Friday, March 14, 2008

Would you believe it?

First things first. Regular readers will know by now that Macro Man's niche in the online financial world is not the detailed breakdown and explanation of complex issues for the benefit of the reading public. He has neither the time (OK, over the the last few weeks he has, but that is rapidly drawing to a close) nor the inclination to do stuff like that- it seems too much like school work. So anyone looking for a breakdown of Barney Frank's plan to save the world would do well to seek other pastures for that information.

However, permit Macro Man to occupy his natural milieu- that of pithy observation- and briefly touch on the Frank plan. The last large government-organized bailout of the US financial system occured 20 years ago in the wake of the savings and loan crisis. The creation of the Resolution Trust Corporation provided a dumping ground for institutions to deposit their crappy loans and thus clean up their balance sheets, and for some time Macro Man has thought that the endgame to the current situation would evolve around similar lines. However, this is the observation that Macro Man wishes to make: the RTC was established in 1989, the stock market didn't start rallying until early 1991, and the economy didn't feel as if it had improved until late '92/early '93. The moral of that particular story is that just because a plan of action is in place doesn't mean that things will improve immediately.....so view the late session bounce in the S&P with that in mind.

Elsewhere, yesterday was just another day and another dollar shag-fest. One wonders if the world's financial press have written a macro in their word processors; you know, hit Shift-F9, and the headline "Dollar trades at new all time low" magically pops up as the headline. Anyhow, the days of the emerging consensus of a dollar rebound seem like a long time ago now, don't they?

However, would you believe that there are some currencies that are doing even worse than the dollar? And no....Macro Man isn't talking about things like the Zim dollar, which don't really count as currencies. He means actual, real currencies, stuff that he has traded professionally within the last twelve months. So let's have a look at the company that the dollar's been keeping (note that on these charts, a trend to the upper right means that the dollar is appreciating):

1) ISK. Yes, the Icelandic krona has done even worse than the dollar, as USD/ISK has risen more than 10% this year. Bear in mind, it doesn't say much about the dollar when you have to compare it with the currency of a country with a double digit current account deficit and a population roughly the size of Toledo, Ohio, but hey- you gotta start somewhere! Remember, boys and girls: you can't spell "risk" without "ISK".
2) ZAR. Hmmm, what's not to love about the rand? South Africa has a bigger inflation problem than the US, a bigger current account deficit as a percentage of GDP than the US, and a less credible head of state than the US. Plus, there's nothing quite like widespread power cuts and rumours that the 2010 World Cupo will be moved, is there?

3) KRW. Perhaps the most surprising of the bunch, the Korean won is a real live currency from Asia- you know, the region that's home to the world's most chronically-undervalued currencies! Obviously the bulk of won weaklness has come in the last week or two, suggesting a pretty heavy flow. Bear in mind that Korea is one of the few Asian countries with a current account deficit (it's the worst of the best?), has a reasonably heavy foreign participation in its equity market, and has a hegemonic shipbuilding industry that has been chronically overhedged in the currency space (i.e., short USD/KRW.) Also, the KRW had strengthened the most of any Asian currency over the past several years, so perhaps some payback was due when things started to go wrong.4) TRY. While the Turkish lira has actually performed much better than expected amidst all this turmoil, it's still weakened modestly against the buck so far in 2008. Then again, this is a country with a large c/a deficit and high inflation....and oh, is early in the process of going cap in hand to the European Union and asking to be admitted to the club.
What's interesting is that all four of these currencies suffer from current account deficit countries, suggesting that external imbalances may be one of the underlying drivers of currency markets so far this year. Then again, AUD and NZD are at multidecade highs...so perhaps not.

All Macro Man can say is that if he takes his freshly-minted UK drivers' license and goes on a driving tour around Europe, say into France and Switzeralnd, he will undoubtedly blanche at the prices. Eventually, this will set up as an excellent trade to buy dollars (USD/CHF at parity is just wrong wrong wrong)....but like the US 2's trade, patience will be required before execution.

16 comments:

MP said...

MM, got a question regarding a possible intervention to stabilize the USD decline. Assuming its a plausible scenario, what would the implications be of a coordinated CB action? What expectations&actions would it trigger among market participants in the ccy space?

Macro Man said...

MP, the waffle answer, but nevertheless the true answer, is "it depends". CB buying of euros, for example, would probably have only a small impact if the ECB were not prepared to cut rates. If the ECB did cut rates aggressively, then I thjink you could see a much bigger impact.

Similarly, if the BOJ were to return to ZIRP in the context of massive MOF intervention, then you probably could see a shift in trend.

However, both of these are hypotheticals, as I really struggl;e to see why the US administration would want to help out Johnny Foreigner in an election year.

MP said...

Maybe I put my question wrong: I am trying to understand the what if scenario. Reads like this: I suppose the intervention takes place (for whatever reasons). How would it affect market participant expectations? Would they rather smell the trouble behind such type of action and bet against it or would they rather feel that the intervention was necessary and a wise thing to do?

Macro Man said...

I think the answer's pretty much the same; if the intervention were conducted without ancillary steps on the part of the relevant policymakers (rate cuts outside the US, for example), the market would tend to view it (after an initial dollar rally) as a $ selling opportunity.

Were policymakers to change the underlyign fundamentals via rate changes, the intervention would be more likely to meaningfully impact medium-term behaviour.

MP said...

Thanks for the insight MM. And for all the efforts that a pretty damn good blog requires. Don't want to overstretch, but another thing that I wonder about is the role of money supply and its linkage (if any) to the way out of the US mess. Any thoughts on that?

Macro Man said...

I am sceptical of the utilkity of money supply in today's modern finan cial world, given that money can be "created" through the derivatives in ways that are not captured by the M's.

Moreover, there are ancillary distortions, like M3 typically rising during periods of crisis, not because of easy money policies, but because of money leaving securities markets and entering money markets (and thus coming under the purview of M3.)

Agustin Mackilay's Global Liquidity Blog is a good resoruce for further explanation, insofar thinking about these sorts of issues is its primary raison d'etre.

Anonymous said...

MM,
you write, "usdchf 1.0000 wrong". I no doubt the Swissy is at a very strange rate against the usd.

Two questions:

What is/could be the " right rate"?
And how you derived that rate?

thx,
panther

OldVet said...

Err, may I say that $2 per Swissie would be better than one? :)

Macro Man said...

Anon, my estimate of "fair value" for USD/CHF is somewhere in the 1.30-1.35 region. This is calculated using an adjusted purcashing power methodology that I use to create a fair value estimate for another of other different currencies as well.

Qualitatively, having lived in Switzerland for a year in the mid-90's, I thought that true PPP was higher...say north of 1.50, in the same way that things in the UK that cost £1 generally seem to cost close to $1 in the US- despite fair value estimates of 1.5-1.65 for GBP/USD.

2and20 said...

that's similar to how i like to consider long-term FX "value"..."things" in UK and Europe cost a hell of a lot more, so therefore currencies are overvalued. The pound deserves to be closer to 1 than 2 against the dollar, it was ~1.40 back in 2001/2002 slowdown, that's what I've got in mind for this cycle. And as for the Euro, even if it was 1-to-1 with the dollar, I suspect most goods and services would still be more in Europe.

Of course, there are many reasons why prices can remain different, as you can't arbitrage away many services, taxes, business rents/rates etc, but it still gives a good idea of over/under-valuation.

2and20 said...

oh, and where's the best place for free FX charting? Yahoo Finance isn't bad, but I'm interested in looking at some long-term charts, they only go back to 1999.

Brian said...

MM - where does your model place GBP/CHF at? Amazing how heavily that pair has been hit. It closed at the very low of the day/week in NY..


2and20 - here's FX charting w/30 years of data
http://efx.tradesecuring.com/Misc/EFX.asp

Anonymous said...

why would any bsc shareholder vote for this deal---everyones cost is much higher--employees own 30% of the stock and two others (joe lewis and the boys from texas own another 15% ish) whats the downside --0 i thinnk unless the fed is putting a horse's head in joes bed not sure this gets voted through

Macro Man said...

I suppose if Bear comes out and says they declare bankrputcy without this deal, and you have a choice between $2 and 0, you go for the 2. One can only presume that the siutation must be pretty dire for the BSC board to have accepted such a paltry sum...unless Jimmy Cayne somehow thought it was a bet at his bloody bridge tournament...

Anonymous said...

not true--if makets calm down during the earn out who knows how much bears assets might be worth--id roll the dice and bear always has--go all in with the 7 NT

Macro Man said...

Well yeah....and if Martians came down and bid $1000/share for BSC, I'm sure the board would hit that bid too. The problem is that as things now stand Bear's net asset position is almost certainly negative to the tune of an 11 figure number, what happens a few months' hence doesn't really matter too much for BSC shareholders right now.

BTW, I', sure that the UK government figured that "if we hold on for a few months, things will improve and we'll be able to finmd a buyer for NRK at a reasonable price"...and we all know how that worked out...