Currencies get interesting

Currency markets have been relatively uneventful for the past few months (some would argue the past few years), a fact reflected that the only alpha trades in the portfolio at the moment are very slow-burn, long-term trades. However, things appear to betting more interesting, if only temporarily, today.

For the first time in a couple of months, Macro Man has received a signal to exit the G10 carry basket, which he did this morning. The limp performance of US equities into the close was the primary culprit, as concerns over subprime and a possible impact on the real economy continue to percolate. While yesterday's headline exisiting home sales were pretty much bang in line with expectations, the details beneath the surface were pretty ugly: supply rose from 8.4 months to 8.9 months, a new high. This would appear to bode quite poorly for today's new home sales data and, by extension, the homebuilders.
Another potential source of uncertainty and angst comes from Japan, where Vice-Minister Watanabe, Japan's chief currency spokeman, has decided to stand down in favour of Naoyuki Shinohara. Now, Macro Man is fairly certain of three things regarding this handover:

1) Macro Man does not know exactly where Shinohara stands on the yen and the carry trade
2) Neither do you
3) It is impossible for him to be MORE laissez faire (and by extension, pro-carry trade) than Watanabe; therefore, the risks must be skewed towards a slightly firmer stance from the Japanese.

The word on the street is that international irritation with Japan is rising fairly steadily; perhaps this personnel switch, along with suggestions that the BOJ might turn slightly more aggressive, has been designed to throw a bone at would-be Japan-bashers everywhere.

While the switch does not necessarily mean an end to the yen carry trade-after all, Mrs. Kobayashi is unlikely to be dissuaded from spending her husband's bonus on either investment trusts or a retail FX credit line- it probably does introduce more two-way risk into the market.

From the time Mr. Watanabe took office in June 2004, for example, EUR/JPY literally never traded lower than it was on his first day, rising very steadily and gently for most of the past two years. Macro Man would suggest that today's switch may well have more impact on the path of the yen rather than the direction, at least in the near term. The implication? Yet another reason to expect volatility to be higher in the future than it'e been in the past.

Finally, Russia has apparently revalued the rouble against its $0.55/€0.45 basket today by just under half a percent. About time too, given the ludicrous money growth and high inflation in the country. While there is no immediate implication for other currencies such as the RMB, it does once again illustrate the pressure on these currencies is virtually all one way.

What's interesting to note is that despite a number of rumours over the past few months, Russia only revalled once FX reserve growth slowed dramatically. UBS put out a note yesterday suggesting that the recent "surge" in the RMB may have come at the same time as a sharp deceleration in the pace of reserve accumulation. It seems quite clear that the newly prominent participants in the "new world order" have a rather strong aversion to anyone profiting from speculating on their currencies. How they square the moral circle with their own speculative activities is a question as-yet left unanswered.

But Macro Man remains of the view that the "free riding" on the global financial system of many FX reserve managers is an issue that will eventually cause condsierable angst in policy circles.