G7 get jiggy on the Yuan

The G7 communiques are out (i can’t find a link at the moment as i have it direct from a trading platform) and there is one clear story and several cloudy ones. The main thrust is that they would like to see the Yuan quicken its appreciation. Well looking at China’s trade surplus that’s pretty obvious. One only has to remember the famous Yen “endaka” from 1971 to 1995 when the $ fell from 360 to just below 80 Yen.

How far will the Yuan rise is anyone’s guess. The day it floats and becomes fully convertible will see a huge increase in volatility and speculative financial flows. However a floating Yuan would actually be beneficial in regulating global imbalances in trade and economic growth.

The Chinese are well aware of it and are probably not minded to open the doors to the Magic Kingdom just yet. They hold the balance of power at the moment and wont be pushed until they are ready. Still continued pressure will eventually tell.

However, it’s not just the Chinese getting a telling off. Some mention has been made of Asia as a whole and of course this refers to Japan. Whilst there was no specific mention of the Yen this will certainly not be lost on those with substantial short yen positions. There was mention of an improving economic situation in Japan and that exchange rates should reflect fundamentals.

The risk inherent in global carry trades was mentioned specifically by Juncker (Luxembourgs PM) saying they wanted the market to be aware of the risks of one way bets, specifically in the foreign exchange markets.

Paulson (US Treasury Sec) mentioned clearly and loudly that the US believed in a strong dollar. Added to that were moans from the ECB crew about the strength of the Euro and how they were bearing the brunt of $ weakness.

The Canadians jumped in on this wagon too noting the Loony is now 3% stronger than the Greenback. Strange times indeed.

So what does all this mean. Well for me it could means the $ depreciation is nearing an end or at least getting into the red zone. From a market perspective i would say NZ/Yen is due for more pounding (back below 80 again) given this is regarded as the major one way bet in the fx markets. The Euro may reverse back to 1.35, the C$ back above parity and the A$ probably could do with a small dusting (maybe down to 85cts).

Stocks could also get pounded this week. Who knows? It’s not a week to be hugely long and comfortable.

FX rates are elastic things and when they get stretched the bounceback (as we saw in August) can be pretty fierce.

P.S. Others may interpret the communique differently so feel free to give me some of your views.

Fed comes to the party…..again

So the Fed yielded to pressure and cut the discount rate. Come borrow more they say….so much for a prudent approach to banking. But really they have no choice. They will just keep flooding the market with dollars for as long as it takes.

The market rallied as expected but it’s hardly a vote of confidence in the system. There will be an expectation of a cut in the funds rate at some point if credit woes continue. The problem is that the last few weeks have been so volatile that for many the opportunity to liquidate positions has not been possible.

Flight to quality has seen the $ rally except for that old favourite $Yen which has taken a pounding.

Who would want to own $? This flight to quality argument alway amuses me given the world is awash with $ and $ assets.

The volatility in the fx markets has been extreme reminding me of the Stg ERM debacle. It just shows that the leverage in the market creates an instability in the system which causes wild swings.  The range mileage in KiwiYen on Friday was the biggest i;ve ever seen in any currency pair…22 big figures in 24 hrs….thats 27.5% in absolute terms of up and down movements.

You would need Kevlar pants to trade that pair. I’ve been trading small amounts but cannot imagine much volume getting through at any reasonable spread.

This is market dislocation. The Fed can cut rates all they want but it wont help people who are under water whether owners of houses on 100% mortgages or funds with boatloads of credit on their books.

Another wild week beckons so expect more central bank ministrations.

Credit Boom ……..Busts

The credit inspired boom of the last 15 years is now over. Markets are in severe dislocation and whilst underlying economies are very sound there is a serious problem in global banking liquidity.

On the good side we have record low unemployment and company profits are in good shape. But the driver of that has been consumption driven by an expanding money supply which has driven up asset prices and created a wave of paper wealth.

Interest rates have been hiked up to halt this boom. It’s too late. The record low rates in the US over the last 5 years created easy money that was too good to refuse. As rates were jacked up people realised they hadn’t done their sums properly.

Wave after wave of derivative offers, capital guaranteed notes and other “too good to be true” offers have come pouring forth. There is nothing so easy as making money out of money.

But mathematics will always intervene. Compound interest takes no prisoners in its tsunami like advance across personal and corporate balance sheets.

The central banks now have no option but to step in and sort this mess out. The risk of systemic crash is clearly a possibility now, not just in stock markets but banking systems.

Whether markets can recover from here is a moot point. They always do eventually whether its months or years.

If the consumer goes to sleep expect a recession plain and simple. It wont matter where you are or what you do.

The important point is that our financial systems need a serious revamp. The gross expansion of the global money supply, condoned by the global central banks, needs a full inquiry.

Nothing less will do.

Global Markets: The Dragon stirs

The ongoing spat between the US and China over the rate of yuan appreciation has boiled over into something more interesting.

Last night Chinese officials threatened the possibility of selling down their US treasury holdings and thereby consigning the US$ to the trashcan. The Chinese are experts at promoting the maxim “don’t throw stones in glasshouses”. They are very astute at pointing out inconsistencies in arguments no doubt employing age old Confucian wisdom.

How the relationship between China and the US will pan out is anyone’s guess but we can be clear about one thing and that is the balance of power has shifted ever so slightly. The phenomenal success of the Chinese economy, based mostly on a large manufacturing base, has given the Chinese are strong foothold in global affairs. Whereas once it was a sleeping dragon content to rule its own domain now it is a major player.

At the same time it has built a strong domestic economy and plays host to the Olympics next year. It seems the US may need China more than China needs the US.

The situation doesn’t look too good for the US. Collapsing credit markets need a steady government security base to hold it all together. Any sell of in the US Treasury market would be a real disaster sending stocks down as well as the dollar.

To some extent we’ve been through this before with the Japanese. In the mid 90s Fred Bergsten hit the headlines calling for a stronger yen. This caused the $ to fall to a record low of 79.65. He was still making this call back in 2002 when he outlined strong reasons for abandoning the Clinton “strong dollar” policy.

This delicate game was fictionalised by Tom Clancy in his book “Debt of Honour” which told of a plot to destabilise the US economy by crashing the Treasury markets and the $. Of course the US won in the end but in real life who knows what would happen. The US authorities run some major interference in the markets when required and i am sure that any severe destabilisation of financial markets would see national security considerations apply (well if they haven’t got that sorted they should!). Sadly many of Clancys’ novels end up happening in real life.

The Chinese are very tactical and astute in their political strategy and very protective of their sovereignty. It will be interesting to see how this plays out but more weakening of global markets cannot be ruled out and with the end of the credit fuelled asset price boom added into the mix cash will be king.

Volatile Markets - par for the course

It’s been an interesting week or so since the RBNZ lifted interest rates t0 a wallet popping 8.25%. The Kiwi peaked above 81cts in a nice blow off move and post rate hike and carefully worded statement it has retraced as far at 75.5cts with the Yen cross taking a battering from 97.50 to 88.50. So much for safe carry trades.

The South Korean Finance Minister made some loud noises about the carry trade implications for the Won which was a bit firm for comfort.

Look really this is just a big game. And in all games there are winners and losers. As we see domestically in NZ with the collapse of yet another finance company, its usually the average risk averse investor who takes a cold bath.

Belgian dentists and Japanese housewives watch out!

All this because irresponsible and incompetent central bankers mismanage the global monetary system.

Leveraged money is like water….it will run down until it finds a place that can hold it. Anything that looks remotely fixed will attract attention..exchange rates, interest rates etc.

In a way speculators act in harmony with natural systems. Our world is in constant flux and it is normal for systems to move as new information is incorporated. Nowhere is this more obvious than the global currency markets…each breath of news is immediately received into the price no matter how minute.

So as soon as Alan Bollard said this is enough for now, then all bets were off and the market responded accordingly. Throw in the sub-prime meltdown in the US and it turned into a rout which could continue further. As i noted previously the Kiwi was at a level worth selling and could fall much further especially if the crosses get unwound.

We shouldn’t be overly concerned because we know the system is built to generate these crises every few years. According to Fred Harrison its every 18 years for the big bust  but currency debacles happen more regularly than that…..Asia, South America, Euro land, Russia…its par for the course.

So don’t be too alarmed. Just remember what Newton said…..whats goes up always comes down….eventually.

Currency Intervention: Kiwis don’t fly

On June 11th the RBNZ intervened in the NZ$ by selling NZ$ around the US$0.7660 level in thin markets. This was followed up by another bout or two resulting in short term sell offs to US$0.76.

This action has create a fair bit of comment most of it apoplectic in nature focusing on the poor NZ central bank against the might of global speculators. The commentary uniformly blasted the RB and trotted out the story of how George Soros buried the Bank of England back in 1992.

Well this is one time i can say “i was there” as i was actually trading Stg at the time, with the regular trader lying on a beach in the Carribean. It was a crazy time to be in the markets but when you were the focal point of action that feeling was magnified. The Bank of England phone line was running hot as we called up to sell more and more Stg. The voice on the other end of the phone was resigned to the ship going down.

It duly did. The next day i had my biggest one day loss in 12 years of trading as the market all but disappeared and every customer was looking to trade. I remember my broker took me out to dinner at the casino in Park Lane to recover. Nice.

But the main point of this story is that Stg was way overvalued and stuck in the ERM where it was required under the Maastricht Treaty to keep the Pound above a certain level which was DM2.7780.

So the Old Lady was just doing her job. She wasn’t taking on Soros or the market but just fulfilling legal obligations. Soros made a bet that the UK would have to pull out of the ERM and that was a political action and you can be sure he would have done his homework there.

So it is very different to what we see when the BOJ intervenes in the Yen at 100 or 145 where there is no legal cap but an extreme extension in rates.

The RBNZ action falls into this camp. The NZ$ is appreciating well beyond fundamentals based on the current account deficit, PPP comparisons and problems for the export sector to sell its goods. It is also suffering from carry trade side effects which are causing a huge inflow of short term investment to take advantage of high interest rates.

Its intervention is justified on those grounds. The NZ$ should be trading around US$0.60 which is just above its long term average. Of course currency rates can run way beyond what might be considered justifiable and for some period of time.

The Great Game continues in the global financial markets where the US sells it paper to trading nations such as Japan and now China in return for goods. One day this game may stop and the US$ will go into freefall.

The same could happen to the NZ$. I would say the RBNZ intervention is justified though how effective it is remains to be seen. Jeff Gamlin at the NBR is quite positive on the profit implications and it’s certainly a good long term trade to buy some foreign reserves. They should be selling as much Kiwi as possible!

As it happens intervention usually works if the intervening bank has some justification. Remember currency speculators like to make money. They don’t care whether it’s up or down.

The RBNZ is in a tight spot regardless of what Grant Spencer, the Deputy Governor , says. They will need a bit of luck to get this right and will need to continue intervening if required at higher levels like 78 and 80. I think though they will be safe there as people are starting to feel the pinch of higher rates.

Also yesterday the Japanese Minister of Finance weighed into the fray with some well placed comments. The Japanese are the experts in intervention and jawboning the currency. That shot across the bows should not be ignored.