it having any noticeable effect on American unemployment. Exports might look excellent to economists and free traders without US workers feeling any better or increasing their spending.
Of the three gold buying groups, the monetarists and the traders are most susceptible to Fed policy changes. But the traders are likely to act first. For them the earliest indication of a genuine change in Fed policy will be enough to abandon their long gold positions for profit. Monetarists are likely to wait until they are sure the Fed will act and then wait again until there is proof that the Fed has acted in time to prevent inflation.
And there we have the pernicious effect on the dollar. Until the Federal Reserve reestablishes the link between economic growth and interest rates the logic of the gold buyers is inescapable. Gold is not predicting a decline in the dollar or the inevitable advent of inflation but it is promising that without a vigilant Fed the first will continue and the second creep ever closer.
Joseph Trevisani
Thursday, October 8, 2009
Market Direction
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
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
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
Wednesday, September 9, 2009
Market Direction
One of the most surprising developments of the financial crisis and recession has been the continued strength of the Japanese Yen.
The return of relative stability to the world financial system has not prevented the yen from retaining the majority of its crisis induced advances. The Japanese currency has held onto 75% of its gains against the dollar, 65% versus the euro, 60% from the aussie and 75% from the sterling. In comparison the dollar has retained only 47% of its euro gain, 33% of its aussie improvement and 56% of its sterling take.
From its pre-crisis lows late last summer the yen appreciated 21% against the dollar, 34% against the euro, 47% versus the aussie and 53% opposed to the pound. The dollar also improved dramatically, gaining 23% against the euro, 39% versus the Australian Dollar and 32% against the pound.
But the dollar has since given back a substantial portion of its gains keeping only an 11% improvement against the euro, 13% to the aussie and 18% against the pound. The yen however has remained potent. It is still 16% stronger against the dollar, 22% stronger against the euro, 24% versus Australian Dollar and 39% against the pound.
The dollar and the yen were the only major currencies that strengthened during the crisis and that alone gave de facto status to each as a safe haven currency. But as the dislocations in the financial system have lessened so has the safe haven benefit to the dollar. Not so, or not nearly so much, for the yen. Why has the Japanese currency retained more of its crisis enhanced quality?
At the height of the crisis enormous quantities of American investments, primarily Treasuries were purchased by panicked investors. The demand for dollars to buy those US instruments was one of the driving forces behind the greenback’s ascent. But as the acute phase of the crisis has ebbed, the funds placed in the safety of T-Bills, Notes and Bonds have gradually left the United States seeking more remunerative investments elsewhere.
The effect on the dollar has been plain and predictable. Close to half of its crisis gains have been lost. The rationale for the dollar’s rise and fall in response to the financial crisis has been logical, determined by the balance between the need for safety and earning, risk and return.
If the rise in the yen was due to the same influx of safety seeking funds, one explanation for the subsequent stability of the yen could be that the owners of those funds find in Japan a congenial investment environment. Let us look at some of the possibilities.
Perhaps investors expect the Japanese economy to recover earlier than the United States or Europe. Japan is still the second largest economy in the world and its position in Asia and as a supplier to China, the largest industrial country to sustain strong economic growth, could help restore the Japanese economy. But in reality the Japanese economy has been underperforming for more than a 15 years, throughout the economic rise of China. Japanese decline is largely due to internal factors, including expensive and protected consumer and agricultural sectors, bureaucratic and regulatory control of much of the economy, pointless and never ending domestic spending and a stultified political system that inhibited most change.
Then perhaps the victorious Democratic Party of Japan (DPJ) will be able to revive the economy and move the country into the 21st century?
But the policy prescriptions of the DPJ do not give the impression of de-regulatory pro-growth, consumer centered plans for Japan’s economy. Japanese public debt is the highest in the industrialized world at 170% of GDP. Yet the election platform of the DPJ, with its Keynesian emphasis on government spending and its vaguely anti-capitalist and anti-globalization stances seems particularly ill-suited to revive the world’s largest export dependant economy.
When the vagueness of the DPJ economic policies is coupled with the inexperience of their legislators and the opposition of the experienced and entrenched bureaucrats that really run the Japanese economy the promise for reform and restoration becomes even more problematic. It is very hard to discern a positive yen aspect from the DPJ policies themselves or from the movements of the yen in the currency markets over the past several months as the DPJ victory became almost certain.
If the prospects for the Japanese economy have not fortified the yen then perhaps the currency has been supported by its ostensible role as a proxy trade for the Chinese Yuan?
When the financial crisis struck the Beijing Government ended the managed appreciation of the yuan; it has been static against the dollar since last fall. It has been surmised that the yen has played a substitute role to the Chinese currency with traders keeping long positions in the yen as a replacement for the unavailable yuan. And while it is true that the end of yuan appreciation and the advent of yen strength coincide, it is more likely that the proxy currencies for the yuan are the Australian and New Zealand Dollars, which have had strong upward moves largely tied to the success of the Chinese economic stimulus.
If the strong yen is not a harbinger of an economically recovered Japan and if its yuan proxy quality is limited, the remaining reasons behind its supposed safe haven status become even more relevant and interesting.
The idea of the yen as a safe haven currency can be ascribed to two factors. First the likelihood of Japanese default is very low and when tied to Japan’s recent history of deflation Japanese bonds provide the investor with safety of funds and currency stability. That was also the default position of the dollar and its issuer the United States Federal government. Both currencies scored highly in the financial crisis.
The second factor applies only to the yen and might be called the empirical choice. By any measured judgment the yen is an unusual choice for a safe haven currency. Except for the unity of the Japanese political system, most other economic and interest rate factors would seem to be against it. The Japanese economy has performed dismally over the past 15 years and Japan has one of the oldest and most quickly declining populations in the world. Its potential for economic growth seems quite limited.
But the financial crisis played a stronger hand than comparative economics. The worldwide collapse in interest rates destroyed the rationale for the carry trade. The result was a vastly strengthened yen because the attendant trade to the selling of the yen crosses was the panic buying of the yen against the US Dollar. As the carry trade loans came home to Japan and the speculative positions in the yen crosses vanished with the credit lines of the hedge funds the yen was bought extensively but only to close existing positions. In other words once the loans and trade positions were covered there was far less speculative positioning against the yen than would be found in a normal market.
The equation of a stronger yen with financial turmoil was not due to the inherent strength and security of the Japanese economy but to the bubble markets in the carry trade and yen funding. The yen did not rise because traders sought the safety of Japanese investments. The yen rose because the currency markets were overwhelmed by the unwinding of the carry trade and yen funding positions.
But from an empirical view the yen appreciation coincided perfectly with the deepening of the financial crisis. It certainly appeared that the yen was being sought as a safe haven currency. And since the yen had strengthened it was, in fact if not in economic logic, a safe haven currency.
Yen strength, to borrow a phrase, prospered in a fit of absence of mind. The tremendous force of the deleveraging carry trade raised the yen to its current heights. But those forces were one way, buying the yen to close shorts but not opening new long positions.
The yen was not truly a safe haven currency during the financial crisis. With the ending of the crisis the yen has not returned to pre-crisis trading levels. The evidence that there were few safe haven flows into the yen is simple; none have left Japan to weaken the yen.
In the US, a true safe haven during the crisis, the flows that entered during the crisis have now largely left. The dollar was boosted by the flows in and declined as they left. The lack of that second move out of Japan and the yen means that the forces pushing up the yen last fall were not seeking safety in Japanese bonds. The yen was a safe haven only by a trading default of the yen crosses.
The return of relative stability to the world financial system has not prevented the yen from retaining the majority of its crisis induced advances. The Japanese currency has held onto 75% of its gains against the dollar, 65% versus the euro, 60% from the aussie and 75% from the sterling. In comparison the dollar has retained only 47% of its euro gain, 33% of its aussie improvement and 56% of its sterling take.
From its pre-crisis lows late last summer the yen appreciated 21% against the dollar, 34% against the euro, 47% versus the aussie and 53% opposed to the pound. The dollar also improved dramatically, gaining 23% against the euro, 39% versus the Australian Dollar and 32% against the pound.
But the dollar has since given back a substantial portion of its gains keeping only an 11% improvement against the euro, 13% to the aussie and 18% against the pound. The yen however has remained potent. It is still 16% stronger against the dollar, 22% stronger against the euro, 24% versus Australian Dollar and 39% against the pound.
The dollar and the yen were the only major currencies that strengthened during the crisis and that alone gave de facto status to each as a safe haven currency. But as the dislocations in the financial system have lessened so has the safe haven benefit to the dollar. Not so, or not nearly so much, for the yen. Why has the Japanese currency retained more of its crisis enhanced quality?
At the height of the crisis enormous quantities of American investments, primarily Treasuries were purchased by panicked investors. The demand for dollars to buy those US instruments was one of the driving forces behind the greenback’s ascent. But as the acute phase of the crisis has ebbed, the funds placed in the safety of T-Bills, Notes and Bonds have gradually left the United States seeking more remunerative investments elsewhere.
The effect on the dollar has been plain and predictable. Close to half of its crisis gains have been lost. The rationale for the dollar’s rise and fall in response to the financial crisis has been logical, determined by the balance between the need for safety and earning, risk and return.
If the rise in the yen was due to the same influx of safety seeking funds, one explanation for the subsequent stability of the yen could be that the owners of those funds find in Japan a congenial investment environment. Let us look at some of the possibilities.
Perhaps investors expect the Japanese economy to recover earlier than the United States or Europe. Japan is still the second largest economy in the world and its position in Asia and as a supplier to China, the largest industrial country to sustain strong economic growth, could help restore the Japanese economy. But in reality the Japanese economy has been underperforming for more than a 15 years, throughout the economic rise of China. Japanese decline is largely due to internal factors, including expensive and protected consumer and agricultural sectors, bureaucratic and regulatory control of much of the economy, pointless and never ending domestic spending and a stultified political system that inhibited most change.
Then perhaps the victorious Democratic Party of Japan (DPJ) will be able to revive the economy and move the country into the 21st century?
But the policy prescriptions of the DPJ do not give the impression of de-regulatory pro-growth, consumer centered plans for Japan’s economy. Japanese public debt is the highest in the industrialized world at 170% of GDP. Yet the election platform of the DPJ, with its Keynesian emphasis on government spending and its vaguely anti-capitalist and anti-globalization stances seems particularly ill-suited to revive the world’s largest export dependant economy.
When the vagueness of the DPJ economic policies is coupled with the inexperience of their legislators and the opposition of the experienced and entrenched bureaucrats that really run the Japanese economy the promise for reform and restoration becomes even more problematic. It is very hard to discern a positive yen aspect from the DPJ policies themselves or from the movements of the yen in the currency markets over the past several months as the DPJ victory became almost certain.
If the prospects for the Japanese economy have not fortified the yen then perhaps the currency has been supported by its ostensible role as a proxy trade for the Chinese Yuan?
When the financial crisis struck the Beijing Government ended the managed appreciation of the yuan; it has been static against the dollar since last fall. It has been surmised that the yen has played a substitute role to the Chinese currency with traders keeping long positions in the yen as a replacement for the unavailable yuan. And while it is true that the end of yuan appreciation and the advent of yen strength coincide, it is more likely that the proxy currencies for the yuan are the Australian and New Zealand Dollars, which have had strong upward moves largely tied to the success of the Chinese economic stimulus.
If the strong yen is not a harbinger of an economically recovered Japan and if its yuan proxy quality is limited, the remaining reasons behind its supposed safe haven status become even more relevant and interesting.
The idea of the yen as a safe haven currency can be ascribed to two factors. First the likelihood of Japanese default is very low and when tied to Japan’s recent history of deflation Japanese bonds provide the investor with safety of funds and currency stability. That was also the default position of the dollar and its issuer the United States Federal government. Both currencies scored highly in the financial crisis.
The second factor applies only to the yen and might be called the empirical choice. By any measured judgment the yen is an unusual choice for a safe haven currency. Except for the unity of the Japanese political system, most other economic and interest rate factors would seem to be against it. The Japanese economy has performed dismally over the past 15 years and Japan has one of the oldest and most quickly declining populations in the world. Its potential for economic growth seems quite limited.
But the financial crisis played a stronger hand than comparative economics. The worldwide collapse in interest rates destroyed the rationale for the carry trade. The result was a vastly strengthened yen because the attendant trade to the selling of the yen crosses was the panic buying of the yen against the US Dollar. As the carry trade loans came home to Japan and the speculative positions in the yen crosses vanished with the credit lines of the hedge funds the yen was bought extensively but only to close existing positions. In other words once the loans and trade positions were covered there was far less speculative positioning against the yen than would be found in a normal market.
The equation of a stronger yen with financial turmoil was not due to the inherent strength and security of the Japanese economy but to the bubble markets in the carry trade and yen funding. The yen did not rise because traders sought the safety of Japanese investments. The yen rose because the currency markets were overwhelmed by the unwinding of the carry trade and yen funding positions.
But from an empirical view the yen appreciation coincided perfectly with the deepening of the financial crisis. It certainly appeared that the yen was being sought as a safe haven currency. And since the yen had strengthened it was, in fact if not in economic logic, a safe haven currency.
Yen strength, to borrow a phrase, prospered in a fit of absence of mind. The tremendous force of the deleveraging carry trade raised the yen to its current heights. But those forces were one way, buying the yen to close shorts but not opening new long positions.
The yen was not truly a safe haven currency during the financial crisis. With the ending of the crisis the yen has not returned to pre-crisis trading levels. The evidence that there were few safe haven flows into the yen is simple; none have left Japan to weaken the yen.
In the US, a true safe haven during the crisis, the flows that entered during the crisis have now largely left. The dollar was boosted by the flows in and declined as they left. The lack of that second move out of Japan and the yen means that the forces pushing up the yen last fall were not seeking safety in Japanese bonds. The yen was a safe haven only by a trading default of the yen crosses.
Tuesday, August 11, 2009
Market Direction
The End of the Dollar Bubble
The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro. But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.
From last September until March the dominant currency trade was a direct kin to the panic in the financial markets. When in doubt, which was a constant, purchase dollar denominated assets. A huge bubble of Treasury assets were bought with foreign and domestic money. As the crisis rolled on, even though it had started in the US, involved many of the most prominent United States financial institutions, and called forth an unprecedented amount of government intervention and a deluge of dollar liquidity, nothing dented the dollar’s ascendancy. Compared with the potential for the rest of the world the United States was the safest holder of wealth.
The strength of the dollar in this period owed nothing to the traditional standards of economic and currency comparison. Though the amassing of the world’s financial liquidity in United States Treasuries would not typically be thought of as an asset bubble, by any measure of the origin and behavior of asset bubbles it was. Treasury prices were driven higher by unceasing demand which for a time ignored cost and return in a desperate race to secure principal. The psychology of fear is not very different from that of greed in its ability to push markets to excess. Bubbles can form for negative as well as positive reasons.
The dollar asset bubble began to unwind with the bottom of the equity markets in March. If the September to March dollar was the security dollar then we can call the March to June dollar the repatriating dollar.
As financial conditions gradually improved, investors sold Treasuries and placed their funds in commodities, worldwide equities, currencies and other instruments looking for appreciation and return. Because the process did not unfold at once, and because it was largely better conditions in the United States that emboldened investors to assume more risk, it seemed that whenever there were improving economic statistics in the US the dollar would sell off. In fact this was the necessary dollar selling that accompanied the repatriation of foreign-owned dollar assets or American dollar assets transferring to overseas markets and investments. .
Neither the rationale for the security dollar nor the logic for the repatriating dollar could last beyond the original financial and market conditions that produced them. Owners of investment funds will not accept minuscule earnings forever. And despite appearances the amount of funds stashed in Treasuries is not infinite. When the repatriation is complete the pressure on the dollar engendered but not caused by a mending US economy will be removed. We may have finally reached that point.
This does not necessarily mean that the dollar is poised for a strong recovery. The US economy has very serious current and pending problems and the path away from the financial crisis to recovery is unknown; but then again that applies to the rest of the world as well.
The Eurozone and Japan are trailing even the small signs of stability that have arrived in the United States. Still, if the historical performance of the US economy is considered along with the enormous fiscal and monetary stimulus that has been applied to the American economy, the dollar could well outstrip its competitors without the revival of normal economic growth anywhere in the world.
Joseph Trevisani
The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro. But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.
From last September until March the dominant currency trade was a direct kin to the panic in the financial markets. When in doubt, which was a constant, purchase dollar denominated assets. A huge bubble of Treasury assets were bought with foreign and domestic money. As the crisis rolled on, even though it had started in the US, involved many of the most prominent United States financial institutions, and called forth an unprecedented amount of government intervention and a deluge of dollar liquidity, nothing dented the dollar’s ascendancy. Compared with the potential for the rest of the world the United States was the safest holder of wealth.
The strength of the dollar in this period owed nothing to the traditional standards of economic and currency comparison. Though the amassing of the world’s financial liquidity in United States Treasuries would not typically be thought of as an asset bubble, by any measure of the origin and behavior of asset bubbles it was. Treasury prices were driven higher by unceasing demand which for a time ignored cost and return in a desperate race to secure principal. The psychology of fear is not very different from that of greed in its ability to push markets to excess. Bubbles can form for negative as well as positive reasons.
The dollar asset bubble began to unwind with the bottom of the equity markets in March. If the September to March dollar was the security dollar then we can call the March to June dollar the repatriating dollar.
As financial conditions gradually improved, investors sold Treasuries and placed their funds in commodities, worldwide equities, currencies and other instruments looking for appreciation and return. Because the process did not unfold at once, and because it was largely better conditions in the United States that emboldened investors to assume more risk, it seemed that whenever there were improving economic statistics in the US the dollar would sell off. In fact this was the necessary dollar selling that accompanied the repatriation of foreign-owned dollar assets or American dollar assets transferring to overseas markets and investments. .
Neither the rationale for the security dollar nor the logic for the repatriating dollar could last beyond the original financial and market conditions that produced them. Owners of investment funds will not accept minuscule earnings forever. And despite appearances the amount of funds stashed in Treasuries is not infinite. When the repatriation is complete the pressure on the dollar engendered but not caused by a mending US economy will be removed. We may have finally reached that point.
This does not necessarily mean that the dollar is poised for a strong recovery. The US economy has very serious current and pending problems and the path away from the financial crisis to recovery is unknown; but then again that applies to the rest of the world as well.
The Eurozone and Japan are trailing even the small signs of stability that have arrived in the United States. Still, if the historical performance of the US economy is considered along with the enormous fiscal and monetary stimulus that has been applied to the American economy, the dollar could well outstrip its competitors without the revival of normal economic growth anywhere in the world.
Joseph Trevisani
Tuesday, August 4, 2009
Market Direction
The rise of the Australian and New Zealand Dollars from their March depths to their current levels has been an Asian success story.
Chinese economic growth has cushioned the effects of the worldwide recession in New Zealand and Australia. Both countries export large amounts of raw materials to Asian manufacturing centers, China foremost. The yuan is fixed to the dollar (unofficially) the aussie and kiwi are not. The Australian economy has avoided recession; the New Zealand economy shrank just 1.0% for two successive quarters. As China returns to strong economic growth and the potential for internal unrest diminishes, the two Asian Dollars rise, and everyone in Asia benefits.
China has boosted her GDP growth from 6.1% in the first quarter of 2009 to 7.9% in the second. Beijing’s four trillion yuan ($587 billion) stimulus has produced tangible results. The Shanghai stock exchange is booming, bank loans and credit are flowing to business and consumers, property markets are hot again, and car sales have overtaken those of the United States. The Chinese government, spending money it actually has, is courted by Washington’s debtor politicians who proclaim their belief in a strong dollar and fiscal rectitude lest China Chinese officials withdraw their support for US deficits. The strength of the Chinese economy is imparted to her trading partners and material suppliers Australia and New Zealand, and their currencies rise against the dollar and the moribund American economy.
The additional success of these two commodity currencies is owed largely to the dynamism of the Chinese economy. Without the demand from the mainland, the miners and ranchers of down under would have few places to sell their products. Though the fall in the Antipodean currencies last year had everything to do with the American dollar, the climb back has been, to a large degree, an Asian affair.
From last summer until this past March the Australian and New Zealand currencies had suffered the same precipitous decline against the dollar as did every major currency except the yen. Panic buying of American Dollar assets trumped every financial and economic consideration during the prolonged financial turmoil. For the six months following the collapse of Lehman in September neither the aussie nor the kiwi sustained any appreciable rally.
However, since the recovery in world financial markets that began in March these two currencies have gained more than twice as much against the dollar as the euro. From March 4th to June 3rd the euro improved 14.3% against the US Dollar. In that same period the Australian Dollar gained 31.4% and the New Zealand Dollar 34.1%.
Traders, portfolio managers, investors, fund managers, almost everyone who had sought safety in the States and Treasury investments began in the second quarter to seek higher returns outside the United States and largely outside the industrialized world. A portion of the improvement in all currencies versus the dollar was due to this repositioning of assets to more favorable economic environments.
The most favorable of all the destinations, by performance, fiscal ability and government intention was China. Of the major trading currencies the Australian and New Zealand economies have the closest economic connection to China. If China grows by exports or domestic consumption the benefit to the Australian and New Zealand economies are direct, substantial and evidenced in the comparative performance of the two economies.
Japan also has large interests in the China. But the Japanese economy is a special case due to its dependence on exports and limited domestic consumer consumption. The yen also has unusual contingencies that give it undue resilience, primarily its decade long participation in the carry trade and its collapse last fall. Nevertheless one of the reasons for the continued yen strength is its Chinese relationship.
The Chinese stimulus was announced in November of last year but its success was not apparent until the recent release of the second quarter GDP numbers. But the advantage to the Australian and New Zealand Dollars was already priced in by the beginning of June.
Further improvement in the currencies will hinge on continued Chinese expansion. The quality of the economic growth in China is open to speculation. Some of the markets, particularly equities and housing, have bubble like aspects to their rise. Bank loans and credit expansion have been overwrought. Mere concern that the government might tighten credit was enough to cause a five percent fall in the Shanghai exchange.
If the Chinese economic recovery is solid, if it is not grounded in misplaced credit generation and speculation, then the aussie and kiwi have a stronger immediate future than any other major currencies. If China cannot sustain her current growth then these commodity currencies will quickly fall to earth. Either way the Australian and New Zealand economic futures will be written in Beijing and not Canberra or Wellington.
Joseph Trevisani
Chinese economic growth has cushioned the effects of the worldwide recession in New Zealand and Australia. Both countries export large amounts of raw materials to Asian manufacturing centers, China foremost. The yuan is fixed to the dollar (unofficially) the aussie and kiwi are not. The Australian economy has avoided recession; the New Zealand economy shrank just 1.0% for two successive quarters. As China returns to strong economic growth and the potential for internal unrest diminishes, the two Asian Dollars rise, and everyone in Asia benefits.
China has boosted her GDP growth from 6.1% in the first quarter of 2009 to 7.9% in the second. Beijing’s four trillion yuan ($587 billion) stimulus has produced tangible results. The Shanghai stock exchange is booming, bank loans and credit are flowing to business and consumers, property markets are hot again, and car sales have overtaken those of the United States. The Chinese government, spending money it actually has, is courted by Washington’s debtor politicians who proclaim their belief in a strong dollar and fiscal rectitude lest China Chinese officials withdraw their support for US deficits. The strength of the Chinese economy is imparted to her trading partners and material suppliers Australia and New Zealand, and their currencies rise against the dollar and the moribund American economy.
The additional success of these two commodity currencies is owed largely to the dynamism of the Chinese economy. Without the demand from the mainland, the miners and ranchers of down under would have few places to sell their products. Though the fall in the Antipodean currencies last year had everything to do with the American dollar, the climb back has been, to a large degree, an Asian affair.
From last summer until this past March the Australian and New Zealand currencies had suffered the same precipitous decline against the dollar as did every major currency except the yen. Panic buying of American Dollar assets trumped every financial and economic consideration during the prolonged financial turmoil. For the six months following the collapse of Lehman in September neither the aussie nor the kiwi sustained any appreciable rally.
However, since the recovery in world financial markets that began in March these two currencies have gained more than twice as much against the dollar as the euro. From March 4th to June 3rd the euro improved 14.3% against the US Dollar. In that same period the Australian Dollar gained 31.4% and the New Zealand Dollar 34.1%.
Traders, portfolio managers, investors, fund managers, almost everyone who had sought safety in the States and Treasury investments began in the second quarter to seek higher returns outside the United States and largely outside the industrialized world. A portion of the improvement in all currencies versus the dollar was due to this repositioning of assets to more favorable economic environments.
The most favorable of all the destinations, by performance, fiscal ability and government intention was China. Of the major trading currencies the Australian and New Zealand economies have the closest economic connection to China. If China grows by exports or domestic consumption the benefit to the Australian and New Zealand economies are direct, substantial and evidenced in the comparative performance of the two economies.
Japan also has large interests in the China. But the Japanese economy is a special case due to its dependence on exports and limited domestic consumer consumption. The yen also has unusual contingencies that give it undue resilience, primarily its decade long participation in the carry trade and its collapse last fall. Nevertheless one of the reasons for the continued yen strength is its Chinese relationship.
The Chinese stimulus was announced in November of last year but its success was not apparent until the recent release of the second quarter GDP numbers. But the advantage to the Australian and New Zealand Dollars was already priced in by the beginning of June.
Further improvement in the currencies will hinge on continued Chinese expansion. The quality of the economic growth in China is open to speculation. Some of the markets, particularly equities and housing, have bubble like aspects to their rise. Bank loans and credit expansion have been overwrought. Mere concern that the government might tighten credit was enough to cause a five percent fall in the Shanghai exchange.
If the Chinese economic recovery is solid, if it is not grounded in misplaced credit generation and speculation, then the aussie and kiwi have a stronger immediate future than any other major currencies. If China cannot sustain her current growth then these commodity currencies will quickly fall to earth. Either way the Australian and New Zealand economic futures will be written in Beijing and not Canberra or Wellington.
Joseph Trevisani
Tuesday, July 28, 2009
Market Direction
What is the purpose of the foreign exchange market, or any trading market for that matter? It seems like a simple question with a simple answer. The purpose is to facilitate exchange, to permit participants to sell and buy commodities, equities or futures and to trade one currency for another. But that simple definition disguises a world of complexity.
If two parties wish to conduct an exchange, of one currency for another or of an equity or bond for a sum of cash the first question is at what price should the transaction take place? In the consumer world, in a supermarket or department store, the price is predetermined by the seller and is rarely changed. The purchaser measures their need for the item against the price asked and makes the decision to buy or not. There is little discussion and no bargaining over the price. The consumer does not say the price will be lower in a few minutes; I will wait until then to make my purchase. Likewise the seller does not normally remove the item from sale expecting the price to rise in a few days. This basic function of price determination or price discovery is essentially different in a trading market. A market transaction differs from a consumer purchase because both the seller and the buyer continually adjust their price expectations to information flowing out from the market to participants and into the market from outside sources.
Market participants, in theory, incorporate all available information into the prices at which they buy and sell. This is called the perfect information assumption of efficient markets theory. Each participant in the market acts as an independent decision maker. Each decision influences the overall market and price level. The market or to be more precise, the price level of a market traded item, is, at any time, the amalgamation of all the price decisions made by all market participants.
On this one topic-- what should the market price be-- the market reflects the decisions of its participants. In foreign exchange markets the decision makers are the traders, all of them, from the smallest retail trader to the largest hedge fund. But how do 1,000 or 10,000 individual decisions, made in ignorance of each other become a market price? How do we know that the price of this mass decision accurately reflects the wishes of 10,000 people?
If three market participants want to buy a commodity at a certain price level and 50 want to sell, the market price for that commodity will fall. But what actually happens? The three bids in the market will be filled but that leaves 47 sellers. If no other bids enter the market the sellers will begin to react to the lack of bids by adjusting their offering prices down, displaying lower and lower prices until buyers enter bids and a trade is made at the new lower level. The sellers and the buyers incorporated the information flowing out of the market, the temporary lack of bids, into their price expectations producing a new price.
A commentator would perhaps say ‘the market fell today ‘. But a market is not an entity. It is only a method for coordinating the decisions of its participants. What occurred is that each participant in the market reacted to the information coming to them from within the market and their combined reaction is the movement in price. It appears to an observer that the ‘market’ traded lower because the thousands of individual decisions that comprise the movement are not given separate life. Only the mass decision, ‘the price’, is represented.
This sense of the decision making power of markets and the ‘market’ as almost a living entity is reflected in the terms we use to describe the price action. We often say’ ‘the market reacted badly to the news’ or ‘the market took profit today’. We personify the market and its behavior. Of course we all know that there is no “market” somewhere below the pavement on Wall Street making the decisions for the stock exchange. But the common use of this ‘market’ shorthand tends to obscure what is the most important psychological point in understanding market behavior. Namely, that the ‘market’ is a picture of the thoughts of its participants, the market is a snapshot; it is a mass mind.
We can remove some of the sense of mystery from the term, “the market” when we remember just who or what ‘the market’ is? The answer is plain enough, to paraphrase the comic strip character Pogo, “we have met the market and he is us’. The logic, analysis and fear that motivate market behavior have their source within the mind and psychology of market participants, that is, within each of its traders.
When analyzing market behavior it is instructive to keep this very simple fact in mind. The market is a mass mind focused on one topic, price. It represents the momentary culmination all of the external and internal inputs that bear on the price of the traded commodity as ranked by the traders in that market. But even if the method by which the market arrives at a decision is obscure, its ingredients are not—they exist in the analysis, outlook aspirations and psychology of each individual trader.
Since the market is a reflection of the minds of its participants and a traders job is to make profits it follows that a trader’s primary task it to match his decision to that of the mass, to anticipate and mimic the decision of the market. There should be no mystery in ‘the market’ even when it thrashes our positions, for the chances are that the operating logic was known to most of traders. Known and rejected by the losing minority of traders but embraced by the majority.
When our trades lose money, whatever the logic of the position, we can be sure we were not alone. But we can equally be sure that we were in the minority. Had we been in the majority the market would have performed as we had anticipated. The market decision process is that simple. It is a matter of putting our assumptions in line with the majority as often as we can. The most effective tool to achieve that is our own empirically tested market psychology. We are the market, if only we can let the mass mind of the market and not our individuality rule our decisions.
The market does not reward iconoclasts.
Joseph Trevisani
If two parties wish to conduct an exchange, of one currency for another or of an equity or bond for a sum of cash the first question is at what price should the transaction take place? In the consumer world, in a supermarket or department store, the price is predetermined by the seller and is rarely changed. The purchaser measures their need for the item against the price asked and makes the decision to buy or not. There is little discussion and no bargaining over the price. The consumer does not say the price will be lower in a few minutes; I will wait until then to make my purchase. Likewise the seller does not normally remove the item from sale expecting the price to rise in a few days. This basic function of price determination or price discovery is essentially different in a trading market. A market transaction differs from a consumer purchase because both the seller and the buyer continually adjust their price expectations to information flowing out from the market to participants and into the market from outside sources.
Market participants, in theory, incorporate all available information into the prices at which they buy and sell. This is called the perfect information assumption of efficient markets theory. Each participant in the market acts as an independent decision maker. Each decision influences the overall market and price level. The market or to be more precise, the price level of a market traded item, is, at any time, the amalgamation of all the price decisions made by all market participants.
On this one topic-- what should the market price be-- the market reflects the decisions of its participants. In foreign exchange markets the decision makers are the traders, all of them, from the smallest retail trader to the largest hedge fund. But how do 1,000 or 10,000 individual decisions, made in ignorance of each other become a market price? How do we know that the price of this mass decision accurately reflects the wishes of 10,000 people?
If three market participants want to buy a commodity at a certain price level and 50 want to sell, the market price for that commodity will fall. But what actually happens? The three bids in the market will be filled but that leaves 47 sellers. If no other bids enter the market the sellers will begin to react to the lack of bids by adjusting their offering prices down, displaying lower and lower prices until buyers enter bids and a trade is made at the new lower level. The sellers and the buyers incorporated the information flowing out of the market, the temporary lack of bids, into their price expectations producing a new price.
A commentator would perhaps say ‘the market fell today ‘. But a market is not an entity. It is only a method for coordinating the decisions of its participants. What occurred is that each participant in the market reacted to the information coming to them from within the market and their combined reaction is the movement in price. It appears to an observer that the ‘market’ traded lower because the thousands of individual decisions that comprise the movement are not given separate life. Only the mass decision, ‘the price’, is represented.
This sense of the decision making power of markets and the ‘market’ as almost a living entity is reflected in the terms we use to describe the price action. We often say’ ‘the market reacted badly to the news’ or ‘the market took profit today’. We personify the market and its behavior. Of course we all know that there is no “market” somewhere below the pavement on Wall Street making the decisions for the stock exchange. But the common use of this ‘market’ shorthand tends to obscure what is the most important psychological point in understanding market behavior. Namely, that the ‘market’ is a picture of the thoughts of its participants, the market is a snapshot; it is a mass mind.
We can remove some of the sense of mystery from the term, “the market” when we remember just who or what ‘the market’ is? The answer is plain enough, to paraphrase the comic strip character Pogo, “we have met the market and he is us’. The logic, analysis and fear that motivate market behavior have their source within the mind and psychology of market participants, that is, within each of its traders.
When analyzing market behavior it is instructive to keep this very simple fact in mind. The market is a mass mind focused on one topic, price. It represents the momentary culmination all of the external and internal inputs that bear on the price of the traded commodity as ranked by the traders in that market. But even if the method by which the market arrives at a decision is obscure, its ingredients are not—they exist in the analysis, outlook aspirations and psychology of each individual trader.
Since the market is a reflection of the minds of its participants and a traders job is to make profits it follows that a trader’s primary task it to match his decision to that of the mass, to anticipate and mimic the decision of the market. There should be no mystery in ‘the market’ even when it thrashes our positions, for the chances are that the operating logic was known to most of traders. Known and rejected by the losing minority of traders but embraced by the majority.
When our trades lose money, whatever the logic of the position, we can be sure we were not alone. But we can equally be sure that we were in the minority. Had we been in the majority the market would have performed as we had anticipated. The market decision process is that simple. It is a matter of putting our assumptions in line with the majority as often as we can. The most effective tool to achieve that is our own empirically tested market psychology. We are the market, if only we can let the mass mind of the market and not our individuality rule our decisions.
The market does not reward iconoclasts.
Joseph Trevisani
Wednesday, July 22, 2009
Market Direction
Since late May the dollar has traded in a limited four figure range against the euro - limited and a bit odd. Good American economic news pushes the dollar down; bad news returns it to favor.
May Non Farm Payrolls, unexpectedly positive, gave the dollar a fainting spell. The June numbers, worse than predicted, revived the greenback. Retail sales figures and consumer confidence have gradually returned from oblivion and the value of the dollar ebbed as they rose.
Risk aversion is the standard explanation. Risk capital, or perhaps it is better to name it capital that is averse to risk, is sequestered in Treasury bills and other dollar denominated safe investments when the economic environment looks, well, risky. The demand for these dollar assets pushes the US currency higher as foreign denominated capital enters the currency markets and is converted to dollars. When economic risk is judged to diminish these funds suddenly pour back out of US Treasuries seeking higher returns. Since those returns are often overseas the dollars are changed for foreign assets and the dollar sinks.
This mechanistic and simplified logic may suffice to explain the weak pro and anti-dollar moves that have played back and forth in the currency since late May. But a larger question looms. Why hasn’t the dollar benefited from the improvement in the US economy? Currency markets, like equities and futures, are discounting machines. They trade now for where their participants think that currencies, stocks or commodities will be at some point in the near future.
The US economic situation compares favorably with that of any of its major currency trading partners. The financial panic has long since dissipated. The banking system is not going to collapse. Present inflation is benign, whatever the real or imagined fears for 2011 and beyond. The Federal Reserve has restrained its essay into overt monetization. At the last FOMC meeting the Reserve Board declined to add to the $300 billion already allotted for Treasury purchases. Perhaps most informative on Fed thinking, the M2 money supply, long neglected, has leveled and even declined a little in May. Last fall and spring as the crisis escalated M2 had jumped at historically unprecedented rates as the Fed pumped liquidity into the economy. But now it seems the Fed has drawn back from the money glut and that can only help to contain future inflation.
One year ago the US unemployment rate was 5.5 %, it is now 9.5%. While such numbers are a serious hardship for workers and businesses they are also a sign of the flexibility of the US labor market. Because American firms operate under relatively few restrictions they are free to use labor as they see fit. US firms can restructure and redeploy resources to meet actual demand. When growth returns US firms are often in a better financial condition to rehire. US unemployment rises faster in a recession but it also falls faster and to a lower level under economic growth. Compare the US employment situation to that of the European Monetary Union (EMU).
EMU unemployment has risen from 7.4% a year ago to 9.5% in June, half the amount of the US increase. In Europe it is far harder for firms to eliminate workers and doing so is far more costly. Thus when the recovery begins there are fewer empty places to fill. Companies remain wedded to resource deployment designed for the last expansion with no guarantee that the new cycle will ask for the same product mix. In comparison US firms are able to meet the new economic situation with a far more flexible outlook.
Many secondary US economic indicators have improved substantially in the past months. Housing is stable, purchasing managers indices have recovered and consumer confidence and retail sales are on the mend. This is not to say that the recession is ended or even ending. But that as a comparative lesson the US is arguably in better shape for recovery than its European competitors. When this improved economic situation is joined to the historical ability of the US economy to work its way out of trouble faster and with more emphasis than any other industrialized economy we have to ask again: Why has the dollar declined?
The answer may lie in Washington and the political and economic agenda of the Obama administration. Currency markets are making their own discount judgments on the potential economic effect of the two major initiatives of the administration: the climate change bill and the creation of a government health service.
Irrespective of the political and policy aims of the two pieces of legislation, and aside from any opinion on the social and environmental desirability of their stated goals, there is no doubt that both will impose huge economic costs on the US economy. For the climate bill the intention is to apply a proper cost to carbon output. The legislation is designed to impose huge new taxes on any users of carbon. Since almost every consumer or industrial product uses carbon somewhere in the production cycle the economic costs will stretch across the entire economy.
The health service bill cannot be funded without raising taxes and will likely incur large additional deficit spending as well. Few economists advise raising taxes in a recession. A further increase in the already vast Federal deficit could well squeeze out much of credit needed for the private economy and raise the cost of credit for all. Both bills, if passed in present form, seem destined to restrict US economic growth and retard recovery from the recession.
American equities have had a strong recent surge as the passage of these bills has become more problematic. The currency markets will soon notice. If the climate bill fails and the universal health care provision is watered down or put off until next year then restraints on the dollar will fall away and it will follow equities higher.
Joseph Trevisani
May Non Farm Payrolls, unexpectedly positive, gave the dollar a fainting spell. The June numbers, worse than predicted, revived the greenback. Retail sales figures and consumer confidence have gradually returned from oblivion and the value of the dollar ebbed as they rose.
Risk aversion is the standard explanation. Risk capital, or perhaps it is better to name it capital that is averse to risk, is sequestered in Treasury bills and other dollar denominated safe investments when the economic environment looks, well, risky. The demand for these dollar assets pushes the US currency higher as foreign denominated capital enters the currency markets and is converted to dollars. When economic risk is judged to diminish these funds suddenly pour back out of US Treasuries seeking higher returns. Since those returns are often overseas the dollars are changed for foreign assets and the dollar sinks.
This mechanistic and simplified logic may suffice to explain the weak pro and anti-dollar moves that have played back and forth in the currency since late May. But a larger question looms. Why hasn’t the dollar benefited from the improvement in the US economy? Currency markets, like equities and futures, are discounting machines. They trade now for where their participants think that currencies, stocks or commodities will be at some point in the near future.
The US economic situation compares favorably with that of any of its major currency trading partners. The financial panic has long since dissipated. The banking system is not going to collapse. Present inflation is benign, whatever the real or imagined fears for 2011 and beyond. The Federal Reserve has restrained its essay into overt monetization. At the last FOMC meeting the Reserve Board declined to add to the $300 billion already allotted for Treasury purchases. Perhaps most informative on Fed thinking, the M2 money supply, long neglected, has leveled and even declined a little in May. Last fall and spring as the crisis escalated M2 had jumped at historically unprecedented rates as the Fed pumped liquidity into the economy. But now it seems the Fed has drawn back from the money glut and that can only help to contain future inflation.
One year ago the US unemployment rate was 5.5 %, it is now 9.5%. While such numbers are a serious hardship for workers and businesses they are also a sign of the flexibility of the US labor market. Because American firms operate under relatively few restrictions they are free to use labor as they see fit. US firms can restructure and redeploy resources to meet actual demand. When growth returns US firms are often in a better financial condition to rehire. US unemployment rises faster in a recession but it also falls faster and to a lower level under economic growth. Compare the US employment situation to that of the European Monetary Union (EMU).
EMU unemployment has risen from 7.4% a year ago to 9.5% in June, half the amount of the US increase. In Europe it is far harder for firms to eliminate workers and doing so is far more costly. Thus when the recovery begins there are fewer empty places to fill. Companies remain wedded to resource deployment designed for the last expansion with no guarantee that the new cycle will ask for the same product mix. In comparison US firms are able to meet the new economic situation with a far more flexible outlook.
Many secondary US economic indicators have improved substantially in the past months. Housing is stable, purchasing managers indices have recovered and consumer confidence and retail sales are on the mend. This is not to say that the recession is ended or even ending. But that as a comparative lesson the US is arguably in better shape for recovery than its European competitors. When this improved economic situation is joined to the historical ability of the US economy to work its way out of trouble faster and with more emphasis than any other industrialized economy we have to ask again: Why has the dollar declined?
The answer may lie in Washington and the political and economic agenda of the Obama administration. Currency markets are making their own discount judgments on the potential economic effect of the two major initiatives of the administration: the climate change bill and the creation of a government health service.
Irrespective of the political and policy aims of the two pieces of legislation, and aside from any opinion on the social and environmental desirability of their stated goals, there is no doubt that both will impose huge economic costs on the US economy. For the climate bill the intention is to apply a proper cost to carbon output. The legislation is designed to impose huge new taxes on any users of carbon. Since almost every consumer or industrial product uses carbon somewhere in the production cycle the economic costs will stretch across the entire economy.
The health service bill cannot be funded without raising taxes and will likely incur large additional deficit spending as well. Few economists advise raising taxes in a recession. A further increase in the already vast Federal deficit could well squeeze out much of credit needed for the private economy and raise the cost of credit for all. Both bills, if passed in present form, seem destined to restrict US economic growth and retard recovery from the recession.
American equities have had a strong recent surge as the passage of these bills has become more problematic. The currency markets will soon notice. If the climate bill fails and the universal health care provision is watered down or put off until next year then restraints on the dollar will fall away and it will follow equities higher.
Joseph Trevisani
Wednesday, July 15, 2009
Market Direction
The origin of the Group of Eight was an invitation from French President Valery Giscard d’Estaing in 1975 to six of the major World War Two combatants to meet at Rambouillet in France. Leaders from West Germany, Great Britain, Italy, the United States, Japan and France attended that first meeting. The impetus to the summit, if not the sole topic, was the first post war economic challenge to the west, the 1973 OPEC oil embargo. In 1976 Canada was invited to join and the group stayed at seven until 1997 when Russia formally became a member.
Although formed a generation after the end of the Second World War, the G-7 represented the dominant nations of the defining event of 20th century history. As with the United Nations for international politics, the G-7 was an attempt to secure the victory of the western economic model. For the first 30 years after the war the only antagonist for the western capitalists had been the political and military threat of the Communists led by the Soviet Union. Until the oil embargo there had not been a serious economic challenge to Western Europe, the United States and Japan.
Why relate this history? The nations of the Second World War consensus that have dominated the world for 60 years are close to bankrupt. Their foreign bankers are now calling the shots; those who pay decide the future.
The abandonment of the climate change issue at the G-8 meeting is an example. Though the global warming agenda is a major part of the domestic political positions of President Obama, Chancellor Merkel, Prime Minister Brown and President Sarkozy the issue was removed from G-8 consideration because China, India and others would not go along. This is perhaps a foretaste of what will happen on every topic in which China and the other BRIC (Brazil, Russia, India, and China) countries have an interest.
China, Russia and India have been very public with their concerns for the long term value of the US Dollar and critical of the effect of American deficit spending. In April, China’s holding of US Treasuries fell for the first time in eleven months. The amount was small, $4 billion and partially offset by a small gain in Hong Kong. But in the charged atmosphere of today’s international economics and in light of US funding needs, the drop was widely noted. From April 2008 until March 2009 the Chinese Government had been steadily acquiring Treasuries; its holding had increased from $502.0 to $767.9, a jump of 53%.
China has also moved to increase the supply and demand for the yuan as an alternative to the dollar by starting limited trade settlement in its currency. On July 6th some firms in five Chinese cities were allowed to begin settling transactions in yuan with companies from Hong Kong, Macau and the ASEAN countries. Non-Chinese banks will be able to obtain yuan from mainland institutions to finance trade.
The Peoples Bank of China (PBOC) has also formulated currency swap agreements with Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea. The PBOC will render yuan to their central banks as needed to pay for imports if these countries are short of the currency.
These moves by the Chinese authorities will not establish the yuan as an international reserve currency. But they will shift some of the trade demand for dollars to yuan. Offered the choice what Asian trading partner of China would not want to remove the volatile and increasingly questioned dollar from their financial equation? The logic is simple and efficient. Why hold reserves in dollars for your China trade and bear the currency risk? Yuan reserves reduce the need for dollars and reduce dollar currency risk.
China has emerged as the engine of growth in Asia and Asian countries are looking to China for the health of their own economies. If yuan settlement becomes the policy of the Chinese Government what trading partner will want to go against Beijing’s wishes and opt for dollar settlement? Considering the size of China’s foreign trade the potential drop in dollar demand could be substantial.
Until now it has been in China's interest to keep the yuan undervalued for trade competition. Since last summer China has effectively re-pegged the yuan to the dollar after three years of gradual appreciation. But that is likely to be a temporary expedient. If China is serious about using the yuan in trade and in permitting outside players, non Chinese players, to hold and store value in yuan, an essential component of a reserve currency, what better way than to resume a gradual appreciation of the currency? For an exporter in Vietnam or Thailand or even Australia, Japan or New Zealand would not an appreciating yuan be a far better option for your China trade capital than the dollar?
Chinese national interest will determine Beijing’s economic policy. But the time is fast approaching when safeguarding her economic development will be far better served by a strong and convertible currency than by a weak yuan priced for export. A strong dollar has been one of Washington’s most effective foreign policy tools for more than 50 years; that fact is not unknown in the Chinese capital.
Joseph Trevisani
Although formed a generation after the end of the Second World War, the G-7 represented the dominant nations of the defining event of 20th century history. As with the United Nations for international politics, the G-7 was an attempt to secure the victory of the western economic model. For the first 30 years after the war the only antagonist for the western capitalists had been the political and military threat of the Communists led by the Soviet Union. Until the oil embargo there had not been a serious economic challenge to Western Europe, the United States and Japan.
Why relate this history? The nations of the Second World War consensus that have dominated the world for 60 years are close to bankrupt. Their foreign bankers are now calling the shots; those who pay decide the future.
The abandonment of the climate change issue at the G-8 meeting is an example. Though the global warming agenda is a major part of the domestic political positions of President Obama, Chancellor Merkel, Prime Minister Brown and President Sarkozy the issue was removed from G-8 consideration because China, India and others would not go along. This is perhaps a foretaste of what will happen on every topic in which China and the other BRIC (Brazil, Russia, India, and China) countries have an interest.
China, Russia and India have been very public with their concerns for the long term value of the US Dollar and critical of the effect of American deficit spending. In April, China’s holding of US Treasuries fell for the first time in eleven months. The amount was small, $4 billion and partially offset by a small gain in Hong Kong. But in the charged atmosphere of today’s international economics and in light of US funding needs, the drop was widely noted. From April 2008 until March 2009 the Chinese Government had been steadily acquiring Treasuries; its holding had increased from $502.0 to $767.9, a jump of 53%.
China has also moved to increase the supply and demand for the yuan as an alternative to the dollar by starting limited trade settlement in its currency. On July 6th some firms in five Chinese cities were allowed to begin settling transactions in yuan with companies from Hong Kong, Macau and the ASEAN countries. Non-Chinese banks will be able to obtain yuan from mainland institutions to finance trade.
The Peoples Bank of China (PBOC) has also formulated currency swap agreements with Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea. The PBOC will render yuan to their central banks as needed to pay for imports if these countries are short of the currency.
These moves by the Chinese authorities will not establish the yuan as an international reserve currency. But they will shift some of the trade demand for dollars to yuan. Offered the choice what Asian trading partner of China would not want to remove the volatile and increasingly questioned dollar from their financial equation? The logic is simple and efficient. Why hold reserves in dollars for your China trade and bear the currency risk? Yuan reserves reduce the need for dollars and reduce dollar currency risk.
China has emerged as the engine of growth in Asia and Asian countries are looking to China for the health of their own economies. If yuan settlement becomes the policy of the Chinese Government what trading partner will want to go against Beijing’s wishes and opt for dollar settlement? Considering the size of China’s foreign trade the potential drop in dollar demand could be substantial.
Until now it has been in China's interest to keep the yuan undervalued for trade competition. Since last summer China has effectively re-pegged the yuan to the dollar after three years of gradual appreciation. But that is likely to be a temporary expedient. If China is serious about using the yuan in trade and in permitting outside players, non Chinese players, to hold and store value in yuan, an essential component of a reserve currency, what better way than to resume a gradual appreciation of the currency? For an exporter in Vietnam or Thailand or even Australia, Japan or New Zealand would not an appreciating yuan be a far better option for your China trade capital than the dollar?
Chinese national interest will determine Beijing’s economic policy. But the time is fast approaching when safeguarding her economic development will be far better served by a strong and convertible currency than by a weak yuan priced for export. A strong dollar has been one of Washington’s most effective foreign policy tools for more than 50 years; that fact is not unknown in the Chinese capital.
Joseph Trevisani
Tuesday, July 7, 2009
The Psychological Utility of Technical Analysis. Market Direction
Technical analysis is sometimes studied as if it contains a grain of secret knowledge or portrays an intrinsic truth about currency movements. Often it is said that a specific chart formation will produce a specific price movement.
Technical analysis does nothing of the sort. A chart is a reflection of past prices, nothing more. In itself a graph cannot predict future price movements. A currency does not trade up of down because of a formation on a chart. It moves because market participants make basic assumptions about future price behavior based on the record of past price action. A charted history of price action is the cumulative story of thousands of trading decisions; it is a record of the past behavior of thousands of individual traders.
Price information is meaningful only because trader’s decisions give it predictive power. A simple proof of the limited forward intelligence of historical price action is the well attested notion that fundamental developments always trump technical analysis. If the Federal Reserve raises rates unexpectedly or the Chinese Government announces it will no longer buy US Treasuries there is no chart formation that has ever existed that will prevent the dollar from rocketing up in the first instance or plummeting in the second.
Technical analysis does not produce price movement. I state the obvious because in the endless attribution of trading cause and effect to ‘the market’ it is easy to lose sight of the actual composition of the market--thousands of individual decision makers. The translation mechanism for technical analysis runs from the information contained in a chart, through the assessment of that information by market participants to the trading behavior of those market participants.
Another way to approach this idea is to ask, just who is the ‘market’ and what is it trying to accomplish every day. It is likely that over 90% of the $3.2 trillion daily volume in the FX market is speculative. That means that everyone in the market from the hedge fund trader with $1 billion under management, to the euro trader on the Deutsche Bank interbank desk to the retail trader in her study, is trying to do exactly the same thing, take home daily trading profits.
Interestingly, the overall worldwide foreign exchange trading volume in 2007, the year of the last survey, increased almost 50% from the prior survey in 2004 of $1.9 trillion daily. The counterparty reporting segment to which retail foreign exchange belongs boosted its share of turnover to 40% from 33% according to Bank for International Settlements in Basel (BIS, 2007) which conducts the tri-annual survey.
To return to my previous point, if every market participant is attempting to do the same thing, namely wring trading profits from the day’s activities, how do they all go about it?
The first thing every trader does, in New York, Tokyo, London and in every land in between is to pull up charts and look for trading opportunities. Every trader looking for profit is judging the same charts. Everyone sees the same price history, and everyone identifies the same potentially profitable chart formations. And, in the absence of other factors, the majority of traders will come to the same trading conclusion based on the observed chart formations.
If euro has been in an up channel for two weeks and is approaching the bottom of the channel most traders looking for an opportunity in euro will bet on the continuance of the up trend and the maintenance of the channel. They will place buy orders just above the floor of the channel. And much of the time the charts will have been proven correct, the euro will indeed bounce from the floor of the channel. But it bounces not because, for instance, the ECB is expected to raise rates at some future date, but because of the fit between the goals, information and assumptions of the market’s traders.
Traders need profits, all charts contain the same information and all traders operate with similar assumptions about market behavior based on chart formations. If enough traders place their buy orders above the bottom of the channel it becomes likely that the euro will bounce off the floor of the channel and continue the upward channel formation, barring external events of course.
There is powerful self-fulfilling logic in technical analysis, it works, because everyone trading believes it will work and makes their trading decisions accordingly. For a retail trader this knowledge is the most accessible and effective trading strategy that exists.
Joseph Trevisani
Technical analysis does nothing of the sort. A chart is a reflection of past prices, nothing more. In itself a graph cannot predict future price movements. A currency does not trade up of down because of a formation on a chart. It moves because market participants make basic assumptions about future price behavior based on the record of past price action. A charted history of price action is the cumulative story of thousands of trading decisions; it is a record of the past behavior of thousands of individual traders.
Price information is meaningful only because trader’s decisions give it predictive power. A simple proof of the limited forward intelligence of historical price action is the well attested notion that fundamental developments always trump technical analysis. If the Federal Reserve raises rates unexpectedly or the Chinese Government announces it will no longer buy US Treasuries there is no chart formation that has ever existed that will prevent the dollar from rocketing up in the first instance or plummeting in the second.
Technical analysis does not produce price movement. I state the obvious because in the endless attribution of trading cause and effect to ‘the market’ it is easy to lose sight of the actual composition of the market--thousands of individual decision makers. The translation mechanism for technical analysis runs from the information contained in a chart, through the assessment of that information by market participants to the trading behavior of those market participants.
Another way to approach this idea is to ask, just who is the ‘market’ and what is it trying to accomplish every day. It is likely that over 90% of the $3.2 trillion daily volume in the FX market is speculative. That means that everyone in the market from the hedge fund trader with $1 billion under management, to the euro trader on the Deutsche Bank interbank desk to the retail trader in her study, is trying to do exactly the same thing, take home daily trading profits.
Interestingly, the overall worldwide foreign exchange trading volume in 2007, the year of the last survey, increased almost 50% from the prior survey in 2004 of $1.9 trillion daily. The counterparty reporting segment to which retail foreign exchange belongs boosted its share of turnover to 40% from 33% according to Bank for International Settlements in Basel (BIS, 2007) which conducts the tri-annual survey.
To return to my previous point, if every market participant is attempting to do the same thing, namely wring trading profits from the day’s activities, how do they all go about it?
The first thing every trader does, in New York, Tokyo, London and in every land in between is to pull up charts and look for trading opportunities. Every trader looking for profit is judging the same charts. Everyone sees the same price history, and everyone identifies the same potentially profitable chart formations. And, in the absence of other factors, the majority of traders will come to the same trading conclusion based on the observed chart formations.
If euro has been in an up channel for two weeks and is approaching the bottom of the channel most traders looking for an opportunity in euro will bet on the continuance of the up trend and the maintenance of the channel. They will place buy orders just above the floor of the channel. And much of the time the charts will have been proven correct, the euro will indeed bounce from the floor of the channel. But it bounces not because, for instance, the ECB is expected to raise rates at some future date, but because of the fit between the goals, information and assumptions of the market’s traders.
Traders need profits, all charts contain the same information and all traders operate with similar assumptions about market behavior based on chart formations. If enough traders place their buy orders above the bottom of the channel it becomes likely that the euro will bounce off the floor of the channel and continue the upward channel formation, barring external events of course.
There is powerful self-fulfilling logic in technical analysis, it works, because everyone trading believes it will work and makes their trading decisions accordingly. For a retail trader this knowledge is the most accessible and effective trading strategy that exists.
Joseph Trevisani
Monday, June 29, 2009
Market Direction
In the past three weeks there have been several indications that the Federal Reserve is reconsidering the extent and perhaps necessity of its extraordinary liquidity provisions to the Treasury market. How far have the chairman and governors pulled back from their quantitative easing policy?
On June 3rd Chairman Bernanke commented in Congressional testimony that Federal deficits cannot continue forever. In fact the deficits can continue, but the Fed’s $300 billion Treasury purchase plan will end unless additional funding is authorized by the Fed Governors. At this past week’s FOMC meeting the board specifically did not authorize further Treasury purchases. The Fed is also letting one of its emergency liquidity programs expire and curtailing two others. None of these developments is an overt change in policy, but they are reassurances that the chairman and the board view these liquidity measures as crisis expedients and not as permanent institutions of monetary and economic policy.
It is easy to forget that the Fed policy of direct support for credit markets was an emergency response to the crisis of confidence that overwhelmed the financial system last fall. Fed purchases of various securities supplied liquidity to non-functioning markets; they were not intended to be permanent. The Fed said as much at the time, though in the ensuing months market focus shifted from the programs themselves to the lack of a clear strategy for absorbing the excess money supply from the economy.
In March the market reaction to the financial crisis was at its peak. Treasury prices had been driven to historical highs by sustained panic buying of US Treasuries. Treasury interest rates and rates on 30-year fixed rate mortgages were at record lows. But even though mortgages rates were extraordinarily low the Fed judged that the reeling economy could not tolerate the surge in interest rates that would occur if Treasury prices began to fall. The governors may have suspected that the Treasury market would begin to drive prices lower and rates higher on its own as conditions normalized
In that context the Fed announced its $300 billion Treasury purchase in the FOMC statement of March 18th. The governors may also have been worried about the impact of the Federal deficit on the bond market whose reaction was then an unknown quantity. But despite the Fed backstop the Treasury market fell relentlessly after March 18 with the 10-year rate rising more than 1.5%. More dangerously the dollar index fell 10% from March 18th to June 6th.
For the currency markets the Fed Treasury program has had one meaning, monetization of the Federal debt.
Judging by the subsequent rise in Treasury rates the Fed governors may have known that the $300 million committed would be insufficient to hold the line on Treasury rates. But that relatively minor amount had a deadly effect on the dollar. The merest suspicion that monetization of US debt was possible sent the dollar into a three month swoon. The inflation that would result from a rapidly falling dollar and the effect of a collapsing dollar on the Treasury market itself could undo much of the economic and rate stabilization that the Fed was striving to achieve.
The Fed concern about the Treasury market was for the economic effect of higher interest rates on the US economy, particularly on the housing market thought by many to be at the heart of the economic collapse. But higher Treasury yields and mortgage rates have not, at least so far, choked whatever positive change in the economy has occurred since March. 30-year fixed mortgages have gained more than a point but the housing market has stabilized; new home and existing home sales in May were both in the center of the range they have exhibited since January.
Personal Consumption Expenditures have revived a bit. They were flat in April and gained 0.3% in May, which was only the third positive month in the past eleven. Non Farm Payrolls were substantially improved in May at -345,000, with the three month moving average (-500,000) having gained almost 200,000 since March (-691,000). Consumer sentiment numbers have moved up steadily since the beginning of the quarter. The economic situation that prompted the Fed quantitative easing has returned to more normal territory.
The Treasury market has also stabilized in the past two weeks. After reaching 4.00% the yield on the 10-year note had declined to 3.54% on the Friday close. The government Treasury auctions, a record $104 billion in the past week alone, have been subscribed at higher rates than normal. The bond markets are not demanding substantially higher rates on American debt, despite the vast continuing supply of US issuance.
The key to the continuance of the Fed Treasury program is the attitude of the credit markets. It is relatively simple. If bond purchasers do not demand higher yields for US debt, then whatever the long term effect of the ballooning US debt and inflation the government will not be forced to pay higher rates. If Treasury prices are not falling the Fed will not have to support the market with further Treasury purchases and the currency markets will not be stampeded away from the dollar by monetization.
Foreign central banks have been unusually critical of the US government’s fiscal and debt policy. The Chinese were so again this week. But what matters are not the banker’s words or their musings about a world reserve currency. What matters is action. As long as the Chinese, Russians, Japanese and private investors continue to buy US Treasuries, the Fed will not have to choose between supporting the US economy and supporting the dollar.
It is a delicate balance but so far the Fed has, with the cooperation of the Treasury markets, kept the pointer right in the middle of the scale. The Fed has managed to mitigate the scare it threw into the currency markets in March with its recent statements and actions.
There are still a huge amount of Treasuries to be sold over the next three months and the economic situation is still dangerous. But the Fed view as reflected in the FOMC statement, no more quantitative easing and a slight though significant withdrawal from the credit markets may be the right and artful balance between keeping down US interest rates and avoiding a dollar panic in the currency markets.
Joseph Trevisani
On June 3rd Chairman Bernanke commented in Congressional testimony that Federal deficits cannot continue forever. In fact the deficits can continue, but the Fed’s $300 billion Treasury purchase plan will end unless additional funding is authorized by the Fed Governors. At this past week’s FOMC meeting the board specifically did not authorize further Treasury purchases. The Fed is also letting one of its emergency liquidity programs expire and curtailing two others. None of these developments is an overt change in policy, but they are reassurances that the chairman and the board view these liquidity measures as crisis expedients and not as permanent institutions of monetary and economic policy.
It is easy to forget that the Fed policy of direct support for credit markets was an emergency response to the crisis of confidence that overwhelmed the financial system last fall. Fed purchases of various securities supplied liquidity to non-functioning markets; they were not intended to be permanent. The Fed said as much at the time, though in the ensuing months market focus shifted from the programs themselves to the lack of a clear strategy for absorbing the excess money supply from the economy.
In March the market reaction to the financial crisis was at its peak. Treasury prices had been driven to historical highs by sustained panic buying of US Treasuries. Treasury interest rates and rates on 30-year fixed rate mortgages were at record lows. But even though mortgages rates were extraordinarily low the Fed judged that the reeling economy could not tolerate the surge in interest rates that would occur if Treasury prices began to fall. The governors may have suspected that the Treasury market would begin to drive prices lower and rates higher on its own as conditions normalized
In that context the Fed announced its $300 billion Treasury purchase in the FOMC statement of March 18th. The governors may also have been worried about the impact of the Federal deficit on the bond market whose reaction was then an unknown quantity. But despite the Fed backstop the Treasury market fell relentlessly after March 18 with the 10-year rate rising more than 1.5%. More dangerously the dollar index fell 10% from March 18th to June 6th.
For the currency markets the Fed Treasury program has had one meaning, monetization of the Federal debt.
Judging by the subsequent rise in Treasury rates the Fed governors may have known that the $300 million committed would be insufficient to hold the line on Treasury rates. But that relatively minor amount had a deadly effect on the dollar. The merest suspicion that monetization of US debt was possible sent the dollar into a three month swoon. The inflation that would result from a rapidly falling dollar and the effect of a collapsing dollar on the Treasury market itself could undo much of the economic and rate stabilization that the Fed was striving to achieve.
The Fed concern about the Treasury market was for the economic effect of higher interest rates on the US economy, particularly on the housing market thought by many to be at the heart of the economic collapse. But higher Treasury yields and mortgage rates have not, at least so far, choked whatever positive change in the economy has occurred since March. 30-year fixed mortgages have gained more than a point but the housing market has stabilized; new home and existing home sales in May were both in the center of the range they have exhibited since January.
Personal Consumption Expenditures have revived a bit. They were flat in April and gained 0.3% in May, which was only the third positive month in the past eleven. Non Farm Payrolls were substantially improved in May at -345,000, with the three month moving average (-500,000) having gained almost 200,000 since March (-691,000). Consumer sentiment numbers have moved up steadily since the beginning of the quarter. The economic situation that prompted the Fed quantitative easing has returned to more normal territory.
The Treasury market has also stabilized in the past two weeks. After reaching 4.00% the yield on the 10-year note had declined to 3.54% on the Friday close. The government Treasury auctions, a record $104 billion in the past week alone, have been subscribed at higher rates than normal. The bond markets are not demanding substantially higher rates on American debt, despite the vast continuing supply of US issuance.
The key to the continuance of the Fed Treasury program is the attitude of the credit markets. It is relatively simple. If bond purchasers do not demand higher yields for US debt, then whatever the long term effect of the ballooning US debt and inflation the government will not be forced to pay higher rates. If Treasury prices are not falling the Fed will not have to support the market with further Treasury purchases and the currency markets will not be stampeded away from the dollar by monetization.
Foreign central banks have been unusually critical of the US government’s fiscal and debt policy. The Chinese were so again this week. But what matters are not the banker’s words or their musings about a world reserve currency. What matters is action. As long as the Chinese, Russians, Japanese and private investors continue to buy US Treasuries, the Fed will not have to choose between supporting the US economy and supporting the dollar.
It is a delicate balance but so far the Fed has, with the cooperation of the Treasury markets, kept the pointer right in the middle of the scale. The Fed has managed to mitigate the scare it threw into the currency markets in March with its recent statements and actions.
There are still a huge amount of Treasuries to be sold over the next three months and the economic situation is still dangerous. But the Fed view as reflected in the FOMC statement, no more quantitative easing and a slight though significant withdrawal from the credit markets may be the right and artful balance between keeping down US interest rates and avoiding a dollar panic in the currency markets.
Joseph Trevisani
Monday, June 22, 2009
Market Direction
After a few months out of the currency spotlight the Federal Reserve will once again be the focus for traders when the Federal Reserve Open Market Committee (FOMC) meets this coming Wednesday and Thursday. This time it will not be the Fed Funds target rate, the central bank’s chief historical policy tool, that will be the locus of interest but the several special programs that the Fed has used to stem the financial crisis, in particular the quantitative easing attempt to cap Treasury interest rates.
Various Fed disbursements have added more than one trillion dollars in liquidity to the United States financial system. With up to $3.25 trillion in Federal debt sold or slated to be sold in the credit markets before the end of the US fiscal year in September oversupply and inflation are serious potential concerns that could drive Treasury interest rates considerably higher.
The 10-year Treasury note has risen more than 1.6% in yield since March and the reason for this sharp increase has gotten much speculative coverage in the press. But in fact the yields on the 10-year note have simply returned to where they were before the financial collapse last fall. Treasury yields have been trending downward for more than twenty years. It was the dip to zero yields in the wake of the Lehman failure that was the singular event not the recent return to trend. That is not to say that the huge coming supply of Treasuries and the theoretical inflation potential of the projected Federal deficits could not drive Treasury rates much higher. But the Friday close of the 10-year Treasury at 3.78% is a likely starting point for an inflation fueled run higher in yields, not an indication that it has already begun.
The currency market reaction to the Federal Reserve quantitative easing policy was as negative for the dollar as the policy itself was ineffective. If the goal of the policy were to put a floor under Treasury prices it failed. If its purpose was to indicate a serious Fed concern for consumer interest rates and hope that the bond market would take the hint it was also a failure. The quantitative easing purchase amount of $300 billion was always far too small to prevent a fall in Treasury prices if market sentiment were negative.
Quantitative easing has been detrimental to the dollar for three reasons. First and most important it monetizes US debt. With trillions of dollars more of US debt yet to be sold this year alone any hint that the US will print dollars to pay for its own debentures is anathema to currency traders and to holders of US debt. The fact that the policy was a failure, Treasury rates rose despite the Fed purchases, was unimportant. It was the potential flood of new dollars that impressed the currency markets. Second, if the US economy could not tolerate a return to more normal Treasury rates from the abnormal levels of March when the 10-year note was in the low 2.00s% then what possibility was there for an economic recovery anytime soon? And finally if the Fed were willing to take the momentous step of buying Treasury issues to keep interest rates from rising then any speculation that the Fed might begin raising rates sooner than expected was misplaced.
When the Fed announced its quantitative policy in March 18th the governors were in reality utilizing their other traditional economic policy tool--Talk. Given the small amount of the announced purchases and the six months time frame the Fed must have hoped that the mere existence of this exceptional precedent would hold the Treasury market much as intervention can sometimes deter the currency markets. The governors must have known that $300 billion would never thwart a determined bond market.
Mr. Bernanke also chose to use this traditional central banker’s tool to limit the effect of the quantitative easing policy. In testimony before Congress on June 3rd he said that ‘deficits cannot continue forever’. It is of course a truism, but it is a truism with a point. The Fed does not control the deficit and rarely makes comment on fiscal policy. But it does control the Fed purchases of Treasuries. The goal of the easing policy was to bolster the consumer economy by keeping mortgage and other consumer rates from rising to levels where they inhibit consumption. Was this criticism of the administration’s deficits an indication that the Fed now views the easing policy as a failure? If that is the case then the link between the deficits and quantitative easing is the dollar.
Nothing will be more damaging to the Obama administration’s deficit funding plans than a collapsing dollar. The mere hint of such a run on the dollar brought heavy and unusual criticism from the Chinese and the Russians; and their warnings are not empty. If the currency markets drive down the dollar because traders fear monetization there will be little owners of US debt can do with their current inventory, selling would only worsen the run. But China and Russia do not have to buy more Treasuries; and the administration must sell Treasuries or abandon its domestic agenda. A substantially lower dollar could also bring crude oil prices to $100 a barrel and beyond. One of the contributing factors to the plunge in consumer spending in the US and elsewhere was the rapid rise in gasoline prices.
The Fed cannot do two things at once. It cannot keep US consumer rates from rising with a renewed and augmented quantitative purchase program and hope to maintain a strong dollar. The currency markets have made their view of quantitative easing quite clear. Even though US interest rates rose from March the dollar fell. Monetization is a greater threat to the dollar than rates are a support.
The Fed governors must decide which is more important: domestic interest rates or a strong dollar. The FOMC approach to quantitative easing will provide the answer. This is an important meeting.
Joseph Trevisani
Various Fed disbursements have added more than one trillion dollars in liquidity to the United States financial system. With up to $3.25 trillion in Federal debt sold or slated to be sold in the credit markets before the end of the US fiscal year in September oversupply and inflation are serious potential concerns that could drive Treasury interest rates considerably higher.
The 10-year Treasury note has risen more than 1.6% in yield since March and the reason for this sharp increase has gotten much speculative coverage in the press. But in fact the yields on the 10-year note have simply returned to where they were before the financial collapse last fall. Treasury yields have been trending downward for more than twenty years. It was the dip to zero yields in the wake of the Lehman failure that was the singular event not the recent return to trend. That is not to say that the huge coming supply of Treasuries and the theoretical inflation potential of the projected Federal deficits could not drive Treasury rates much higher. But the Friday close of the 10-year Treasury at 3.78% is a likely starting point for an inflation fueled run higher in yields, not an indication that it has already begun.
The currency market reaction to the Federal Reserve quantitative easing policy was as negative for the dollar as the policy itself was ineffective. If the goal of the policy were to put a floor under Treasury prices it failed. If its purpose was to indicate a serious Fed concern for consumer interest rates and hope that the bond market would take the hint it was also a failure. The quantitative easing purchase amount of $300 billion was always far too small to prevent a fall in Treasury prices if market sentiment were negative.
Quantitative easing has been detrimental to the dollar for three reasons. First and most important it monetizes US debt. With trillions of dollars more of US debt yet to be sold this year alone any hint that the US will print dollars to pay for its own debentures is anathema to currency traders and to holders of US debt. The fact that the policy was a failure, Treasury rates rose despite the Fed purchases, was unimportant. It was the potential flood of new dollars that impressed the currency markets. Second, if the US economy could not tolerate a return to more normal Treasury rates from the abnormal levels of March when the 10-year note was in the low 2.00s% then what possibility was there for an economic recovery anytime soon? And finally if the Fed were willing to take the momentous step of buying Treasury issues to keep interest rates from rising then any speculation that the Fed might begin raising rates sooner than expected was misplaced.
When the Fed announced its quantitative policy in March 18th the governors were in reality utilizing their other traditional economic policy tool--Talk. Given the small amount of the announced purchases and the six months time frame the Fed must have hoped that the mere existence of this exceptional precedent would hold the Treasury market much as intervention can sometimes deter the currency markets. The governors must have known that $300 billion would never thwart a determined bond market.
Mr. Bernanke also chose to use this traditional central banker’s tool to limit the effect of the quantitative easing policy. In testimony before Congress on June 3rd he said that ‘deficits cannot continue forever’. It is of course a truism, but it is a truism with a point. The Fed does not control the deficit and rarely makes comment on fiscal policy. But it does control the Fed purchases of Treasuries. The goal of the easing policy was to bolster the consumer economy by keeping mortgage and other consumer rates from rising to levels where they inhibit consumption. Was this criticism of the administration’s deficits an indication that the Fed now views the easing policy as a failure? If that is the case then the link between the deficits and quantitative easing is the dollar.
Nothing will be more damaging to the Obama administration’s deficit funding plans than a collapsing dollar. The mere hint of such a run on the dollar brought heavy and unusual criticism from the Chinese and the Russians; and their warnings are not empty. If the currency markets drive down the dollar because traders fear monetization there will be little owners of US debt can do with their current inventory, selling would only worsen the run. But China and Russia do not have to buy more Treasuries; and the administration must sell Treasuries or abandon its domestic agenda. A substantially lower dollar could also bring crude oil prices to $100 a barrel and beyond. One of the contributing factors to the plunge in consumer spending in the US and elsewhere was the rapid rise in gasoline prices.
The Fed cannot do two things at once. It cannot keep US consumer rates from rising with a renewed and augmented quantitative purchase program and hope to maintain a strong dollar. The currency markets have made their view of quantitative easing quite clear. Even though US interest rates rose from March the dollar fell. Monetization is a greater threat to the dollar than rates are a support.
The Fed governors must decide which is more important: domestic interest rates or a strong dollar. The FOMC approach to quantitative easing will provide the answer. This is an important meeting.
Joseph Trevisani
Tuesday, June 16, 2009
Market Direction
In a normal world these two charts would be complementary. As interest rates on the 10-year Treasuries rise one could reasonably expect the Dollar Index to follow. But ever since March18th when the Federal Reserve announced its $300 billion quantitative easing policy, the divergence has been pronounced.—the higher Treasury rates climb the lower the Dollar Index sinks. Has the natural order of the currency markets been upended?
10 Yr Treasury Yield 1 year chart
Dollar Index 1 year chart
In normal economic times the currency market and the bond market respond to the anticipation of higher US rates. The price of Treasuries fall, the yield climbs and the dollar gains. It is the expectation of returning economic growth and inflation that piques the anticipation for a new upward rate cycle from the central bank. If this were a standard recession, with three quarters of negative growth already past, historically low rates, large amounts of additional liquidity, and the first stirrings of recovery, market anticipation would focus on the changeover to a restrictive rate policy.
But these are not normal times. Fed rate policy is constrained by the recession and the residue of the financial crisis. The Fed cannot and will not raise rates until the economy is clear of the threat of deflation and the financial system has restored its ability to lend and supply credit to the economy.
The Fed is in a bind. If it lets consumer interest rates rise it undermines the economic recovery its policy has been trying to foster since last year and risks choking off whatever economic stabilization has been achieved. But if it increases its purchases of Treasury debt to keep rates low then it provokes fears of future inflation; and, what is perhaps more damaging, the suspicion that the US government is willing to monetize its debt.
In the current economic environment, and especially in light of the government’s unprecedented funding needs, extensive Fed purchase of government notes, quantitative easing, will cause as much harm as good. ‘Quantitative easing’ is simply a different term for the monetization of government debt. The Federal Reserve buys debt issued by the Treasury and the Treasury uses the proceeds of the sales to pays its bills, which means distributing the new dollars to the economy.
The inflationary result of quantitative easing is twofold. It contributes directly to present inflation by increasing the money supply and by devaluing the dollar, raising the cost of dollar priced commodities like crude oil. Higher oil prices feed back into consumer price inflation. Last summer’s $4.00 a gallon gasoline was at least partly caused by the historically weak dollar. The cost of gasoline acts as a direct drag on consumer spending, reducing disposable income. The pump price for a gallon has gained more than the dollar in the past two months.
The second effect of quantitative easing is more insidious but in the long run far more damaging to the US dollar. If higher rates for US Treasuries indicate an oversupply of these dollar assets then they pose a danger to the dollar’s status as the world’s reserve currency. One of the basic functions of a reserve currency is as a store of value for liquid assets. If investors look into the future and see only an ever increasing supply of dollar assets for sale, in numbers far beyond the rate of economic growth in the US, issued by Washington to fund its deficits, then the value of those assets will likely to fall..
The financial crisis was a singular event and it prompted an unprecedented flight to quality in the Treasury market. The demand for security was so great that Treasury yields fell far below historical analogues. Two developments particular to the Treasury market and abnormal in the sense of never having occurred before have kept the currency markets from responding in a standard fashion to the rise in Treasury rates.
First, the recent increase in the 10-year yield has taken place in the contest of historically low Treasury rates. The 2.03% yield of last December was an anomaly and the return to more normal yields should not be taken to mean anything but that the most extreme portion of the financial crisis is passed. Higher Treasury yields do not in this case mean a change in Fed policy is near.
10 Year Treasury Yield 20 Year Chart
The second Treasury market development is also brand new and without historical example: the budget plans of the Obama administration.
The Democratic administration isn’t just issuing record debt this year. For the next ten years, in the government’s own projections, deficits never drop below $500 billion in any year. The administration claims that this scale of debt is necessary to help the US avoid the worst effects of the recession. But the costs of the array of new programs that are part of the budget projections dwarf anything that the US government has ever enacted before. Every dollar of this new spending will have to be borrowed.
For the Treasury market the vast supply of issuance threatens to overwhelm demand. This quantity of government debt has never been put for auction to the world’s investors. Their response is unknown. Will the United States government be able to sell its debt and fund its deficit? Yes. The question is at what cost. How much higher will returns have to go to keep buyers purchasing US securities?
In pushing Treasury rates higher, the bond market is responding to the enormous pending supply of government debt and to the historic lows in Treasury yields that resulted from the financial panic. 3.7% yields in the 10-year Treasury are not indicative of a Fed on the verge of a restrictive interest rate policy. .
Because both developments were singular to the Treasury market and do not yet represent a scenario dangerous for the US economy the currency market response was muted. It remains to be seen if currency traders view the projected massive increase in American debt as a positive or negative for the dollar.
Joseph Trevisani
10 Yr Treasury Yield 1 year chart
Dollar Index 1 year chart
In normal economic times the currency market and the bond market respond to the anticipation of higher US rates. The price of Treasuries fall, the yield climbs and the dollar gains. It is the expectation of returning economic growth and inflation that piques the anticipation for a new upward rate cycle from the central bank. If this were a standard recession, with three quarters of negative growth already past, historically low rates, large amounts of additional liquidity, and the first stirrings of recovery, market anticipation would focus on the changeover to a restrictive rate policy.
But these are not normal times. Fed rate policy is constrained by the recession and the residue of the financial crisis. The Fed cannot and will not raise rates until the economy is clear of the threat of deflation and the financial system has restored its ability to lend and supply credit to the economy.
The Fed is in a bind. If it lets consumer interest rates rise it undermines the economic recovery its policy has been trying to foster since last year and risks choking off whatever economic stabilization has been achieved. But if it increases its purchases of Treasury debt to keep rates low then it provokes fears of future inflation; and, what is perhaps more damaging, the suspicion that the US government is willing to monetize its debt.
In the current economic environment, and especially in light of the government’s unprecedented funding needs, extensive Fed purchase of government notes, quantitative easing, will cause as much harm as good. ‘Quantitative easing’ is simply a different term for the monetization of government debt. The Federal Reserve buys debt issued by the Treasury and the Treasury uses the proceeds of the sales to pays its bills, which means distributing the new dollars to the economy.
The inflationary result of quantitative easing is twofold. It contributes directly to present inflation by increasing the money supply and by devaluing the dollar, raising the cost of dollar priced commodities like crude oil. Higher oil prices feed back into consumer price inflation. Last summer’s $4.00 a gallon gasoline was at least partly caused by the historically weak dollar. The cost of gasoline acts as a direct drag on consumer spending, reducing disposable income. The pump price for a gallon has gained more than the dollar in the past two months.
The second effect of quantitative easing is more insidious but in the long run far more damaging to the US dollar. If higher rates for US Treasuries indicate an oversupply of these dollar assets then they pose a danger to the dollar’s status as the world’s reserve currency. One of the basic functions of a reserve currency is as a store of value for liquid assets. If investors look into the future and see only an ever increasing supply of dollar assets for sale, in numbers far beyond the rate of economic growth in the US, issued by Washington to fund its deficits, then the value of those assets will likely to fall..
The financial crisis was a singular event and it prompted an unprecedented flight to quality in the Treasury market. The demand for security was so great that Treasury yields fell far below historical analogues. Two developments particular to the Treasury market and abnormal in the sense of never having occurred before have kept the currency markets from responding in a standard fashion to the rise in Treasury rates.
First, the recent increase in the 10-year yield has taken place in the contest of historically low Treasury rates. The 2.03% yield of last December was an anomaly and the return to more normal yields should not be taken to mean anything but that the most extreme portion of the financial crisis is passed. Higher Treasury yields do not in this case mean a change in Fed policy is near.
10 Year Treasury Yield 20 Year Chart
The second Treasury market development is also brand new and without historical example: the budget plans of the Obama administration.
The Democratic administration isn’t just issuing record debt this year. For the next ten years, in the government’s own projections, deficits never drop below $500 billion in any year. The administration claims that this scale of debt is necessary to help the US avoid the worst effects of the recession. But the costs of the array of new programs that are part of the budget projections dwarf anything that the US government has ever enacted before. Every dollar of this new spending will have to be borrowed.
For the Treasury market the vast supply of issuance threatens to overwhelm demand. This quantity of government debt has never been put for auction to the world’s investors. Their response is unknown. Will the United States government be able to sell its debt and fund its deficit? Yes. The question is at what cost. How much higher will returns have to go to keep buyers purchasing US securities?
In pushing Treasury rates higher, the bond market is responding to the enormous pending supply of government debt and to the historic lows in Treasury yields that resulted from the financial panic. 3.7% yields in the 10-year Treasury are not indicative of a Fed on the verge of a restrictive interest rate policy. .
Because both developments were singular to the Treasury market and do not yet represent a scenario dangerous for the US economy the currency market response was muted. It remains to be seen if currency traders view the projected massive increase in American debt as a positive or negative for the dollar.
Joseph Trevisani
Monday, June 8, 2009
Market Direction June, 08, 2009
Several confidence measures in the United States have returned to the levels they held before the great financial collapse last fall. Do they presage an impending economic recovery?
US Consumer Confidence readings from the Conference Board and University of Michigan have pulled out of their deep post September troughs. The same is true for the Institute for Supply Management’s (ISM) manufacturing and services surveys. But these forward looking sentiment statistics contrast markedly with measures that gauge actual economic commitments. The performance of the consumer and manager is much at odds with what they say is their economic view.
The return of these sentiment indicators nearly to pre-collapse levels combined with the massive fiscal and monetary stimulus packaged enacted in the industrialized countries has convinced many equity traders and commentators that the recession has or will shortly ebb and growth is soon to revive. The problem with this scenario is that there are no substantive indicators that agree with the diagnosis.
In August of last year the University of Michigan overall consumer confidence number registered 63, in September the month of the Lehman bankruptcy, it was 70.3. These reading were down from occasions in the low 90s in the early part of 2007. In May of this year confidence had recovered to 68.1 from the mid-50s post collapse; this is the highest indication after September.
The 'expectations' section of the survey experienced a similar rebirth. From 67.2 in September 2008 it fell to a low of just over 50 in February before recovering to 69.4 in the month just past.
The 'current conditions' reading also improved but less than the others. It was 71 in August 2008, 75 in September, suffered a low in November of 57.5 and recovered to 68.3 in April of this year followed by a drop to 67.7 in May.
Readings from the Conference Board show a similar progression. The overall number was 58.5 last August, 61.4 in September and 54.9 last month. The ‘expectations’ component was 54.1 last August, 61.5 in September, 51 in April 2009 and 72.3 in May. And as with the Michigan survey, ‘current conditions’ was the most problematic. It was 65 in August of last year, 61.1 in September, reached a low of just below 22 in March of this year and by May had regained only 28.5.
The pattern is fairly uniform. A reviving ‘expectations’ component pulls the overall reading higher, while the 'current conditions' component is weak, or as in the Conference survey, barely in recovery at all.
The ISM results are similar. The manufacturing survey registered 49.9 in August 2008, 43.4 in September and by May had recovered to 42.8 from the mid 30s in February and March. 'New orders' were the most buoyant scoring a mildly expansionary 51.1 in May, above the 48.2 reading of last August and the sub 30 low of last November.
The non-manufacturing survey composite was 50.4 in the month before the crash, 50 in September, reached a low of 37.4 last November and had regained 44.0 last month. 'New orders' were 49.5 in August, 50.6 in September, dropped to a bottom on 35.6 in November and had bounced to a still contracting level of 44.4 in May.
But these sentiment numbers have not translated into consumer spending or industrial activity. It is as if everyone is saying. Yes, things are better, but I am not spending, I am saving more and I am worried about my job. But if you are asking, yes the overall economy has improved since last fall.
Consumer credit, personal expenditures, industrial production, and capital utilization remain firmly in recessionary territory.
Consumer deleveraging continues apace. Last September American consumers added $6.98 billion in debt to their portfolios. The three month moving average for consumer credit was $3.436 billion in August 2008 and $2.886 in September. In April of this year consumer credit contracted $15.7 billion; in March Americans subtracted $16.5 billion from their debt. The three month moving averages for these months were -$14.366 billon and -$7.533 billon respectively.
Personal expenditures have declined in six of the past eight months from last September. The only positive months were January and February of this year, when spending was prompted by retailers’ heavy post holiday discounts. In the eight months before September 2008 the ratio was exactly the opposite, six positive months and two, July and August were negative.
The productive economy is even more depressed than the consumer. Industrial production has been positive in only one month since the beginning of last year, October 2008. Capacity utilization in April was 69.1%, and has dropped even month since December 2007.
And consumers now have a new worry; US Federal deficits have the potential to create an interest rate drag on future economic growth.
Government bond prices have fallen substantially since March putting upward pressure on interest rates in the economy. On Friday the 10 year Treasury closed at 3.83% up more than 1.6% since March. 30 year mortgage rates near 5.4% are almost 0.5% higher than one month ago. Concomitantly the vast Federal funding needs have begun to damage the dollar. The lower the dollar goes the higher reach commodity prices fueling inflation. A sinking dollar driving up crude oil prices belongs to the scenario that gave consumers $4 a gallon gasoline last summer. The Fed will be very hard pressed to keep rates low enough to benefit consumer spending, facilitate government debt sales and restrain fears of future inflation.
Considering the chasm that the world economy has fallen into since last fall, some recovery in sentiment was inevitable. Catastrophe averted is better than catastrophe endured but to borrow a phrase from Churchill, 'We must be very careful not to assign to this deliverance the attributes of a victory. Wars are not won by evacuations'.
I suspect that the relief that the world did not end last fall and spring is coloring the expectations of consumers and managers alike. Outlooks are much better; indeed it would be hard to be much worse than the media coverage of the economy last fall. But relief is not migrating from the mind to the pocketbook. More improvement will have to happen, particularly in the job outlook, before the consumers again take up their burdens.
US Consumer Confidence readings from the Conference Board and University of Michigan have pulled out of their deep post September troughs. The same is true for the Institute for Supply Management’s (ISM) manufacturing and services surveys. But these forward looking sentiment statistics contrast markedly with measures that gauge actual economic commitments. The performance of the consumer and manager is much at odds with what they say is their economic view.
The return of these sentiment indicators nearly to pre-collapse levels combined with the massive fiscal and monetary stimulus packaged enacted in the industrialized countries has convinced many equity traders and commentators that the recession has or will shortly ebb and growth is soon to revive. The problem with this scenario is that there are no substantive indicators that agree with the diagnosis.
In August of last year the University of Michigan overall consumer confidence number registered 63, in September the month of the Lehman bankruptcy, it was 70.3. These reading were down from occasions in the low 90s in the early part of 2007. In May of this year confidence had recovered to 68.1 from the mid-50s post collapse; this is the highest indication after September.
The 'expectations' section of the survey experienced a similar rebirth. From 67.2 in September 2008 it fell to a low of just over 50 in February before recovering to 69.4 in the month just past.
The 'current conditions' reading also improved but less than the others. It was 71 in August 2008, 75 in September, suffered a low in November of 57.5 and recovered to 68.3 in April of this year followed by a drop to 67.7 in May.
Readings from the Conference Board show a similar progression. The overall number was 58.5 last August, 61.4 in September and 54.9 last month. The ‘expectations’ component was 54.1 last August, 61.5 in September, 51 in April 2009 and 72.3 in May. And as with the Michigan survey, ‘current conditions’ was the most problematic. It was 65 in August of last year, 61.1 in September, reached a low of just below 22 in March of this year and by May had regained only 28.5.
The pattern is fairly uniform. A reviving ‘expectations’ component pulls the overall reading higher, while the 'current conditions' component is weak, or as in the Conference survey, barely in recovery at all.
The ISM results are similar. The manufacturing survey registered 49.9 in August 2008, 43.4 in September and by May had recovered to 42.8 from the mid 30s in February and March. 'New orders' were the most buoyant scoring a mildly expansionary 51.1 in May, above the 48.2 reading of last August and the sub 30 low of last November.
The non-manufacturing survey composite was 50.4 in the month before the crash, 50 in September, reached a low of 37.4 last November and had regained 44.0 last month. 'New orders' were 49.5 in August, 50.6 in September, dropped to a bottom on 35.6 in November and had bounced to a still contracting level of 44.4 in May.
But these sentiment numbers have not translated into consumer spending or industrial activity. It is as if everyone is saying. Yes, things are better, but I am not spending, I am saving more and I am worried about my job. But if you are asking, yes the overall economy has improved since last fall.
Consumer credit, personal expenditures, industrial production, and capital utilization remain firmly in recessionary territory.
Consumer deleveraging continues apace. Last September American consumers added $6.98 billion in debt to their portfolios. The three month moving average for consumer credit was $3.436 billion in August 2008 and $2.886 in September. In April of this year consumer credit contracted $15.7 billion; in March Americans subtracted $16.5 billion from their debt. The three month moving averages for these months were -$14.366 billon and -$7.533 billon respectively.
Personal expenditures have declined in six of the past eight months from last September. The only positive months were January and February of this year, when spending was prompted by retailers’ heavy post holiday discounts. In the eight months before September 2008 the ratio was exactly the opposite, six positive months and two, July and August were negative.
The productive economy is even more depressed than the consumer. Industrial production has been positive in only one month since the beginning of last year, October 2008. Capacity utilization in April was 69.1%, and has dropped even month since December 2007.
And consumers now have a new worry; US Federal deficits have the potential to create an interest rate drag on future economic growth.
Government bond prices have fallen substantially since March putting upward pressure on interest rates in the economy. On Friday the 10 year Treasury closed at 3.83% up more than 1.6% since March. 30 year mortgage rates near 5.4% are almost 0.5% higher than one month ago. Concomitantly the vast Federal funding needs have begun to damage the dollar. The lower the dollar goes the higher reach commodity prices fueling inflation. A sinking dollar driving up crude oil prices belongs to the scenario that gave consumers $4 a gallon gasoline last summer. The Fed will be very hard pressed to keep rates low enough to benefit consumer spending, facilitate government debt sales and restrain fears of future inflation.
Considering the chasm that the world economy has fallen into since last fall, some recovery in sentiment was inevitable. Catastrophe averted is better than catastrophe endured but to borrow a phrase from Churchill, 'We must be very careful not to assign to this deliverance the attributes of a victory. Wars are not won by evacuations'.
I suspect that the relief that the world did not end last fall and spring is coloring the expectations of consumers and managers alike. Outlooks are much better; indeed it would be hard to be much worse than the media coverage of the economy last fall. But relief is not migrating from the mind to the pocketbook. More improvement will have to happen, particularly in the job outlook, before the consumers again take up their burdens.
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