Thursday, January 08, 2009
And now the second half of this year's non-predictions, following on from yesterday's first five:
6) EUR/GBP will NOT trade at par. This non-prediction is less controversial than it was a week ago, given the 5% sell-off in the cross. Macro Man must confess to feeling slightly bemused about sterling; having felt for years that it was bum-clenchingly overvalued (viz, last year's comment that cable would not reach a new high), it now looks farcically undervalued against other European currencies.
While this is clearly a result of the ongoing market and economic implosion, and the resultant easing policies pursued by the BOE, from Macro Man's perch it has overshot. After all, at least UK policymakers have (belatedly) realized the nature of the problems they are confronting. In the Eurozone, meanwhile, the economic pity party is just getting started. In December, Germany registered its first rise in unemployment of the cycle- something tells Macro Man it won't be the last. With the possible exception of the Swiss franc, the euro remains the most overvalued major currency in the world...and the lesson of the past year and a half is that that which is overvalued eventually gets nailed. Ultimately, EUR/GBP at 1.00 is just flat-out wrong, and Macro Man doesn't think it will happen.
7) The DXY will NOT make a new low in 2009. The DXY is mostly the euro, so this is really just another way of saying that EUR/USD will not trade meaningfully above 1.60 this year. From a technical perspective, the DXY rally has yet to reach meaningful retracement targets, so Macro Man would expect the buck to rally from here, taking the DXY to somewhere between 90 and 100, From a market perspective, Macro Man remains skeptical that years of dollar borrowing and leverage can be unwound over a few months, especially in an environment of impaired market liquidity. And from a monetary perspective, Macro Man believes that QE is an irrelevance for the dollar until the velocity of money starts to rise again....in other words, until those dollars "dropped from Ben's helicopter" make their way back into the system. For now, they are merely going to shore up holes in balance sheets.
8) China will NOT stop taking the piss in currency markets. In Macro Man's ideal world, China pulls the bid in USD/RMB, slashes its FX reserves by 75% and uses the money to fund the beginnings of a domestic social safety net, and thus buggers off from trading EUR/USD. His ideal world also entails the Pittsburgh Pirates winning the World Series and West Ham the European Cup....so a cursory glance at the sports pages will confirm that we are pretty damned far away from that ideal.
While there has been a bit of sturm und drang emanating from Beijing recently about the inutility of accruing more reserves and/or buying more Treasury bonds, there is also the small matter of the economic downturn and the desire to maximize net exports. Macro Man suspects that the latter consideration will prevail in domestic policy circles, which makes sense given his views on the dollar and US bonds. As the chart below demonstrates, the rise in FX reserves in China has been inexorable (if you don't already, tune in to Brad Setser for ongoing analysis of this issue.) So for better or for worse, we'll all have to continue living with Voldemort, the cockroach of global finance.
9) High grade credit spreads will NOT reach their wides of 2008. There are three dynamics at work here. First, dealers and punters had every incentive to mark this stuff as wide as possible to end 2008; after all, no one was getting paid last year, so it didn't really matter if it cost you more money. Whereas this year, there's at least a hope you get paid...so why not start the year with an extremely favourable mark? Second, the Fed is now targeting spread product, specifically MBS. As mortgage spreads tighten, yield-seekers will eventually be forced to move slightly out the credit curve. And finally, high grade credit generally bottoms first...certainly before the stock market. Observe how in the last cycle, AAA spreads made their wides in mid-2000, before the economy really went into recession. Sure, they remained elevated for a number of years afterwards.....but they didn't make new wides. Given the implied default rates in high-grade credit at current pricing, the asset class looks pretty cheap...especially in comparison to stocks. It can remain cheap for an extended period, of course....but Macro Man reckons that the chart below will not make a new high this year.
10) The approval rating of Gordon Brown and Barack Obama will NOT be as high as they are now at the end of 2009. The last yougov poll that Macro Man can find puts Gordon Brown's approval rating at 38%, substantially higher than its October lows. In Macro Man's view, the bounce has less to do with GB's "vision", "leadership", and "saving the world" than it does with the ineptitude of the Opposition. Given the likely trajectory of the UK economy in 2009, Brown's own ineptitude will eventually re-emerge as a factor in his ratings.
As for the president-elect, it strikes Macro Man that he would need to cure cancer, walk on Mars, and score the winning touchdown in the Super Bowl (all in addition to resolving the financial and economic crisis with the stroke of a pen) to meet expectations. So even if Obama does a good job (and it's in everyone's interest that he does), the grim reality of the 2009 recession is likely to reduce his approval rating from the the current 67%.