Is the worm turning, if ever so slightly, for the dollar? Regular readers will recall that last summer, Macro Man began to contemplate the notion that aggressive Fed easing would generate a "dollar down bubble." The view played out as well as possibly could have been expected, in both the currency and the commodity space; Macro Man's only regret is that he was hors de marche when the most impulsive breakdown in the dollar occurred. And yet he now finds himself less tactically bearish of the buck than he's been since August of last year.
Recent data from Europe suggests that some of the pain of tighter credit is starting to spread. While there is still no assurance that the ECB will act in the near or even medium term to cut rates, it seems clear that the endgame will be an ECB rate cut. That, combined with the nosebleed valuations of EUR/USD (and many of its closely correlated peers), makes dollar shorts less attractive at the moment. When when considers that Voldy and co. have been selling EUR/USD, there's even more reason for concern on dollar shorts.
An even more interesting dynamic is playing out in Asia. China has seen its trade surplus shrink markedly; part of this is seasonal, but part of it appears to be cyclical: China's export growth has fallen off, thanks in part to weak demand in the US, but import growth remains firm, no doubt partially due to a negative terms of trade shock. And part of that ToT shock is, in Macro Man's view, a direct result of the "commodity leg" of the dollar down bubble. And that is why Macro Man postulated that CBs could be trying to support the dollar against euros, rather than their usual euro buying.
Regardless, the dynamic in Asia seems to have changed. For most of the past several years, short USD/Asia has been a favoured "fundamental" dollar short, given the relative imbalances that Brad Setser has written so much about. However, a few people, most notably Stephen Jen of Morgan Stanley, are being to question this trade, at least tactically. Given that China is shutting down next month for the Olympics (they need a few months to clear the air), one could argue that CBs will be less willing to tolerate the appreciation of their currencies without an ongoing growth driver.
Whether that's true or not, there's pretty clearly been a change in market view on China. The 6 month NDF has put in its largest correction higher since the RMB floated in July 2005.
A broader Asian currency index, on the other hand, has shown little signs of such a substantial correction. While some are cetainly well off their highs (KRW springs to mind), overall the recent hiccup is little more than a blip on the chart.
USD/JPY, on the other hand, is more interesting. Macro Man ran a little study to determine the historic scope of bear market rallies, wherein a bear market is defined as a negative 6 month change, and a 'bear market rally' is the difference between the spot rate at time t and the minimum of the last 6 months. The chart below shows the results; the current bear market rally in USD/JPY is the largest since early 2000- a rally that marked a medium term low in the pair.
At this point, Macro Man isn't prepared to call an end to the dollar down bubble- after all, real policy rates in the US are laughably low. However, he finds himself more neutral than he's been in the better part of the year, and tactically his position against "stuff that moves" has edged towards the long side.
He's aware that he has a lot of company in wondering if the dollar is set to bounce, a lot of which has more conviction and, in all probability, bigger positions than him. For this reason he's allocating a pretty small risk budget to a "dollar bounce" trade. But as he looks around, he sees some interesting RV trades in the EM space: certain CBs (Bacen, CBT) are clearly worried about inflation and are/will soon be acting on those concerns. If Asia starts dropping the ball on inflation, perhaps a rotation out of Asia and into high carry EM is on the cards- particularly if equities continue to confound the bears and grind higher.
Recent data from Europe suggests that some of the pain of tighter credit is starting to spread. While there is still no assurance that the ECB will act in the near or even medium term to cut rates, it seems clear that the endgame will be an ECB rate cut. That, combined with the nosebleed valuations of EUR/USD (and many of its closely correlated peers), makes dollar shorts less attractive at the moment. When when considers that Voldy and co. have been selling EUR/USD, there's even more reason for concern on dollar shorts.
An even more interesting dynamic is playing out in Asia. China has seen its trade surplus shrink markedly; part of this is seasonal, but part of it appears to be cyclical: China's export growth has fallen off, thanks in part to weak demand in the US, but import growth remains firm, no doubt partially due to a negative terms of trade shock. And part of that ToT shock is, in Macro Man's view, a direct result of the "commodity leg" of the dollar down bubble. And that is why Macro Man postulated that CBs could be trying to support the dollar against euros, rather than their usual euro buying.
Regardless, the dynamic in Asia seems to have changed. For most of the past several years, short USD/Asia has been a favoured "fundamental" dollar short, given the relative imbalances that Brad Setser has written so much about. However, a few people, most notably Stephen Jen of Morgan Stanley, are being to question this trade, at least tactically. Given that China is shutting down next month for the Olympics (they need a few months to clear the air), one could argue that CBs will be less willing to tolerate the appreciation of their currencies without an ongoing growth driver.
Whether that's true or not, there's pretty clearly been a change in market view on China. The 6 month NDF has put in its largest correction higher since the RMB floated in July 2005.
A broader Asian currency index, on the other hand, has shown little signs of such a substantial correction. While some are cetainly well off their highs (KRW springs to mind), overall the recent hiccup is little more than a blip on the chart. 
USD/JPY, on the other hand, is more interesting. Macro Man ran a little study to determine the historic scope of bear market rallies, wherein a bear market is defined as a negative 6 month change, and a 'bear market rally' is the difference between the spot rate at time t and the minimum of the last 6 months. The chart below shows the results; the current bear market rally in USD/JPY is the largest since early 2000- a rally that marked a medium term low in the pair.
At this point, Macro Man isn't prepared to call an end to the dollar down bubble- after all, real policy rates in the US are laughably low. However, he finds himself more neutral than he's been in the better part of the year, and tactically his position against "stuff that moves" has edged towards the long side. He's aware that he has a lot of company in wondering if the dollar is set to bounce, a lot of which has more conviction and, in all probability, bigger positions than him. For this reason he's allocating a pretty small risk budget to a "dollar bounce" trade. But as he looks around, he sees some interesting RV trades in the EM space: certain CBs (Bacen, CBT) are clearly worried about inflation and are/will soon be acting on those concerns. If Asia starts dropping the ball on inflation, perhaps a rotation out of Asia and into high carry EM is on the cards- particularly if equities continue to confound the bears and grind higher.
6 comments
Click here for commentsMM,
Replywhat's going on, you are trading in your better judgement (see your piece some days ago) in order to jump on the "ECB will cut" bandwagon? Admitted, the euro area is probably slowing down - at least some of the "housing boom" countries clearly are. But first, the ECB is well aware that Spain et al. have been booming and growing above potential in recent years - and hence will need to underperform for some time to adjust (not least their huge ca deficits which nobody talks about as they are hidden within the currency union). And second, even if the euro core (read Germany) was slowing down - which is far from certain - the ECB would not have room to cut for a long time to come. Inflation TRENDS are abysmal - and the closer you look at the data, the more obvious it becomes that even core inflation will remain above the ECB target for a long time to come. Given that europe is a less flexible economy - i.e. slack will show up in lower inflation only with long time lags - so why/how on earth would the ECB want to cut?
PS I am not an ECB insider, so have no superior knowledge on what's going on there. This is based purely on observation and common sense.
B, when I say 'endgame', that's what I mean...ultimately, they will need to cut, whether in September or this time next year. I don't really intend to play the game of 'when will they' via the strip or anything like that. But ultimately, it's the market that sets asset prices, and if the market is going to want to focus on weak activity data in Europe- which I think, on balance it will, though not perhaps at 1.30 LDN time tomorrow- then that has a market impact, especially if Voldy et al are whacking the euro.
Replyc'est hors du marché..
ReplyIn typical fashion the market overshot itself. This alone would suggest to me some dollar firming was in order.
ReplyI'm wondering if it's not so much the greenback appreciating against the euro as much as it's the euro struggling against other currencies at the moment. In addition to the ECB & BOE rate decisions (which you folks in Europe seem to treat like some kind of celebrity event) I'll be cluing in to Germay's trade balance for March as another barometer of how much slowing is occuring.
All that said, I'm not as sanguine about a sustained dollar recovery. IMO investors simply are not pricing in how a very weighed down and increasingly thrift minded consumer is going to translate in to negative earning surprises 6 months to 2 years down the road.....stimulus checks or no stimulus checks.
In the end, what will surprise people is not so much their perception of how severe the U.S. downturn was as much as the duration of weak growth before a real expansion occured again.
As such, it won't surprise me to see the Fed cut rates again late this year or in 09'.....regardless of how much money they continue pumping in to the economy.
The FRB will follow the EFF all the way to 0%. With the operative word being "follow."
ReplyThe dichotomy will be double digit .gov and private borrowing costs.
Hi MM,
ReplyI agree with Bureaucrat and think that market partecipants have recently been eager to overestimate "bad news" rather than "good news" about EU economy (cognitive dissonance?), trying to force ECB to cut rates. As I once wrote, my daily job as a credit analyst within a multinational credit insurer allows me to get at least a timely feedback on current business conditions and as far as I know things are bad in Spain and Italy, where small and medium sized firms are really struggling to service ourstanding debts, but no such news is coming from France or Germany (and France and Germany ARE the euro...)
Meanwhile, GBP might prove to be real thing for a shorting game...
Read you later, AT