Mid-Week Position Summary

Short USD/MXN @ 12.93

Capital Ratio: 12.62

I continue my bullish stance on the peso despite a slight pullback into the 13.04-13.1 region.  I increased my position by 25 percent last Thursday at 13.05.  Sandy, and nervousness over the jobs numbers and elections coming up have been weighing on risk sentiment.  If anything, the internal fundamentals in Mexico have strengthened, with Mexico registering an above 4 percent YoY GDP growth rate for Q3, and a hawkish policy statement coming out of the Banco de México.  I will be watching the ADP and BLS jobs numbers closely, and may take profits if good news causes a euphoric pop in risk appetite.  That said, the peso's excellent yield, and along with my strong capital position make sitting tight an attractive option as well. 

Doing the Rounds: USD Grinds Higher Amid General Risk Aversion

The US dollar has been grinding upward against its major peers today as markets are met with a general mood of risk aversion.  EUR/USD appears poised to make another run at the 1.28 handle, though only a sustained break below this key psychological point would reestablish a mid to longterm bearish trend.  Likewise, cable traded lower today in the 1.600-40 range.  Conflicting signals from Bank of England officials have also weighed on Sterling.  Again, watch a break below 1.60 for clues as to the midterm trend.  USD/MXN spiked up to 13.1087, missing my sell order by a measly 13 pips, before heading back down towards the top end of the 13-13.07 range where the pair has spent the majority of the last few trading session.  The Canadian Dollar continued its slide, with USD/CAD trading back above parity.  AUD/USD was also dinged this morning, trading down roughly 30 pips from Friday's 1.0360 highs.  Finally, it is interesting to note that the less liquid pair USD/PEN has also seen its biggest daily gain in nearly four months.  Peru's Nuevo Sol has been appreciating as the South American country has maintained some of the strongest growth in the region as the result of sound macro-economic policy.  This, despite the central bank's intervention to smooth out the appreciation of the nation's currency.  USD/PEN traded above 2.6 for the first time since September after closing at 2.5910 last Friday.

In general, market conditions have not changed.  Look for bargain hunters to come in to position themselves for Friday's jobs report.     

Weekend Update: Corporate Earnings, Jobs Report in Focus

The week to come is choke full of data points to be priced in by the market.  Many big names report quarterly earning throughout the week.  Right out of the gate on Monday Baidu(BIDU) and Burger King(BKW) report, after and before the close respectively.  Tuesday the 30th sees Eaton Corp (ENT) and Deutsche Bank (DB), and BP(BP) report, while General Motors (GM) will host its conference call before the open on Wednesday morning.  Exxon and Chevron report on Thursday and Friday respectively.

The flurry of corporate names reporting should set the tone for risk sentiment going into the all important jobs report, expected to come in at 145k, released at 8:30 AM EST on Friday.  Considering all this, and with the specter of an ultra close US presidential election weighing on some market participants, we're in for a volatile week. 

News: Banco de México Stands Pat, for Now.

Mexico's central bank held its key interest steady at 4.5 percent today in an announcement released at 10:30 AM central time in Mexico City.  The five member board headed by Austín Carstens has kept its target rate, the rate at which banks lend to each other overnight on an unsecured basis, at a record low since May of 2009, though has maintained a "neutral monetary policy," in the words or Mr. Carstens since then.  Mexico's relatively strong economic performance during the global recovery has caused the nation's central bank to refrain from further asset purchases or rate reductions for three years, even as its counterparts in both advanced and emerging markets have stepped up efforts to speed growth through monetary stimulus.  Both the Federal Reserve and the Bank of England have recently expanded their respective QE programs, while this quarter has also seen surprise rate cuts from emerging market economies like South Africa and Thailand.

Mexico's decision to hold its rate at 4.5 percent was widely expected by most analysts, however, the statement of monetary policy provides new insight into the overall stance of the Banco de México's board of governors.  While the growth outlook was somber, and warned global macro risks such as the so-called fiscal cliff in the US and the ongoing trials and tribulations of the Euro-zone, the bank appears to be losing its patience with inflation.  Inflation in Mexico hit 4.77 percent last month, outside of the central bank's target of two to four percent.  While the bank in its statement attributed the rise in general inflation to supply shocks in both food and energy, noting that core inflation has stayed steady, it expressed the will to act even if it judges risks of higher inflation are only due to short term spikes in the price of oil and/or agricultural commodities.  Of particular concern to the bank is the possibility that above target general inflation may skew inflation expectations in the real economy upward, even if the rise in CPI is mainly due to price increase in items excluded from core inflation, rather than a general rise in prices across all sectors.  The bank therefore strongly hinted at possible rate hikes in the near future to "consolidate currently low inflation expectations, prevent 'contamination' of the process of price formation in the rest of the economy, and not compromise the bank's commitment to achieving a longterm inflation target of 3 perent."

Furthermore, Carstens has stated publicly on several occasions that volatility in global financial markets has resulted in overselling of emerging market currencies, particularly the Mexican Peso.  He has continually characterized the peso as "clearly undervalued" and has stated that further appreciation back towards 11 MXN per USD would be a welcome relief to both Mexican consumers and businesses which have been squeezed by higher import costs.  That said, Mr. Carstens has also insisted that any kind of peso appreciation must come from strong fundamentals and economic performance rather than any specific or set of central bank policies.

This morning's announcement failed to move the peso which bounced around in a range today and closed in New York at 13.02 per USD.   

Commentary: The Week Everything Changed in USD Land

I remember watching CNBC on September 15 2008, hours after failure of Lehman Brothers.  Markets were panicking and chaos reigned. But looking back in my memory of the jumbled mess of swirling rumors, idle speculation, and fear driven hypotheticals, one image remains burned into my mind's eye.  To this day, I remember the words "US Dollar Sharply Weaker" popping up in the text box above the stock ticker as it cycled through various headlines.  To those of us who have stayed in the market since then, this simple historical fact may come as a shocking revelation.  Indeed, for the better part of four years now, any bad news, inside or outside the US, has been met by investors around the world running to the greenback.  Bad US jobs reports, surging dollar.  Weak German consumer confidence, surging dollar.  China growth concerns, surging dollar.  What is most striking is that even disappointing economic news out of the US seems to be good for the dollar, as market participants assume that a weak US economy means a weak world economy, and they run to the safe haven asset of choice, ironically, the US dollar itself.

However, during the week after the collapse of the once venerable Lehman Brothers, the data shows that people, of all place, ran to the Euro.  Below is a figure of the daily exchange rates for EUR/USD in the two weeks following failure of Lehman.

EUR/USD during the two weeks following the collapse of Lehman Brothers.  The bad news of the failure of a major US firm at first sent the Euro higher versus the greenback as US fundamentals appeared to be the weakest in decades.  The following week however, as the the market digested the depth of the crisis and its global impact, investors raced back into the dollar as a safe haven despite the fact that the crisis had its origins in the US.  The Euro would continue a massive slide all through October and would not find a bottom until April of 2009 at 1.20 USD per EUR. 

The fact that the Euro surged and then fell tells a story that has been slowing unfolding over the past few decades since before the dot-com bubble.  From 1980 until the 2001 recession, the United States had been generally seen as the best opportunity for growth in the world.  All through the 80s and 90s, the dollar rose with domestic equities as the United States was leading what many around the world saw as a secular bull market.  But by the start of the new millennium, the 4.5 percent growth of the nineties was replaced more measured 2.5 percent growth of the early 2000s. For the first time in nearly two decades, the market looked outside the US for the biggest opportunities for growth, and the dollar got hammered.  The biggest beneficiaries were both in vogue emerging markets like Brazil, but also well established economies like Austrailia and Canada.  Both of these countries have seen their dollars push past parity with their American counterpart.  (They crashed during the 2008-09 crisis but have since recovered)

So for that one week after the fall of Lehman, the market had interpreted the failure of the largest US investment bank as just the latest chapter in the overall story of a secular US decline.  Accordingly, major actors continued US divestment.  But as we know now, within a matter of days, investors would be fleeing back into the US dollar as global growth concerns moved to the fore as the crisis deepened.  It wasn't just another failure of a big US firm which was sending signals that the best days for the US were behind it, the entire world financial system was on the brink, and now the amazing story of growth seen in emerging markets was unraveling.  The dollar now traded differently.  Any bad news, US or international, sent it soaring, while even good domestic numbers would cause it to fall as more risk was bought.  In a mere two week span, everthing had changed in USD land.

Today, and as global heads of state, finance ministers, and central bankers continue their quest for growth, the USD stands at a crossroads.  It could continue the trend of trading lower on good news and higher on bad news, as investors seek to continue the pre-2008 emerging bull market which was brought to a screeching halt by the financial crisis.  On the other hand, with the mess in Europe, the US may be poised to lead the world recovery.  In the latter scenario, the dollar would begin to trade higher on good domestic numbers as investors moved into US equities and corporate bonds.  Eventually, the world demand for US debt would rise even more as investors bought T-bills on the speculation that the dollar would appreciate.  If a strong US jobs report ever sends the dollar higher instead of tumbling against emerging market currencies and EUR, it would represent a major shift in the psychology of the market and may be clear indication of a new secular bulls market for both the USD and US equities.

For those of us still interested in emerging market currencies, it may be time to consider switching to a cross rather than buying them against the US dollar.  One idea I have been toying with is switching to the Yen as my funding currency for MXN purchases.  For those of you interested emerging markets like India, South Africa, or Turkey. I would recommend buying ZAR/JPY or TRY/JPY instead of selling USD/ZAR or USD/TRY respectively.  If your broker does not offer these crosses, try buying USD/JPY on dips (I am looking to get long at 79) to hedge against the eventuality of a stronger dollar based on stronger US fundamentals.              

Mid-Week Position Summary

Short USD/MXN @ 12.9000

Capital Ratio: 10.08 percent

I am all in on the peso after booking some modest profit on long GBP/USD positions earlier earlier in the week. Order filled right before a slight pullback to 12.98.  The longterm tread remains bearish with many investment houses upgrading their outlook on Mexico's peso.  The fundamentals remain strong with a growing Mexican economy, strong foreign demand for peso denominated assets,  sound fiscal policies by the central government, and a hawkish central bank.   The trade has nice positive carry and I intend to hold this position even if there is a large  short term pop in light of my strong capital position and ability to ride out losses.  I will target the 2011 low of 12.55 in the medium term (1-2 months) and look to get short again for the one to two year target of 11 pesos to the dollar. 

Commentary: Will the Outcome of the US Presidential Election Move the FX Market?

Markets watch US presidential elections.  All the way back in 2000, the uncertainty around the result caused a large sell off of stocks on Wall Street which sent the Dow plunging.  (The dot-com bubble had also burst in March of 2000)  With the country charging towards the edge of the fiscal cliff, and the prospect of a lame duck Congress having to fix it, all eyes are on Washington.  Furthermore, slow growth, and overhang from Europe is weighing heavily on investor sentiment.  Here at FX-Fusion, it is our opinion that actors across the entire economy are still weary from the crisis of 2008, and for the past few years investors have been slowly wading back into the market.  Households are still deleveraging by aggressively paying off non-mortgage debt, and young people are renting because they are still afraid to enter a recently beaten down housing market.  The economy is growing, but despite this, the market is still looking for a clear signal which will either turn the bulls loose or bring in the bears, both of whom have spent the summer and fall waiting with baited breathe for any major news out of Europe .  So in this uncertain, directionless environment, market events matter more than ever.  Finally,   Mitt Romney has been pushing the "China is a currency manipulator" meme for months now, so I think that it is quite appropriate for me to share my thoughts on how the election next month may impact the FX market. 

What About China?

As President Obama correctly pointed out, USD/CNY has appreciated substantially since 2010.  The chart below illustrates this point.     

The Managed Appreciation of  the Chinese Yuan.  The People's Bank of China (PBOC) held the exchange rate with the US dollar constant for decade from 1995 to 2005 before allowing significant appreciation.  It reestablished the peg in 2008 to help its exports during the Great Recession.  In 2010, after significant nudging from the Obama Administration, China again allowed its currency to appreciate. 

 So the Reminbi (aka Yuan)  has already been allowed to rise against the dollar.  Sell USD/CNY, its a great carry trade with significant chance for further Yuan appreciation.  But as important as flexible exchange rates are for preventing trade and capital flow imbalances, it should be obvious to anyone that even if the Yuan were at parity with the dollar, it would still be attractive to ship jobs there because labor costs are so much cheaper.  In short, the only way to compete with China without bringing down real wages stateside (an adjustment that would take decades) is for US workers to gain more education and training so that they are many times more productive that their Chinese counterparts.  I am not the first or hundredth person to point this out, but it definitely bears repeating.  Labelling China a "currency manipulator" won't solve the massive trade imbalance.  Furthermore, since China is already allowing its currency to appreciate, doing only serves to antagonize the third largest economy in the world.    

Will a Romney Win Result in a Stronger Dollar? 

A well respected fund manager recently opined that an inevitable Romney victory will result in a stronger dollar on the speculation that Romney would appoint a more hawkish Fed chairman.  This very thought had crossed my mind a few weeks ago, back before the polls had tightened.  More hawkish language from the Fed, or the prospect of a tightening of monetary policy may cause temporary dollar rallies, but speculating on the election is foolhardy.  First, with national polls virtually tied and a slight Obama lead in the electoral college, the contest between Mr. Romney and President Obama is basically a coin flip.  Furthermore, a Romney victory may very well not move the markets because Ben Bernanke's term does not expire until 2014.  The prospect of an unknown Fed chairman being installed two years in the future is hardly a clear data point for the market to price in.  In short, spec plays based on the election are probably just gambling.  But if that is your thing, let me suggest going short AUD/USD on th prospect of further rate cuts from the RBA and the corresponding monetary tightening that would come with a new Fed Chairman.  

Parting Shot:  China is already letting its currency appreciate.  Speculating on  the election is foolish because the polls are tied and it is a distinct possibility that the result does not move the market.