Commentary: Can No News Be Good News?

As widely expected, Banco de México held its target rate for overnight interbank loans at 4 percent.  The real news toady was the shift in bias from the governing board from slightly dovish to a markedly neutral tone.  The bank signalled no further rate cuts, or rate increases.  It it reaffirmed its view that transitory supply shocks were driving the above target inflation of recent months.  Specifically, high agricultural prices were passing through in the form of increased food costs for the consumer.  The bank noted that core inflation was coming in on target at 3.02 percent, and predicted a drop in the general inflation index by August.  

On the FX front, the bank discussed substantial capital flows into Mexico, which has both reduced borrowing costs for firms but also resulted in a marked appreciation of the peso.  At the same time, the bank opposes capital controls, and called the peso's appreciation from last year's record lows as "important" for helping to keep inflation in check. Other recent publications of the bank have warned of downside risks of sudden stops or reversals of capital flows which time after time have devastated emerging market economies.

Today's statement was generally somber, stressing slow growth observed in advanced economies and the threat this poses to growth in emerging markets.  The bank seems to recognize that the performance of the Mexican economy has been generally good.  The bank did not stoke market euphoria nor discourage further foreign investment.  The bank's seems to have gotten its message across.  The peso was little changed this morning, trading around 12.14 per dollar as of 8:04 PM GMT.      

Commentary: MXN's Medium Term Future Tied to Banco De México Policy Statement

This Friday, Banco de México issues its first monetary policy decision after cutting its key policy for the first time since 2009.  For nearly all of 2012, and especially through the height of the Eurozone crisis last June, the central bank kept a firmly hawkish bias with two related themes.  The slightly above target inflation observed in the general index was due to 'transitory shocks' in commodity prices, which tended to push up food and energy costs.  Core inflation continued to be on target, registering around three percent.  Despite stable core inflation, the bank communicated its committent to achieving its inflation target in nearly all its policy announcements last year.  Paraphrasing from the Spanish, "Despite the transitory nature of the shocks causing elevated inflation, rate increases may be necessary to anchor inflation expectations and prevent the contamination of the mechanism of price transmission in the broader economy."  In sum, the bank was not about to let external factors derail its policy objective of low and stable inflation, even if acting meant slower growth.  

By 2013, inflation had slowed in both the core and non-core indices.  Growth had also slightly moderated.  Therefore, the central bank shifted its bias.  Inflation had been tamed, so now "a rate reduction may be advisable to help the economy adjust to slower growth and constrained inflation."  In March of this year, Banco de México acted by cutting the overnight interbank lending rate by fifty basis points to all time low of 4 percent.   
  
Since then, the Mexican peso has continued to appreciate, mainly because of Mexico's excellent fundamentals and a promise by the bank that the cut was a one-off and not the beginning of an "easing cycle." Today, inflation stands at 4.25 percent, or 1.25 percentage points off the central bank's three percent objective.  More troubling, core inflation stands at 3.02 percent, while non-core inflation is a whopping 8.25 percent.  In other words, the transitory shocks, which seemed to have abated earlier this year, have returned.  The board must now decide whether stable and low core inflation is good enough, and reaffirm its intentions to cut rates should growth slow, or if it must meet its inflation target at all costs, even it means sacrificing growth, and fighting external shocks.  Meanwhile, all time high net longs for the Mexican peso and record foreign bond buying demonstrate the incredibly bullish investor sentiment towards the Latin American giant.  Signalling the possibility of more easing may cost the central bank credibility, since only six weeks ago in promised it would not cut further.  On the other hand, a reassertion of a hawkish tone may well send  USD/MXN into sub ten territory given the market's current euphoria.  In general, Banco de México has been very open to peso appreciation, but policy makers never like to see currencies rise too far too fast.  Therefore, the formulation of the exact wording of the policy statement will be a careful dance for the central bank.  The future Mexico's currency hangs in the balance.   

News: Risk Off in Asia as JPY and USD Rally

More risk off in Asia as the Yen and US dollar rally.  USD/JPY was trading at 98.86 as of 3:52 AM GMT, after closing at 99.40 in New York.  EUR/USD was also dinged, and looks poised to retest the 1.30 handle, at least in the short term.  USD/MXN was back above 12.30.  USD/MXN had spiked to as high as 12.35 from 12.28 during the US session, before plunging down back down to 12.25.  MXN looks to be extremely well bid, as evidenced by this whipsaw action.  As such, selling USD/MXN on rallies remains the preferred strategy.  I have my offer in at 12.35.  I booked profits on a short deal which got filled at 12.30 this morning.  I ended up exiting at 12.26, in light of the awesome volatility.  That said, I have maintained a core position in anticipation of a further leg downward.  Patience is necessary with MXN.  Bouts of risk aversion beat this currency up, but the excellent fundamentals mean that longterm it will appreciate.  Be willing to ride out short term losses, rake in carry, and look for MXN to make multi-year highs.  

Back on the JPY outflow story, the wires are a buzz with JPY funded carry trade ideas.  Aside from MXN, many names seem to like TRY.  As far as very high yielding currencies go, Turkey's lira looks to be the best bet.  Though Turkey is running a current account deficit of 6.6 percent of GDP, it is making progress on this front.  Last year the current account deficit was approaching ten percent of GDP. Turkey's current account woes come from the unfortunate fact that it must import nearly all of its fossil fuels. The fiscal deficit is relatively modest, coming in at 2.8 percent of GDP.  Finally, a recent sovereign upgrade means that Turkey really shouldn't have trouble finding the external financing to plug either of these holes.  This contrasts nicely with other high yielding currencies such as ZAR and INR.  Both 'yield' over six percent, but South Africa and India both face widening current account and fiscal deficits in the five percent of GDP range.  India is on notice of a possible downgrade, and South Africa was already downgraded earlier this year. Growth is slowing in all three of these countries, with quarterly GDP well below potential.    In sum, TRY looks to be the best bet for carry trades.  TRY has a nice yield, as is probably faces little risk of depreciation in the medium term.  ZAR and INR yield more, and will appreciate if these countries get their acts together.  However weak fundamentals coupled with deteriorating sovereign credit worthiness means that these currencies could face sharp and sudden depreciation on any sort of bad news.  I certainly was on board the long TRY/JPY trade from 47 to 53, missing the latest jump higher to the 55 levels we see now. If I decide to establish a position again I will try to buy a dip, and target 60 in the long term.  

 

Japan's Largest Life Insurer Plans and other Flows

Japan's Largest Life Insurer Plans and other Flows 

A major post on some Japanese outflows from Marc Chandler.  Click the link above to check out Marc's blog!

News: Lack of Japanese Outflows Puzzles Yen Bears

It makes perfect logical sense.  Lower yields in Japan engineered by the BoJ's new easing program ought to induce Japanese investors to seek higher yields abroad.  Under this scenario, the necessary Yen sales to execute these trades ought to send JPY even lower, as real money initiates short Yen positions along with speculators.  There's just one problem with story though, it hasn't happened.  Japanese capital is staying home.  Despite warnings from inflation hawks, BoJ policy has yet to drive Japanese investors into risky foreign outlets.  

A Soaring Nikkei 

The Bank of Japan policy has already been an unabashed success for one segment of Japanese society: equity investors.  Since the election of the LDP government in December, Japanese stocks have soared nearly 50 percent, as evidenced by a 4000 point jump in the Nikkei index from 8500 to over 13000.  This unprecedented rise in a major equity index has even caused many foreign hedge funds to go over-weight on Japanese stocks in the hopes of cashing in on the wall of money being unleashed on the markets by the BoJ.  Ironically, these represent inflows into Japan, not outflows.  Indeed, even an unhedged long Nikkei position is well in the green despite Yen weakness.  This year, in US dollar terms, the Nikkei has returned over 11 percent. 

Ultimately, such a bull run in stocks gives the Japanese investor little reason to seek returns aboard.  Why go through the added effort of studying foreign companies and governments, possibly through linguistic and cultural barriers, when such handsome profits can be reaped on the local stock market.  We saw the same phenomenon in the US as the Federal Reserve eased credit during the Great Recession.  Despite predictions of massive capital flight followed by a collapse of the dollar, investors simply shifted out of bonds and into high yielding defensive stocks.  Nobody bought higher yielding Cetes (Mexican government debt) or Canadian bonds. To the contrary, many of those investors, spooked by the global downturn, brought money home.  

Home Bias Returns 

In the end, most investors, including large institutionals, just aren't savvy enough to make foreign investments. In the face of uncertainty, people go with what's familiar every time.  For the Japanese investor with a large bond portfolio, shifting into local stocks is much less scary than buying risky or exotic foreign debt.  This trade, so far, has also been incredibly profitable.  Markets are driven by human beings, and sadly many human beings make investment decisions based on emotions, personal predilections, or outright prejudice.  You wouldn't believe how many otherwise savvy investors still see Mexico as an economic wasteland.  In the long run, markets may be rational, but they are hardly efficient.  It takes years markets to reward sound economic management in developing economies.  The fact that the Mexican Peso is still trading so far below PPP is case in point.  In the end, the fact that so many investors are unwilling or unable to do the research to take currency risk results in some tremendous bargains for those of us willing to do the work. 

            

 

News: "Risk-Off" Slams Stocks, Gold, Commodities. USD and JPY Rally

Stocks turned sharply downward today as risk off swept the markets.  Weak PMI data out of China sent AUD sharply lower in Tokyo, along with the Nikkei index.   The Yen also surged, USD/JPY plunged to 97.89 and AUD/JPY, having pressured 106 last week, is now below 100.  Likewise, AUD/USD is down nearly 300 pips, from Friday's close.  This pair is fast approaching 1.03.   EUR has shown some resilience, but still gave up 50 pips against the greenback.  This is more evidence that the structural pain for this pair is over and that a slow and steady recovery to pre-crisis levels in now in the cards.  At the very least, the "sell the Euro on any bad news whatsoever" crowd appears to have exited.  Certainly, if the European sovereign debt crisis abates, and risk appetite increases (as evidence by summer stock market boom), EUR/USD could well approach the 1.45 level.  Back in North America  CAD has traded with broader market; USD/CAD is back above the 1.02 handle, closing in New York at 1.0241. 

Emerging market currencies have also been slammed.  INR and THB were both down a bit, but the real damage was seen in ZAR and my beloved MXN.  ZAR is down nearly 3000 pips against the dollar, a Rand sell off which basically erases last week's rally.  USD/ZAR is now poised to test multi-year highs.  Given the market tone on South Africa, and its shaky fundamentals, I see this pair going to 10.  

MXN got whacked, after briefly rallying on the Tokyo open.  Though it appears that MXN is still strongly supported by local fundamentals, it is critical to maintain objectivity.  I missed an opportunity to book some profits, though I added to my long MXN position this afternoon.  On USD/MXN, I am still targeting 12, for now.  

  

 

CB Gov. Carstens: Peso Strength in Line with Fundamentals, Sees Further Appreciation.

In testimony before the Mexican Senate, central bank Governor Agustin Carstens stated that the appreciation of the Peso was in line with fundamentals of the Mexican economy, and that the Peso would continue to strengthen so long as Mexico posted high growth relative to the United States, and maintained sound public finances.  When asked point blank if the Peso was overvalued, Carstens pointed towards the 11.5 low of July 2011, stating that USD/MXN was still significantly above that level.  Carstens also highlighted large foreign reserve purchases have helped keep the peso from soaring even higher, stating that without this intervention, USD/MXN would probably already be at 10.  Petreleos de Mexico, the state owned oil monopoly, exchanges dollars at the central bank rather than on the open market in a special program to help lessen volatility of the Mexican currency.  

These comments are largely in line with Carstens speech earlier this year. At an event sponsored by the Singapore Monetary Authority, Carstens warned of a perfect storm of capital flows flooding emerging markets.  Carstens warning that slow growth in advanced economies coupled with extremely accommodative monetary policy may drive investors into emerging market debt and equities, Carstens stated that, "the appetite for risk has returned and the quest for yield is in full force." 

In Australia, the RBA has held firm on eschewing calls to weaken AUD despite cries from exporters. "This is the hand we've been dealt," commented a deputy RBA governor, stating there was little that a relatively small country like Australia could do to weaken AUD without significant risk of causing a panic.   A commodity boom, high yield, and a AAA sovereign debt rating has made the Aussie an investor favorite for the past three years.  Australia is the fastest growing economy among advanced nations, and avoided entering a technical recession in 2009.  The RBA was one of the first central banks to raise rates after the 2008 collapse.  

      

Commentary: Frustration and Timing

I am coming off the most frustrating 24 hours in my trading career as the BoJ sent the Yen tumbling nearly 400 pips off recent highs against the USD.  No sooner than had I publicly predicted a broader pullback did the BoJ send JPY surging downward.  The money figures aren't important.  My loss that I ended up booking six hours before the rally was underway was modest.  The frustration is that I literally had the worst timing possible.  I bought at the high and sold at the low.  

 As I examine what went wrong, I believe that it can be attributed to two factors.  First, I attempted to time the market, something that can be very profitable but is so difficult it usually bears no fruits.  Alas, the possibility also exists that EUR is now off its lows and I should have just aligned myself with the longterm upward trend last week instead of insisting on finding the exact low point.  

A related factor was failure to implement my original trade objective and purpose.  I bought USD/JPY a few weeks ago at 96.66 on the theory that the longterm trend was higher, even though a pullback may be in the cards.  I initiated a  very small position, and planned to buy into weakness.  However, as my EUR/CHF also started under-performing, I panicked and felt like I had to close some positions to stop paper losses from causing me to fall to far below earlier high water marks.  This is emotional trading.  Mathematically, the chance of a margin call was extremely remote, and so there is no excuse for allowing psychological discomfort to alter underlying convictions.  

The past twenty four hours have been a valuable lesson that thankfully have cost me very little.  Such is life as a trader.  Its hard to move on, but I must.  With US non Farm Payrolls twelve hours away, its a big day tomorrow.     

Commentary: Surveying the Week's Wreckage

This past week has not been fun for me.  EUR/CHF, my main position continues to slow grind lower.  I also booked a loss on a long USD/JPY position after the tone has tuned firmly bearish.  I still look to get long, but the evidence points to the fact that we are witnessing a larger pullback.  Notably, a poll of Japanese exporters showed that this sizable group of firms expects USD/JPY to retrace all the way down to 85.  Referring to the BoJ and real Japanese economy, one story on the wires declared "what we have here is a failure to communicate."  Alas, it looks like the specs are running for the exits, and the real money still hasn't caught on to the fact the Bank of Japan intends to, at least indirectly, weaken the Yen.  In light of this, and the risk off mood driven by some weaker than expected data, I chose to go flat and wait to get long again at a lower level.   

As for EUR/CHF, I will continue to stay long and buy into weakness.  Its no fun having a big paper loss on the books, but even if this pair fell to the 1.20 floor I would still be up a nice 10 percent year on year.  I have raised my USD/MXN offer to 12.5, in anticipation of some gloomy jobs numbers this Friday.  Longterm however, the market still seems to want to take this pair lower, and I expect that the Peso will slowly work its way down into the 11s no matter what Friday's report reveals.  

The surging Aussie has me giving Asia another look.  INR seems to finally ended its slide, though serious concerns remain.  USD/THB has pulled back on risk off sentiment, though the fundamentals remain excellent.  The low volatility of this pair also makes shorting it an attractive carry trade.  Stay tuned for a briefing later this week.   

News: Yen Rallies as Nikkei Sells Off

To the financially uninitiated, the fact that the Japanese currency and Japan's major equity index have been tending to move in opposite directions may seem especially puzzling.  However, the explication of this odd financial phenomenon is more of an exercise in human psychology than economics, inasmuch as the two can be distinguished. Why on Earth would the Yen strengthen as its stock market tumbles?  The reasons are similar to those that caused the US dollar to surge on bad US job numbers last summer.  The so-called home bias, is at work. Whenever risk sentiment is hampered, investors turn to what they know.  We saw it over the summer as US funds sold off foreign assets, European or otherwise, amid the Eurozone crisis, and we are seeing it today as Japanese names are diving into JGBs.  The result is a strange inverse on the FX market.  When major countries get into trouble, sometimes there own currencies will strengthen as local investors flee into home country government bonds.  

According to various stories on the wires, the fate of the Yen is now firmly in the hands of large Japanese life insurers and pension funds.  These funds will be under enormous pressure generate returns to meet obligations in an ultra low rate environment. This factor, along with a sagging Nikkei and doubts about Abenomics, could push these funds to turn to international assets denominated in foreign currencies in order to boost yield.  Certainly, structural capital outflows would hammer then Yen, but for my part, I haven't given up on the BoJ.   The markets are still waiting for "unlimited monetary stimulus," and aggressive plans to implement large scale asset purchases will set off a fresh round of Yen selling.  Of course, as discussed earlier, foreign inflows hoping to cash in on a further rally in the Nikkei would be a major concern for anyone looking to sell the Yen.  However, it seems doubtful that any inflows from foreign purchasers of Japanese equities would counteract the fleeing and hedging done by corporates and other market participants on the back of any big BoJ easing announcement.  It is also highly likely that foreign funds would short the Yen as hedge against currency risk if they initiate any long trades on Japanese equity markets.  

Positioning for the week ahead, its all jitters as markets await US non-Farm Payrolls this Friday.  I booked profits on my short USD/MXN positions expecting a rally, and the decision is working out nicely.  I look resell this pair at 12.40.  USD/JPY continues to be slammed as JPY is gaining against virtually everything.  Alas, I was stopped out at cost on a long CAD/JPY position this afternoon.  Right now the market is definitely all about the US against the rest.  North America sold off today, (even USD/ZAR fell 600 pips) but it still looks like the western hemisphere is well positioned for the rest of 2013.  

Finally, a more interesting question is if the recent rally in EUR/USD suggests that this pair has bottomed above my earlier 1.25 target.  I refrained from shorting this pair precisely because I still think the longer term trend is up despite any short term pain.  Aggressive traders may look to establish a small long position and continue to buy on the way down should the rally fade.  While I am loathe to use technical analysis, a safer strategy may be to wait for the pair to reestablish a foothold above 1.30 before going long in order to ensure that the trend is firmly higher.