Those of you who read this blog probably have figured out two things. First, I really like the Mexican peso, and plan to hold it for the long to medium term. Another strongly held conviction I have, second only to the potential for MXN, is that the Japanese Yen must depreciate. Japan remains a safe haven despite its weak internal fundamentals underscored by chronic deflation problems, a rapid aging population which will soon struggle to replace itself, and a general sense of stagnation and malaise. While the Japanese may be able to fix their animal spirits and come out of their melancholia, the BOJ and the national government are probably useless at fixing their deflation and demographic crises. The BOJ does not have the courage to enact an aggressive enough asset purchase program that would cause above target short term inflation but finally end the decades of deflation which have resulted in tens of trillions of Yen in lost growth. The national politicians on the other hand will never stand up to voters and enact a sensible immigration policy which welcomes immigrants from other parts of Asia to replace Japan's dying population.
Those of you watching the markets this month saw the dip in the Peso followed by its recovery, and a surge in the Yen, followed by its collapse to seven month lows. So did your humble analyst reap handsome profits from the realignment of the short term trends with the long term fundamentals? Alas no. When the panic earlier this month over the fiscal cliff came, I had already initiated as many positions as I had felt comfortable holding. I had a huge long MXN position and had no exposure to the Yen. When the big peso pullback came, I was unable to buy the dip for fear of getting over leveraged. I was simply forced to ride out the losses. The excessive risk which comes with excessive margin also stopped me from shorting the Yen as it popped during the run up to the election. In sum, even when you have fundamental beliefs in your positions, keeping a little dry powder is always a powerful move. There is a huge opportunity cost to giving up all liquidity and going all in, even when the long term fundamentals are with you. This is especially true when major market events are on the horizon. Such was the case in October, with coming US elections and the looming fiscal cliff. In retrospect, despite my confidence in the time in the Peso, and I'm still confident, keeping some cash on the sidelines would have enabled me to take advantage of the inevitable volatility.
Friday, November 23, 2012
Saturday, November 17, 2012
Weekend Update: Fiscal Cliff Weighs Heavily on Markets
Mexico missed on GDP last Friday, growing at a 3.3 percent YoY basis for the third quarter for 2012, slightly below analysts expectations. Markets didn't care though, and the Peso closed up nearly 1000 pips from the 13.25-29 lows, ending the trading day in New York at 13.15. Press conferences held by US congressional leaders had an upbeat and optimistic tone about an early resolution to the fiscal cliff. The news buoyed the Peso, which sells eighty percent of its exports to the US. The fundamental story in Mexico is still positive, despite this recent miss. The events of Friday make it clear that the fate of the Peso, as long as Mexico is stable, is tied to external factors like Europe and the US budget talks, and not internal factors like Mexico's growth rate. I remain cautiously optimistic, for now.
Tuesday, November 13, 2012
Commentary: Why the US Won't Go off the Fiscal Cliff
Since the US presidential elections earlier this month, markets have been under considerable downward pressure over fears of the fiscal cliff. Equity markets are posting red across the board. The Dow Jones has experienced several 200+ point sell offs in the recent sessions. On Fx, markets are expressing the general risk off mood by running to 'safe haven' assets like the USD and JPY, while selling off riskier currencies such as MXN, TRY and ZAR. AUD and CAD have shown some resilience, but both are off their highs. AUD is objectively the most 'respectable' high yielding currency. Australia is the only advanced economy whose central bank is not implementing very low interest rate policies.
The fiscal cliff undoubtedly presents the greatest macro-economic risk to the global recovery, and policy makers in Washington would do well to craft an agreement as quickly as possible to calm jittery markets. The going off the cliff would tighten fiscal policy by cutting the deficit by roughly 800 billion. This would be achieved by spending cuts and the repeal of all the Bush tax cuts. Currently, the deficit is roughly 1.2 trillion; an unprecedented sum for an unprecedented slowdown. Those concerned about the fiscal cliff are falling back on the economic dogma developed by John Maynard Keynes in the 1930s, which established that in the short run, the amount of production in the economy equaled the amount of spending in the economy. A crucial part of that spending is deficit spending by government.
The obvious plan is to allow fiscal policy to tighten slowly over time so that the consumer and investors can pick up the slack as the government deficit falls. This may call for say 50 to 100 billion is deficit reduction for 2013, with more reductions throughout the decade as the recovery takes hold. The composition of this reduction, ie, how much is achieved through cuts and how through tax increases is probably largely irrelevant, and Obama knows it. 100 billion dollars in a 15 trillion dollar economy is just not that big a deal, even with Keynesian multipliers. Obama will push for tax increases on the rich in order to achieve a post election political victory. To me, this seems a waste of hard won political capital, since again the total deficit reduction only should be about 100 billion at max, and the Bush tax cuts for top earners (250,000k+) is only 80 billion a year. A much more significant longterm policy achievement would be to reform immigration or pass the Dream Act. Both would spur growth by removing artificial barriers to the movement of human capital.
Thankfully, there are many vested interests who want to maintain the status quo. This includes voters who will not willingly accept that their taxes should go up, as when as innumerable industries which rely on government contracts. When all is said and down, the groups that experience the most pain when the deal is struck later this year will be those groups with the least clout in Washington and the least organized lobbying efforts.
The fiscal cliff undoubtedly presents the greatest macro-economic risk to the global recovery, and policy makers in Washington would do well to craft an agreement as quickly as possible to calm jittery markets. The going off the cliff would tighten fiscal policy by cutting the deficit by roughly 800 billion. This would be achieved by spending cuts and the repeal of all the Bush tax cuts. Currently, the deficit is roughly 1.2 trillion; an unprecedented sum for an unprecedented slowdown. Those concerned about the fiscal cliff are falling back on the economic dogma developed by John Maynard Keynes in the 1930s, which established that in the short run, the amount of production in the economy equaled the amount of spending in the economy. A crucial part of that spending is deficit spending by government.
The obvious plan is to allow fiscal policy to tighten slowly over time so that the consumer and investors can pick up the slack as the government deficit falls. This may call for say 50 to 100 billion is deficit reduction for 2013, with more reductions throughout the decade as the recovery takes hold. The composition of this reduction, ie, how much is achieved through cuts and how through tax increases is probably largely irrelevant, and Obama knows it. 100 billion dollars in a 15 trillion dollar economy is just not that big a deal, even with Keynesian multipliers. Obama will push for tax increases on the rich in order to achieve a post election political victory. To me, this seems a waste of hard won political capital, since again the total deficit reduction only should be about 100 billion at max, and the Bush tax cuts for top earners (250,000k+) is only 80 billion a year. A much more significant longterm policy achievement would be to reform immigration or pass the Dream Act. Both would spur growth by removing artificial barriers to the movement of human capital.
Thankfully, there are many vested interests who want to maintain the status quo. This includes voters who will not willingly accept that their taxes should go up, as when as innumerable industries which rely on government contracts. When all is said and down, the groups that experience the most pain when the deal is struck later this year will be those groups with the least clout in Washington and the least organized lobbying efforts.
Sunday, November 11, 2012
Weekend Update: Bracing for the Week Ahead
It's Sunday night in the US and the coming weeks have many of us who have placed risk on bets nervous. The uncertainty as to the resolution of the so-called fiscal cliff spooked markets last week, causing big sell offs in currency and equity markets. On FX, the market ran to the USD and JPY, both posting big gains for the week. USD/MXN kissed 13.25 before closing at 13.2 Friday night. While I remain bullish on the fundamentals, as do the analysts, the short term volatility has certainly raised my blood pressure. I can only take solace in my 'capital firewall.' The USD/MXN could hit 14 again and I would not be forced to close my positions. I am currently raking in about thirty percent annually in carry, and remain confident that I can liquidate at a tidy profit in the neighborhood of 12.8.
The long term trend for USD/JPY remains bullish, and traders would be advised to look for spots to get long. USD/INR is probably overbought in the short term, and the long term outlook may improve as both the RBI and the central government push market oriented reforms. Scotia Bank sees a retest of the 51 level for USD/INR in the coming quarters. I will be watching the situation closely, for now however, my fate lies entirely with the Peso. The key will be not to panic even if the Peso continues to dip as Washington rhetoric heats up. Once it becomes clear that the US is not going off the fiscal cliff, the Peso will resume its mid to long term upward trend.
The long term trend for USD/JPY remains bullish, and traders would be advised to look for spots to get long. USD/INR is probably overbought in the short term, and the long term outlook may improve as both the RBI and the central government push market oriented reforms. Scotia Bank sees a retest of the 51 level for USD/INR in the coming quarters. I will be watching the situation closely, for now however, my fate lies entirely with the Peso. The key will be not to panic even if the Peso continues to dip as Washington rhetoric heats up. Once it becomes clear that the US is not going off the fiscal cliff, the Peso will resume its mid to long term upward trend.
Wednesday, November 7, 2012
Mid Week Position Summary
Short USD/MXN @ 12.93
Capital Ratio: 12.66
Still sitting tight and earing carry off my short USD/MXN position, after booking a modest profit on a USD/INR short position Tuesday night. No changes in the fundamental picture. On election night, the Peso soared in Asia and Europe then gave up all its gains stateside as risk off sentiment overwhelmed markets. Many believe that it was due to fears over the 'fiscal-cliff,' but profit taking most likely was a significant factor, at least with the USD/MXN shorts, since this is the second time in a week the peso has failed to consolidate big gains.
On Asian FX, watch USD/INR which may make a further run at the summer highs if fears that post-election paralysis will send the US off the cliff continue to weigh heavily on markets. On the fundamentals, Prime Minister Singh continues to push liberalization reforms, and the RBI remains more concerned with inflation than growth. That said, the reserve bank would certainly begin to cut rates aggressively if inflation eases. This seems unlikely however if the Rupee continues to depreciate. The much more likely scenario is the attempt of the central government to spur Rupee appreciation via reforms aimed at boosting India's competitiveness. Such a scenario would certainly take the enormous pressure currently on the RBI and give it more room to maneuver on the monetary policy front. In sum, I remain a cautious seller of USD/INR on rallies in light of a probable deal on the looming US fiscal adjustment. I look to initiate a small short position at 54.75, and hopefully earn some nice carry over a month or two. My target will be the early October lows of 51.05. More commentary on India to come.
Capital Ratio: 12.66
Still sitting tight and earing carry off my short USD/MXN position, after booking a modest profit on a USD/INR short position Tuesday night. No changes in the fundamental picture. On election night, the Peso soared in Asia and Europe then gave up all its gains stateside as risk off sentiment overwhelmed markets. Many believe that it was due to fears over the 'fiscal-cliff,' but profit taking most likely was a significant factor, at least with the USD/MXN shorts, since this is the second time in a week the peso has failed to consolidate big gains.
On Asian FX, watch USD/INR which may make a further run at the summer highs if fears that post-election paralysis will send the US off the cliff continue to weigh heavily on markets. On the fundamentals, Prime Minister Singh continues to push liberalization reforms, and the RBI remains more concerned with inflation than growth. That said, the reserve bank would certainly begin to cut rates aggressively if inflation eases. This seems unlikely however if the Rupee continues to depreciate. The much more likely scenario is the attempt of the central government to spur Rupee appreciation via reforms aimed at boosting India's competitiveness. Such a scenario would certainly take the enormous pressure currently on the RBI and give it more room to maneuver on the monetary policy front. In sum, I remain a cautious seller of USD/INR on rallies in light of a probable deal on the looming US fiscal adjustment. I look to initiate a small short position at 54.75, and hopefully earn some nice carry over a month or two. My target will be the early October lows of 51.05. More commentary on India to come.
Monday, November 5, 2012
Doing the Rounds: Markets Largely Sideways before US Elections, Greek Debt Vote
Markets were largely sideways today with little activity of note. EUR/USD and GBP/USD consolidated last week's losses, closing at 1.2792 and 1.5980 respectively. On the Pacific front, AUD/USD and USD/JPY were also little changed, with both pairs closing within a few pips of where they were on Friday. On emerging markets, USD/MXN traded in a tight range, bouncing around between 13.02-13.05. The market is clearly looking for direction. However, as long as the fundamentals remain strong, the Peso should still have legs with which it can continue its run. USD/INR and USD/TRY were the only significant movers today. USD/INR surged overnight in Asia after a typical bout of risk aversion that traders have become accustomed to. Turkey's Lira traded higher, breaking through the 1.78 level versus USD after Fitch upgraded its sovereign debt.
The key risks events for this week are definitely the US presidential elections and the Greek parliament vote to implement its austerity plan. Stateside, markets see the race deadlocked, but abroad most actors are pricing in an Obama victory. US equities may get a slight bump if Romney pulls off an upset. However, any post-election moves ought to be transitory in nature, and given that market expectations are very hard to pin down, difficult to forecast. Finally, most objective analysts don't see the election having much impact on the fundamental growth trajectory for the US.
Progress in Europe might give the Euro a welcome rally, and would certainly help it consolidate the gains in has posted in the last three months from its July 31 low. However, this event will almost certainly be over shadowed but the aftermath of the election, so caution is advised.
The key risks events for this week are definitely the US presidential elections and the Greek parliament vote to implement its austerity plan. Stateside, markets see the race deadlocked, but abroad most actors are pricing in an Obama victory. US equities may get a slight bump if Romney pulls off an upset. However, any post-election moves ought to be transitory in nature, and given that market expectations are very hard to pin down, difficult to forecast. Finally, most objective analysts don't see the election having much impact on the fundamental growth trajectory for the US.
Progress in Europe might give the Euro a welcome rally, and would certainly help it consolidate the gains in has posted in the last three months from its July 31 low. However, this event will almost certainly be over shadowed but the aftermath of the election, so caution is advised.
Friday, November 2, 2012
Commentary: USD Higher on Better than Expected Jobs
A week ago I opined about how the USD will begin to trade higher on good internal numbers coming out of the United States. I also stated my belief that such an event will portend the return to a dollar bull market as investment comes home, and foreign investors turn to the US as the most promising growth opportunity within the advanced economies. I was not expecting to be posting this so soon, but today, we saw the first signs of shift towards market conditions I outlined a mere ten days ago. Jobs numbers surprised to the upside today, and rather than trigger a flurry of indiscriminate risk buying which would ironically ding the dollar and buoy everything else, the market chose distinct winners and losers today. To start off, EUR/USD got hammered today which makes sense. The strong jobs reports signals a US led recovery, while Europe remains mired in uncertainty as it slowly works through its sovereign debt crisis. Under this scenario, it is perfectly reasonable for the market to expect capital flows from Europe to the US and reprice EUR/USD accordingly. Cable, was also down today, off its 1.6130 highs of earlier this week. Again, the British economy stands to fair worse if the US (rather than Europe) leads the recovery among advanced economies. AUD/USD was down too, not so much a loss of confidence in the Austrailian economy, but more of "pressure release" as the dollar rose against EUR. The dip in EUR/AUD confirms this hypothesis. Floundering emerging markets like South Africa got whacked on the job news too. The RSA is experiencing internal labor unrest, and relies on Europe for the majority of its exports. Finally, JPY was a huge loser today. Bought as a safe haven asset, the mid to long term economic prospects for Japan are shaky at best. Expect to see further weakness in the Yen as the US recovery picks up steam.
The winners today were, not surprisingly CAD and MXN, economies which stand to gain the most from robust US growth. USD/CAD traded back below parity. USD/MXN was under some significant pressure and dropped down to 12.9272. It was unable to gain a foothold however, and was pushed back to 13.03 where it started the trading day as actors booked profits. This suggests that USD/MXN is already a crowded trade, and it may take some sustained and clear real money flows to Mexico for the Peso to break through. Watch remittances in dollar terms (they are down big in peso terms mainly due to peso appreciation!) and flows on export demand and tourism. The local bond market is also a place cautious investors will seek yield as the Fed has signaled that it will continued to keep interest rates low until 2015. A sovereign upgrade, a rate hike, or a large acquisition in Mexico by a US firm would as be very supportive of the Peso. I continue to hold my large long peso position, but I now realize that it will be a slower grind towards my 12.55 target than originally anticipated.
In short, we may in in for a dollar bull market as investors around the globe turn to the US as the dog with the least amount of flees. I am still bullish on Mexico, but funding buying MXN against JPY rather than USD just got much more attractive.
The winners today were, not surprisingly CAD and MXN, economies which stand to gain the most from robust US growth. USD/CAD traded back below parity. USD/MXN was under some significant pressure and dropped down to 12.9272. It was unable to gain a foothold however, and was pushed back to 13.03 where it started the trading day as actors booked profits. This suggests that USD/MXN is already a crowded trade, and it may take some sustained and clear real money flows to Mexico for the Peso to break through. Watch remittances in dollar terms (they are down big in peso terms mainly due to peso appreciation!) and flows on export demand and tourism. The local bond market is also a place cautious investors will seek yield as the Fed has signaled that it will continued to keep interest rates low until 2015. A sovereign upgrade, a rate hike, or a large acquisition in Mexico by a US firm would as be very supportive of the Peso. I continue to hold my large long peso position, but I now realize that it will be a slower grind towards my 12.55 target than originally anticipated.
In short, we may in in for a dollar bull market as investors around the globe turn to the US as the dog with the least amount of flees. I am still bullish on Mexico, but funding buying MXN against JPY rather than USD just got much more attractive.
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