Midweek Position Summary

Portfolio Composition: 

Long EUR/CHF     16.67 Percent 

Short USD/MXN     50      Percent 

Cash                      16.67 Percent 

Rough few days of trading, booking profits too early and having my short GBP/AUD position get blown out.  AUD continues to be under mild pressure, dipping below 1.04 to the greenback.  Sterling has rallied, despite abysmal fundamentals.  I decided to cut my losses when Chinese PMI surprised to the downside.  As expected, AUD got whacked, so at least I stemmed the bleeding and stopped a moderate loss from becoming a substantial one.  

I am ready to take a break for a while from the crazy volatility we've seem in recent weeks.  I continue to buy USD/JPY on dips, and sell USD/MXN on rallies.  I prefer the latter, since I like earning a nice carry each day.  I also am looking to pick up some TRY/JPY on the next pull back, again, playing Yen weakness and Turkey's nice growth story.  

Two other currencies have peaked my interest of late, Korea's Won (KRW) and  Peru's Sol (PEN).  PEN is undergoing a 'managed appreciation' according to central bank, which is buying USD in the spot market to slow the Sol's rise.  However, Peruvian officials have stated that the Sol's rise is in line with excellent fundamentals and that the central bank simply trying to ease the currency adjustment so that the real economy has time to adapt.  Let's face it,  6.5 percent growth, a budget surplus, low and stable inflation, and a public debt at a mere 21.6 percent of GDP are all going to be extremely supportive of the Sol.   Alas, the Sol is not offered by any retain FX brokers that I know of, just one more reason I need to get an institutional account.  

South Korea continues to post solid growth, and sizable budget and current account surpluses.  The newly elected president Park Geun-hye intends to use budget surpluses to improve infrastructure and stimulate growth.  KRW has come under some pressure recently after rising throughout 2012.  The concern is that South Korea will be forced to enter the 'currency war' because Japan is one of its major trading partners.  However, to my mind, whatever action the Bank of Korea could conceivably take, it certainly would be far less aggressive than anything undertaken by the BOJ. Therefore, selling JPY/KRW appears to be a promising trade, especially considering its nice carry.  

   

Midweek Position Summary

Portfolio Composition: 

Short USD/MXN 14 Percent 

Cash                   86 Percent  


Booked profits this morning on my short JPY positions, taking a modest profit after going long USD/JPY and TRY/JPY a few days ago.  The techs seem to think that JPY is oversold short-term, though even they acknowledge that the fundamentals point to a continued downward trend.  Accordingly, I plan to buy both these pairs on dips.  I also closed part of my USD/MXN position this morning to lock in some profits.  The continued bull market for the Peso makes trading around my longterm short position a low risk proposition.  Currently I am looking to sell more USD/MXN at 12.7 and take profits at 12.6.  My target for my longterm trade remains 12.  In the one to two year term, I see scope for USD/MXN to go below 10.   

News: Banco de Mexico Shifts Bias, USD Broadly Firmer

The Banco de Mexico held its target interbank overnight rate at 4.5 percent.  It marks the nearly the three and a half anniversary since the central bank, led by Augustin Carstens, cut its key policy rate to a record low in the depths of the Great Recession.  The past several meetings and statements from the Bank have focused on structural downside risks to the global economy, namely the fiscal cliff and the European sovereign debt crisis.  Another recurring theme has been the slightly above target inflation, which crept up to close to five percent in the summer of last year.  The Bank has reaffirmed in many statements that this has been due to rising energy and commodity prices, and a weaker peso driven by bouts of risk aversion.  Core inflation has remained subdued. Despite this, the Bank has remained steadfast in its commitment to maintain inflation expectations, and has threatened to raise rates even if rises in headline inflation were largely due to external factors. This month, with headline inflation falling comfortably to 3.57 perecent, comfortably within target, the bank shifted its focus towards growth.  Namely, the statement hinted at a possible rate cut, if inflation remains within target and growth slows.

The USD was broadly firmer today, gaining against most of its major peers.  AUD/USD dipped back below 1.05 as the Aussie struggles to gain a foothold above 1.0550. The Canadian Dollar dipped, dropping nearly 50 pips on the New York open against its American counterpart before paring nearly half those losses.  Sterling continues to be under pressure, dropping down below 1.59 to the dollar on bad UK consumer confidence numbers and decline demand for safe-haven assets.  The EUR/USD traded briefly below the 1.33 level, but since popped back up to 1.3320.  1.34 continues to be a brick wall for the pair.  The Yen has traded sideways, but the dollar has held its gains against the Japanese currency, trading above the critical 90 level.

 

Commentary: Currency War Goes from Crazy Talk to Remote Possibility

Over the Christmas holidays I spoke off the record with a WSJ reporter about the weakening Yen.  I explained incoming PM Shinzo Abe's platform of pursuing a two percent inflation target, and monetary easing to boost exports and combat deflation.  "Isn't that a currency war," the reporter replied.  No.  Japan's fundamentals had deteriorated, both in the short and medium term.  Japan was back in recession, with GDP contracting 3.5 percent year on year in the fourth quarter.  Government finances were a mess, with debt totally over 220 percent of GDP, and an annual budget deficit of 9.7 percent of GDP.  Japan's declining population, and refusal to admit immigrants also meant that there will be fewer taxpayers to hit up when the fiscal day of reckoning comes.   Furthermore, despite two decades of incredibly loose monetary policy, Japan was still plagued by chronic deflation.  Yet the Yen was near post war highs, fueled by a remarkable demand for so called 'safe-haven' assets amidst European sovereign debt crisis.  (Why the Yen continues to a be safe haven given Japan's bleak outlook is beyond me)  So no, a nudging of the yen downward by signalling out of the Bank of Japan and the newly elected LDP government was no currency war.  It was simply bringing the Yen back into line with the fundamentals when the markets had failed to do so.  

Then the Norges Bank stated that persistent strength of Norway's krone would be a factor in future rate decisions.  Then it was the Euro's turn, with Jean-Claude Juncker, head of the council of EU finance ministers, calling the Euro exchange rate "dangerously high."  These comments were walked back considerably by the ECB's Nowotny, who stated that the FX rate for the Euro was of little concern.  Japan's new government also sent out mixed signals.  Some officials started to express concern that the Yen was now too weak; the LDP secretary general declared that USD/JPY should not rise above 90.  Shinzo Abe was unflapped, redoubling the commitment to his economic program by seeking to appoint a "bold new leader" to head the BOJ when Governor Shirakawa's term ends in April. 

Then Russian central bank deputy governor cried foul.  Alexei Ulyukayev lamented the policy of Yen depreciation, adding further that "Other colleagues from respected central banks and governments already pursue this policy. This is not a path towards global coordination but a separation."  While Mr. Ulyukayev did not use the term currency war, he is the most senior global policy maker to express concern over the recent policy shifts towards weaker currencies coming out of central banks worldwide.  

We are far from the competitive devaluations of the 1930s seen Europe, but a full blown currency war and all its destabilizing effects has move from be unimaginable to remotely possible.   


  

News: Alleged Translation Error Squeezes Shorts in the World's Most Crowded Trade

Japanese Finance Minister Amari probably did not predict the chaos he was about to set off in the FX market while speaking to the reporters in Japanese around 3 AM GMT.  His comments, originally translated as "the Yen has depreciated to levels consistent with the fundamentals" sent Japan's monetary unit soaring last night, as traders priced in the reality that Japan's government would not take additional steps to weaken the Yen.   Mr. Amari also acknowledged that a weaker Yen may cause pain for consumers.  Nearly ten hours later, reports came out that Amari's comments had been mistranslated.  Apparently the minister had said the the "Yen is continuing to depreciate to levels consistent with the fundamentals."  The latter translation is if anything an endorsement of further Yen depreciation, not an attempt to ease the Yen's slide.

Indeed, looking back, the whole episode looks rather dubious.  Why would the government express concern for consumers while simultaneously advocating a two percent inflation target?  Hadn't the PM Abe already made the case that short term pain associated with slightly higher inflation would be more than compensated by the uptick in economic activity that would come with finally beating down deflation? 

The huge swings in the Yen caused by the issuance of this headline, and its later retraction, certainly shows how crowded the short Yen trade has become.  The Yen has actually managed to hold some of its gains from the erroneous translation.  As we saw with the post Draghi 'whatever it takes' comments, when trades get crowded, it does not take a lot for fatigue to set in. 

Commentary: In Contrast to Euro Bears, Yen Bears are not Fighting Central Banks or Governments

I entered the FX market on June 1st 2012.  It was the height of the European sovereign debt crisis, Greece could not take bailout funds because it could not form a government.  The Euro was in free fall, plunging on any bad news whatsoever, and failing to hold gains from news driven rallies.  On June 17th, when the pro bailout coalition eked out a narrow victory in Greek elections, the Euro popped nearly 200 pips, but then plummeted within hours, giving up all its gains and then some.  Its hard to imagine a more bearish market.  

This bearish tone was underscored by the glee of many right wing fund managers and speculators which let their emotions and predilections cloud there judgment.  A bet against the Euro was bet against socialism.  The failure of the Euro was only further proof to these ideologues that anything short of free-market capitalism in its purest form was bound to fail.  Or better put, in their Ayn Rand-Ron Paul echo chamber, the EU and Euro had to fail.  

To the Euro bears' credit, European fundamentals were looking pretty bleak last May.  Yields on Italian and Spanish bonds were over seven percent.  Most of the periphery countries were in recession, and the core nations of Germany, France, and Great Britain were hoping to avoid negative GDP growth.  In other words, 0 percent growth was looking like a surprise to the upside.  Such bleak prospects certainly deterred investment, and warranted a weakening in the Euro, but it did not spell irrevocable doom for the common currency. Europe remains a highly developed economy, with functioning democracies, an educated population, and competent central bankers.  Europe is still an economic super-power, and therefore, unlike many emerging market economies, it has the unique luxury of being able to shape its own economic destiny.  

And the policies to shape that destiny were obvious to me and many other analysts back in June of last year.  The ECB must purchase bonds from the peripheral countries to reduce the 'sovereign premia' which were causing the debt crisis.  Meanwhile, the IMF and European Council would enforce reforms and credible deficit and debt reduction plans on the countries in trouble like Greece, Spain, Portugal, and Ireland.  There would be no internal devaluation.  Such a policy would take decades and would kill the patient well before the cure.  Instead, the asset purchases by the ECB would cause inflation in the core to be higher than in the problem countries.  This would increase the competitiveness of these countries without forcing nominal wages and prices to fall.  So was it any surprise, on July 26th, when Mario Draghi, the head of powerful central bank which set monetary policy for one of the major economic engines of the world, said this in a speech? 

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.  

Suddenly, governments, which the vast majority of the Euro bears hated, were ready to act. So no, an economic super power was not going to stand idly by and go quietly into the night.  Is it really that surprising that a goverment with the wherewithal to save itself did so?  

Today, we see a similar currency devaluation with Japanese Yen.  Like Europe, Japan faces enormous economic challenges  However, like Europe, Japan is an economic superpower, with incredible wealth and prosperity relative to most nations of the world. The crucial difference is that the Yen depreciation is part of the government's recovery plan. A bet against the Yen is not so much a bet that Japan will fail as a state, rather, that the BOJ and the new LDP government with follow through on their stated programs.  To be sure, poor fundamentals will certainly weigh on the Yen in the short term.  But in contrast to the Euro, these poor fundamentals will be on top of the main drivers of Yen weakness, central bank and government action.  Eventually, Yen depreciation will be a major factor in Japan's return to prosperity as Japanese products become more competitive abroad. 

Europe and Japan have a long way to go to return to economic prosperity, but it is foolhardy and arrogant to believe that the leaders of such economic powerhouses would just sit back and wait for the phone to ring. 

   

Commentary: Silly Season and The Trillion Dollar Coin

Reporting on the trillion dollar coin proposal has been abysmal, probably because most reporters, average citizens, and congressmen have no idea what the Federal Reserve does.  Anyway, here's a quick and dirty explanation of how the trillion dollar coin solution would work.  

The Federal Reserve issues money by purchasing securities, conversely, it retires money by selling off portions of its security holdings.  Federal Reserve notes are therefore 100 percent collateralized by existing financial assets.  

Historically, the treasury has also issued money in the form of gold and silver coins, as well as certificates which could be redeemed for specie.  This 'treasury money' has not been a major part of the money stock since the 1950s.  Today, it consists of a tiny sliver of the monetary base, comprised entirely of bullion and commemorative coins issued by the mint for numismatists.  These coins, while technically legal tender, are never intended to be actually used as money.  In fact, the melt weight of most of these coins is many times their nominal denominations.    

For accounting purpose, the mega coin would increase the treasury balances by one trillion dollars.  This would allow the treasury to issue a further one trillion dollars in bonds and bills without technically going over the debt limit.  The coin itself, like other 'commemorative' coins issued by the treasury would not be used as money.  The treasury would raise funds in the form of Federal Reserve notes by selling bonds of the international capital markets.  The coin would merely create the necessary accounting fiction to empower the treasury to conduct these operations without authorization (in the form of a raising of the debt ceiling) from Congress.       

It is sad when a the world's leading economic power flirts with crashing its own economy by refusing to pay its bills.  Its tragic when the adults in the room are forced to float such silly ideas to avoid catastrophe.    

Doing the Rounds: Euro Way Down as Debt Ceiling Looms

The Euro is fast approaching 1.30 per USD, and not retesting 1.33 after spiking up to 1.3275 after the US House passed the tax compromise.  I cut my losses at 1.3104 after getting long at 1.3200.  Tough to take a hit after ending 2012 so strong, but as it turns out I was fortunate to get out well before the bottom.  The  greenback was broadly stronger today, up nearly 0.25% against its other major peers according to the WSJ dollar index.  AUD/USD was off its post deal highs of 1.0515, and continued its slide during the Asian session trading at 1.0439 at 2:33 AM GMT. Mexico's Peso and South Africa's rand were down, closing  though neither has given back all of its  gains from the 0 deal.  USD/JPY continues to test new highs, which has lent considerable support to AUD/JPY and CAD/JPY crosses.  In general, we are witnessing a classic case of buy the rumor, sell the news.  Traders have been quick to take profits after the the tax deal, especially since Republican leaders are openly expressing there intentions to have another debt ceiling fight.  I intend to lay low, slowing rebuilding my positions in the Peso and perhaps a JPY cross.  The Washington dysfunction is far from over, and USD/MXN may well return to the 13. 0-1 range in the short term, so great care is required.