Another day, another dollar (to be sold.) Macro Man's comment that EUR/USD could conceivably trade towards 1.4575 by month-end is looking slighty less outlandish. Indeed, the buck has already plumbed new depths against the AUD, BRL, and PLN, amongst others, while gold is once again looking perky. After an irritating few days of profit-taking, it's beginning to look as if the dollar-down bubble is inflating once again.
There are exceptions to the rule, of course. While the last two weeks have seen the greenback weaken markedly against most Asian currencies, it's been remarkably stable against the RMB. Part of that was down to last week's Chinese holidays, but there's been virtually no catch-up in the spot rate this week. As discussed on Tuesday, this may be a result of the imminent Party Congress. But having given the matter some thought, Macro Man has devised a couple of alternative theories.
The Bloomberg terminal has a function, WCRS, which allows one to see the performance of a currency against a universe of other currencies over a given time period. Macro Man thought it would be interesting to see how the RMB stacks up against every currency in the known universe year-to-date. He was stunned by the result. Out of 180 (!) currencies in the Bloomberg universe, the RMB ranks 93rd in terms of spot performance this year- and it's basically tied with numbers 91 and 92, the Georgian lari and the Tunisian dinar. So despite a massive current account surplus and huge capital inflows, the RMB is essentially the median performer of all the world's currencies. Could it be that the authorities are targeting a median return? Macro Man asks that only partially with tongue in cheek, as the RMB's lack of appreciation on a global basis is difficult to explain any other way. (In case you're interested, the best performer this year has been the Gambian dalasi, and the worst the Zimbabwe dollar.)
An alternative explanation rests with one of Macro Man's primary beefs with the Chinese currency regime; namely, while they are happy to punt around in other nations' currencies, they damn sure don't want foreigners speculating on their own. The chart below shows the annualized USD/RMB decline priced into 3 month NDFs and the one month change in the actual spot rate. Observe that when the market prices in a faster rate of RMB appreciation (low points on the blue line), the actual pace "magically" appears to decelerate (spikes higher in the red line.) The correlation of the two series in 2007 is -0.18. So it seems that the authorities have maintained the mindset that they'll only permit currency appreciation when the market is not positioned for it. Meanwhile, SAFE happily contributes to the seemingly inexorable rise in the euro. This is why Macro Man favours international mediation from the IMF, or someone else, lest the world economy fall into a broad-based protectionist trap.
Turning back to the Federal Reserve, Macro Man cannot help fixating on that passage from the recently-published minutes of the September 18 FOMC meeting:
"Such a measure should not interfere with an adjustment to more realistic pricing of risk or with the gains and losses that implied for participants in financial markets."
Now, it's certainly Macro Man's impression that the larger-than-expected rate cut has interfered with the re-pricing of risk, but he decided to delve further. Macro Man tracks a financial conditions index similar to that calculated by Goldman Sachs. He recalibrated the index so that it was at 100 the day that the Fed first started tighening rates in June 2004. As the chart below indicates, financial conditions are only a couple of beeps away from 100- in other words, US financial conditions are more or less identical to where they were when the Fed funds rate was at 1.25%!!!! Note how the index has fallen sharply since the last Fed meeting, indicated by the arrow. Over the past month or so, US financial conditions have unwound half of the entire tightening. Is it any wonder that equities are at all-time highs and the dollar is plumbing close to all-time lows against some currencies?
Macro Man also looked at the risk index he tracks...and the story is the same. The index is a normalized scale, with 0 equating to risk neutrality, 1 equating to risk appetite 1 SD above neutral, -1 equating to risk aversion 1 SD above neutral, etc. Note how, despite the rally in equities, Macro Man's index was still hovering comfortably in risk aversion the day before the rate cut (as indicated by the arrow.) As you can see, risk appetite has now climbed to its highest level since the Fed started tightening policy (though nowhere near the heady heights of the equity bubble at its apex.)
What conclusions are we to draw from this? That the Fed don't know what they are doing...or that they don't care? Macro Man isn't sure if it matters; neither one makes him want to hold dollars...or Treasuries either, for that matter. If Mr. Bernanke wants to know why people still call him Helicopter Ben, a glance at these charts will tell the tale. In the meantime, the risk trade remains on, baby, until Ben decides to land his chopper. 
There are exceptions to the rule, of course. While the last two weeks have seen the greenback weaken markedly against most Asian currencies, it's been remarkably stable against the RMB. Part of that was down to last week's Chinese holidays, but there's been virtually no catch-up in the spot rate this week. As discussed on Tuesday, this may be a result of the imminent Party Congress. But having given the matter some thought, Macro Man has devised a couple of alternative theories.
The Bloomberg terminal has a function, WCRS, which allows one to see the performance of a currency against a universe of other currencies over a given time period. Macro Man thought it would be interesting to see how the RMB stacks up against every currency in the known universe year-to-date. He was stunned by the result. Out of 180 (!) currencies in the Bloomberg universe, the RMB ranks 93rd in terms of spot performance this year- and it's basically tied with numbers 91 and 92, the Georgian lari and the Tunisian dinar. So despite a massive current account surplus and huge capital inflows, the RMB is essentially the median performer of all the world's currencies. Could it be that the authorities are targeting a median return? Macro Man asks that only partially with tongue in cheek, as the RMB's lack of appreciation on a global basis is difficult to explain any other way. (In case you're interested, the best performer this year has been the Gambian dalasi, and the worst the Zimbabwe dollar.)
An alternative explanation rests with one of Macro Man's primary beefs with the Chinese currency regime; namely, while they are happy to punt around in other nations' currencies, they damn sure don't want foreigners speculating on their own. The chart below shows the annualized USD/RMB decline priced into 3 month NDFs and the one month change in the actual spot rate. Observe that when the market prices in a faster rate of RMB appreciation (low points on the blue line), the actual pace "magically" appears to decelerate (spikes higher in the red line.) The correlation of the two series in 2007 is -0.18. So it seems that the authorities have maintained the mindset that they'll only permit currency appreciation when the market is not positioned for it. Meanwhile, SAFE happily contributes to the seemingly inexorable rise in the euro. This is why Macro Man favours international mediation from the IMF, or someone else, lest the world economy fall into a broad-based protectionist trap.
Turning back to the Federal Reserve, Macro Man cannot help fixating on that passage from the recently-published minutes of the September 18 FOMC meeting:"Such a measure should not interfere with an adjustment to more realistic pricing of risk or with the gains and losses that implied for participants in financial markets."
Now, it's certainly Macro Man's impression that the larger-than-expected rate cut has interfered with the re-pricing of risk, but he decided to delve further. Macro Man tracks a financial conditions index similar to that calculated by Goldman Sachs. He recalibrated the index so that it was at 100 the day that the Fed first started tighening rates in June 2004. As the chart below indicates, financial conditions are only a couple of beeps away from 100- in other words, US financial conditions are more or less identical to where they were when the Fed funds rate was at 1.25%!!!! Note how the index has fallen sharply since the last Fed meeting, indicated by the arrow. Over the past month or so, US financial conditions have unwound half of the entire tightening. Is it any wonder that equities are at all-time highs and the dollar is plumbing close to all-time lows against some currencies?
Macro Man also looked at the risk index he tracks...and the story is the same. The index is a normalized scale, with 0 equating to risk neutrality, 1 equating to risk appetite 1 SD above neutral, -1 equating to risk aversion 1 SD above neutral, etc. Note how, despite the rally in equities, Macro Man's index was still hovering comfortably in risk aversion the day before the rate cut (as indicated by the arrow.) As you can see, risk appetite has now climbed to its highest level since the Fed started tightening policy (though nowhere near the heady heights of the equity bubble at its apex.)
What conclusions are we to draw from this? That the Fed don't know what they are doing...or that they don't care? Macro Man isn't sure if it matters; neither one makes him want to hold dollars...or Treasuries either, for that matter. If Mr. Bernanke wants to know why people still call him Helicopter Ben, a glance at these charts will tell the tale. In the meantime, the risk trade remains on, baby, until Ben decides to land his chopper. 
10 comments
Click here for commentsHi Macro Man,
ReplyI like your blog and it's one of my first reading everyday.
Can you explain how your US Financial Condition Index and Index of Risk Appetite are calculated?
Thank you,
Thanks for your kind words. Unfortunately I cannot really say much about the construction of the indicators as they are proprietary; however, they do correlate well with similar indicators published by various investment banks.
ReplyMM,
Replyi had written a comment here a few minutes ago; as it hasn´t shown up yet, i´ll resend it. Apologies if it shows up again later.
I was saying that perhaps it´s not the Fed who doesn´t know what it´s doing, but the markets. If the Fed lowered the 50 bps mainly because of the credit conditions, which is what I read from the minutes yesterday, then it was perfectly sensible and further easing should not be expected to be a certain event.
The markets, however, seem to believe (want to believe?) fervently in the reflation story, and may be surprised as soon as the next meeting -- in your wording, may find out that the chopper hasn´t taken off at all...
cheers!
avinash goldfish
Welll.......I can just about agree that the market's risk orgy has been misplaced (in terms of the breadth of stuff that's rallied.) But for the Fed to deliver more than just about anyone not wearing rose-tinted spectacles was looking for....and at the same time implying that they didn't want to create moral hazard...it makes me scratch my head.
ReplyIsn't the Bernanke Fed supposed to be emphasizing clear communcations? At least when Greenspan bailed everyone out, he did it intentionally. If it is the case that Bernanke didn't see what would happen, that's almost worse than if it was intentional.
interesting Chart -- the Greed&Fear Index. Big Picture blog the other day posted a similar thread on this, but that chart looks different from urs here... it points to a more neutral stand.
Replyhttp://bigpicture.typepad.com/comments/2007/10/greedfear-index.html
I love ur blog vy much as well n its usually my last reading everyday (am in Tky). Thanks.
also, interesting observation on that RMB negative correlation.
One of your best posts, MM. I particularly liked the concluding paragraphs.
ReplyRegards,
Ananth
weichristineliao, a number of insitutions have these sorts of indices, which were first developed at JP Morgan about 10 yrs ago. They tend to vary in terms of "length" of signal. I quite like the one I've got...it turns over freuqnetly enough to be useful in market-timing, but not so much so that it's a chop-fest.
ReplyAnantha, thank you!
MM,
Replyregarding the Fed's communication, considering that the September meeting was on the week following the BoE's disastrous attempt to fight moral hazard, I get more sympathetic to their pulling what looks like a "let's let them think what they want if it helps them calm down, and next month we set them straight" reasoning...
It doesn´t look like central banking as usual, of course, but the conditions were not usual in any meaningful sense... this is why i believe that seeing this cut as the first of a series, "because central banks smooth rates", is plain wrong reasoning (even if they eventually do cut again)...
by the same token, they would, imo, have done a superb central banking job if they do not cut in October and reinforce that the September decision was taken mainly because of the credit markets...
anyway, we´ll have plenty of time to see what they´ll eventually do...
Cheers, and congratulations for this superb blog,
a. goldfish
I'd agree that the full story has yet to run, and I am trying hard to be a Monday morning quarterback here. looking back at what I wrote on the day of the meeting, I said that bonds/currencies were priced for 25/25, and equities for 50/50. In retrospect I guess I was wrong, given the nature of the subsequent equity rally.
ReplyPerhaps we can but Ben some slack, therefore, and assume he may not have wanted to disrupt equities....or maybe that he wanted to give bond/credit markets a pleasant surpise. Either way, it seems like mighty odd behaviour for someone who claims not to target asset markets.
Still, I think 25/25, with a readiness (either stated or unstated)to act further as necessary would have warded off some of the potential moral hazard dangers, and would have removed the impression that the Fed resides under Jim Cramer's thumb.
I think I might do a poll on this...
MM - there's no need to do a poll, as everyone has voted in the market and the liquidity-correlated complex is way bid. It seems even seems perhaps overbid because the market appears to smell that neither BB, Congress, nor Paulson have the spine or appetite to pre-emptively rebalance anything preferring instead to be bitch-slapped by the market, or inflation, or both.
ReplyPerhaps you should frame you question(s) as: At what Gold Price (CRB Index Level, USD Index level etc.) (if any) will the Fed RAISE rates? Or at what USD level will the EU throw down the gauntlet, or at what USD Price of oil will the US consumer cry "uncle".
The disorderly rebalancing outcome will suck - whether by market chaos, protectionism or iterations and feedback loops of both. But note: there is a scenario in which the bond market is finally and majestically released from the PBoC lockbox, either in retaliation for something (NTBs, pecuniary trade restriction, Taiwan) or to give a near-religious vision to where it might be deemed to be needed (e.g. a petulant US congress and popular anti-China US sentiments).