Tuesday, June 26, 2007

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.


Anonymous said...


Outstanding observations, as always. Do you think that the change of one person in Japan makes much difference? I assume Japan won't change much without US based pressure, but the US is focused on China policy rather than Japan. The status quo seems so entrenched everywhere.

However I take your point that it can't get more liberal so the risk is one sided. Or so it seems to me too.


Anonymous said...

what is the point of a 0.5% reval? if you are going to do it, why not do a bit more, and really change something? Incidentally, while russian reserve growth slowed recently, it hasn't really turned negative -- so lots of folks who made speculative bets on the ruble still had (in all probability) those trades on. they just weren't adding to them quite as fast ...


Macro Man said...

Keith, my perception, for what little it may be worth, is that pressure probably is mounting on Japan- not just from the US (Congress more than Treasury), but also Europe. That Japanese automakers are building new factories in Japan for the first time in a generation tells you quite a bit about how competitive the yen is at these levels.

Will the new guy represent a sea change? Probably not, but the change does increase uncertainty. And lest we forget, Watanabe himself erpresented a change in policy from his predecessor, Kuroda, who masterminded the intervention program of 2003-04. Watanabe probably deserves plaudits for being the least interventionist Japanese currency czar in living memory.

Brad, who knows what they are up to. Certainly half a percent ain't gonna make much difference one way or another. One would have to prresume that, much like PBOC, CBR doesn't actually want to change the status quo a whole lot.

And I would whole-heartedly agree with the notion that the market had the Russia trade on...it's a trade that makes a lot of sense.

"Cassandra" said...

MM - "the market" (and I of course realize the limitations of such a generalization) is in wanton petulant-child mode. My kids - probably unwittingly - likewise get to this same place from time-to-time, especially my middle one. At such a point, they are over-excited and ebulliently determined to pursue their whims, utterly impervious to moral suasion, logical argument, threats (both real and fabricated for the sake of striking fear of consequence), until, finally, say-what-you-will about corporal punishment, the only thing that can restore a healthy sense of respect and balance of power between the child's parochial selfishness and fear of actual consequence is a good old-fashioned spanking.

It goes without saying that coordinated threats (and actions) were all so easy in those globally obsequious days when the only thing that mattered was the G7 - and this really was just the whims and dictates of US UK & Germany. I am so NOT looking forward to my own kids teenage years.....when my son will undoubtedly be bigger and stronger than me and my daughters will come home "inked" and "flip me the bird" when I demand they be home by 1100pm...

Econocator said...

A smartly timed move on the carry basket Macro Man. There are a few factors that argue the case for further yen weakness: wider political uncertainty in Japan, absolute interest rate differentials, and the reduced attractiveness of the other funding currencies. However, it does look like the authorities may be turning up the volume on their anti weak yen rhetoric. Combined with the potential for increased risk aversion more generally and the extreme valuation of the yen, I wouldn't be surprised if we saw some two-way risk introduced in the near future.

Macro Man said...

Cassandra, I'm not sure if these markets are like petulant children or bewildered parents.

I look at FX carry and I see very, very few professional investors that don't run the sort of mechanistic carry basket demonstrated on this blog who have it on. Most people I speak to see somewhat bemused by the resilience of the carry trade, almost like a sitcom parent.

Holders of subprime structured credit, meanwhile, must feel like the Michael Douglas character in "Traffic". They're supposed to be on top of things but have just found that their kids are involved in a horrible, horrible situation.

Econocator, that's the exact point that I am making- that yen volatility will probably go up. As for the timing of the exodus, that's a mechanistic thing driven by the filter that I use. Sometimes it makes one look smart, and other times....less so.

"Cassandra" said...

I wasn't suggesting which participants were most like the petulant child. What you are saying is simply that the real marginal investors behind the move are retail or flow-based, whether chasing yield, for FDI, or mere diversification.

At the end of the day, however, a sale of Yen, CHF or SGD for GBP,,BRL, Turkish Bahklavas or what have you will cause ripples and cascades of these funding currencies vs. the majors, and that such flow is, as Fmr Secy Rumsfeld was notorious for saying, "decidedly unhelpful" in moving the world towards something resembling a sustainable equilibrium, rather than away from it.

What is deterministic is that in every cycle, excess liquidty inevitably directs money towards the pinnacle of folly, be it Web-grocer, dark fiber, overinvestment in real estates, US over-consumption or private equity, the latter being a stellar example: where capital has little more to do than buy en-masse an already listed enterprise, strip it and rape it, fire some folks, book some fees, gear it up, collect some more fees, then return it to the public market with a negative EV, heightened pension risk now borne by the public PBGC, for consumption by retail and index funds, all so that some over-educated clever boys can afford to fly-private and send their kids to Miss Porter's.

Macro Man said...

Look on the bright side, though... Stevie Schwartzman, et al. are going to get stitched up on taxes ("what? you mean we actually have to pay taxes? like the little people?") , and China's FX holdings are now worth a little less than they were a few hours ago, thanks to BX dipping below the offer price. Schadenfreude is not a particularly noble feeling, but I cannot help hoping that all their forays into non- (or at least less-) rigged markets experience a similar annualized return to that delivered by BX today...

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