The First Shots

Thursday, January 22, 2009

For some time, Macro Man has held the view that one of the primary second-order risks of the current financial crisis and the concomitant recession would be a broad-based rise in protectionism and beggar-thy-neighbour policies.

To be sure, for the likes of China and other Asian mercantilist nations, such activities are meat and drink for economic policymakers. But yesterday saw the first shots fired in the West, whre there were not one, not two, but three separate currency comments from policymakers. It reminded Macro Man of nothing so much as a fight scene from the old Adam West Batman series:

WHAM! Phiipp Hildebrand of the SNB said that with the zero-interest bound rapidly approaching, the bank would consider "unlimited" currency intervenion to weaken the CHF. Cue a predictable rally in EUR/CHF:

POW! It seems as if France has moaned about currencies every year since the late 1960's Bretton Woods balance of payments crisis. They continued the streak in style yesterday, as FinMin Christine Lagarde rapped the BOE on the knuckles for doing nothing to defend sterling. (The UK Treasury issued a swift two-word rejoinder, the second word being "off".)

"Separately", a G7 source (codename: Fer a Cheval Bleu), mentioned that G7 would dicsuss sterling weakness at next month's meeting.

BAM! Yesterday was quite an interesting exercise in game theory, as there was an enormous ($6 billion) option expiry in USD/JPY at 10 am New York time. The strike price was 90.00, and and expiry USD/JPY was trading at.....90.05. The thinking in the market was that the option short would need to buy $6 billion after expiry, and were leaning long as a result. When the institution in question pulled the bid at 10.01, a 3% plunge down the elevator shaft swiftly ensued, taking USD/JPY down to its previous low of 87.10.

Intervention rumours swiftly ensued, though USD/JPY subsequently squeezed higher along with US equities. But still, it would be quite a statement for Japan to intervene in currency markets in week one of the Obama administration. Such a statement, in fact, that the presumptive Treasury Secretary Geithener made a comment yesterday (admittedly not targeted at Japan specifically) reiterating the US preference (or demand, depending on your perspective) for flexible, market-determined exchange rate regimes for major trading economies.
The list of countries that prefer a "competititve" (economist-speak for weak) exchange rate is a long and growing one, while the list of those wishing for a stronger local currency is rather short indeed. Something tells Macro Man that we haven't seen the last of this issue....

Elsewhere, bond bears now have their chance to shine. Equities have quite going down in a straight line (the SPX has rallied on 75% of the last 4 trading days!!!), and long bonds have broken a fairly key support line. If the bond bubble is gonna burst (say that five times quickly after a few beers!), the ducks are lining up for the first shot to happen now.

Posted by Macro Man at 9:41 AM  


Didn't long UST buble sort of burst already (end-of-Dec roundish)? 30s down from 140+ to about 125... Still has a some way to go, but I'd say it's half way there already. .

vlade said...
11:46 AM  

Macro man, what are the implications on the FX markets (USD, JPY and EM) if the bond bubble does burst?

Thank you vm I really enjoy your post!

Anonymous said...
12:15 PM  

which bond bubble? could the fact that bonds are up here have anything to do with the fact that rates are at zero?

Anonymous said...
12:50 PM  

Bit left field I know but anyone got a rate for Goldman sachs CDS's??

Anonymous said...
1:03 PM  

Bond bubble:
CPI in US,Europe,UK will be negative come June/July and Policy rates between zero and one and a bit ... as the Japanese experience showed, you can have very low nominal rates and for quite a while in that context despite debt/GDP at 100% or above.
But one has to keep in mind that Japan had a very positive trade balance all along ... ie some parts or Japan were lending to other parts of Japan ... what will matter a lot in 2009 now that almost every countries in the G20 need to issue a lot more debt is whether you need foreign investors or not … I believe more in a relentless sovereign spread widening situation in 2009 rather than a global bond market sell off … it started … I do not see what could stop it … and it’s like football … Germany will win in the end …. Sorry (Flash) Gordon.

BlueMonday said...
1:16 PM  

Macro man, what are the implications on the FX markets (USD, JPY and EM) if the bond market sells off aggressively?

Anonymous said...
1:29 PM  

Tell high grade corporates that borrowing rates are zero, and I suspect that they will beg to differ. Relative to HG, MBS, et al, UST look pretty rich- hence the bubble.

While short rates are an important explanatory variable in determining bond yields, they are far from the only one. True, others such as CPI and growth considerations suggest low bond yields. But still others (the budget, marginal FX reserve recycling by mercantilists) are less favourable. My own equations suggest an equilibrium US 10y yield in the neighbourhood of 3.5- 3.75%.

Macro Man said...
1:40 PM  

GS CDS = 316 at the mom. If you have BBG, type BANK GO and you get a handy list.

If there is a massive bond collapse (not my base case, mind, but a popular view in some quarters), one would presume the c/a deficit countries would initially get pummelled....including the dollar.

Macro Man said...
1:54 PM  

Corp debt is value then GS cds at 300bps mean a risk free yield on 5yr bonds of near 4% over uk 5yr gilts at 2.75...

Anonymous said...
2:10 PM  

Reminder of MM's non-prediction number 3 for 2009: "the bond bubble will not burst".

So that non-prediction is a bit more nuanced now (just two weeks later): there won't be a massive bond collapse but...

(1) yields on 10-year US bonds will increase around 100 basis points from current levels;

and (2) the bond bubble WILL actually burst (or is already bursting) for many countries (some not so insignificant, eg Italy, Spain and eventually even the UK?).

bsanchez said...
5:17 PM  

meat and drink? what happened to bread and butter?

Anonymous said...
5:29 PM  

1) A bond bubble not bursting is not the same thing as a cheeky tactical short. I suspect there will be plenty of demand (from the Fed if no no one else at 3.5%

2) Meat and drink = bread and butter for all those people on the no carb diet.

Macro Man said...
5:48 PM  

I want to play with a Bloomberg terminal! Do you know if any UK libraries or such things have subscriptions where members of the public can go and mess about?

Long shot I know. :P

Darryn said...
6:00 PM  

yeah, me too, i'll code middleware and/or data mining apps for free in exchange for a terminal.. :)

Anonymous said...
6:52 PM  

Monsieur Fox loves the Fer a Cheval Bleu reference!


Linda P. said...
8:28 PM  

If you've worked for a financial firm then you can usually get 3months free if you're inbetween jobs....

Anonymous said...
9:31 AM  

MM where art thou? Looking forward to hearing your thoughts on the impending currency war...

Gus said...
10:40 AM  

Feeling like crap, but today's (non-topical)post is up....

Macro Man said...
11:41 AM  

With a US treasury bond, you get back all your money, the return depends on the yield you purchase it at. With stocks, well, good luck to you.

Competitive devaluation is just a matter of time. If none of the so called "stimulus", TARP or the alphabet soup that the US Treasury or the Fed policies work, there is no other choice.

The Japs have been particularly quiet about the strength of their currencies. Hell, if I owned that much treasury bonds, I will be screaming like mad.

The new Obama administration poke at China is both untimely and callious. The Chinese just need to stop buying US Treasury, and USD and US Treasury rates will crash.

Better be careful, the US have more to lose than the others.

gonegolf said...
8:21 AM  

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