A weaker dollar - another view

More about the relative value of currencies. The Economist released its Big Max Index past weekend. The index looks at the relative cost of Big Mac in various countries to gauge how over- or undervalued the currencies in those places are.
“The Economist” has developed the Big Mac Index as a way to determine if currencies are overvalued or undervalued. The thought is that a McDonald’s Big Mac being pretty much the same everywhere around the world, one should expect the cost to be the same as well.
Last year the most overvalued currency right was the Norwegian Krona, with the Big Mac +121% more expensive in Oslo than in the US. Hong Kong and Malaysia have the most undervalued currencies, a Big Mac costing 52% less there than in the US.
Now look to this:



The numbers marked in red are the areas I would like to highlight. They are representative of massive currency overvaluation in Europe (+72% in Norway, +55% in Denmark, +29% in the Eurozone) and absurd levels of undervaluation in Asia (-49% in China, –52% in Hong Kong, –47% in Malaysia and –42% in the Philippines).

So what does this mean for the U.S. Dollar going forward? The U.S. currency depreciation against major free-floating developed economy currencies is over. The Euro is 50% overvalued, Sterling is 28%. There is not a lot of upside to that trade from here. On the other hand, the Asian and Middle East currency pegs are at some risk of busting wide open. The Asians and Middle East have held their currencies way too low for way too long. Inflation is rife in these countries as a result. It is only a matter of time before new pegs are found or a currency basket is used to replace the dollar peg. For China, the timing will be critical as their currency is significantly undervalued and protectionist sentiment in the U.S. is sure to mount as the slowdown takes hold.
On the whole, the U.S. Dollar should continue to be weak. But, weakness should come at the expense of Asia and the Middle East more than Europe.

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A weaker dollar?

If we look to the States it’s amazing to see how the shape of the financial landscape has changed since August 2007. Rates plunged from 5.25% to zero, the fiscal deficit went up from 2% to 13%, mortgage rates went down to 4.50% from 6.5%, the FED balance expanded from 850 billion USD to 2 trillion USD and we can go on.
David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, points out that there is one policy tool that is practically unchanged since two years ago … the US dollar. “It is the only policy tool that has not budged one iota since the crisis erupted two years ago. But we are sure that as the unemployment rate makes new highs and increasingly poses a political hurdle in a mid-term election year, it would make perfect sense for a country that always operates in its best interest - even if it may not be in everyone’s best interest - to sanction a US dollar devaluation as a means to stimulate the domestic economy,” he said.
Why is there no devaluation?
It ‘s called deflation. The D-word is a bad thing for owners of debts. They have to run for the hills and in doing so they’re looking for dollars to pay off everything which is dollar denominated. Another support is coming from the fact that different entities are still forced to show appetite for dollar assets. If they let the buck slip, the value of their dollar assets will be hurt.

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South Africa

No renko charts today. The reason? I don’t trust this rally. Too classic. In an expiration week and then on Tuesday and Wednesday. An evil set-up.
We're not going there.
So we show something else.
The correlation between a currency and its stock index.
South-Africa to be precise.
First a weekly chart of the iShares South Africa and the ZAR:

And this is a daily picture of this situation.

What is the trend of the ZAR? Renko style :-)

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After slamming the brakes...

Stock markets are not longer a proxy for the ‘real’ economy neither is the price action in some other asset classes.
However, we are convinced that the ‘green shoots’ of last months are nothing more than the logical reaction of the economy after we hit the brakes last September with the Lehman and AIG-drama.
Economic activity came abruptly to a halt. The following months, inventories were depleted and the economic activity we experience now is nothing more than an effort to replenish these inventories.
There is economic activity but on a low level.
The global economy is recovering very slowly and it’s not coming to an end soon.
So the recession is here to stay, people will spend less and no way there is inflation in the pipeline.
That means that after the shake-out of dollar and bonds, they will come back in vogue and that is not good news for other markets.
Although we thing that after this correction in stocks another sharp rally can follow.

And there is Europe: 15% of the British economy is linked to the financial industry (in the States only 5%). This oversized sector is still in a downturn and this can hurt the pound. Spain, Portugal, Ireland and Italy can not cut rates in order to deal with the local economic weakness. As a result they must take on more debt, increasing the probability of more rating downgrades. The risk they will leave the EU and go back to their own currencies is growing. Fast.

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Russia and Moskou on the Thames

Vlad Putin is doing it again: a new gambling law banishes Russian casinos. That means 1 bln USD less in tax revenues and the loss of 500.000 jobs. If you want to go for some gambling fun, you take a train to Kaliningrad, the Altai region, Primoriye or the Sea of Azov.
Or you start investing in Russian shares.

The ECB let rates unchanged and the non-farm payrolls were worse than expected in the US.

This one comes from Niall Furguson, author of ‘The Ascent of Money/ A financial History of the World’ commenting on the Sterling and the negative outlook for the AAA status:

"We’re not Iceland or Ireland, but we’re closer to them than we are to the U.S.,”

To compare Ireland with Iceland – although one letter difference – is not funny at all. Anyway: if the pound pops it will be fast and furious as the 5 year sovereign CDS jumped to 81 and the numbers are becoming worse every month

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The Latvian pressure cooker

The Latvian pressure cooker is still on the stove.
We know the story: Latvia, the former Eastern European tiger, pegged his currency to the euro in order to speed up growth a little. Than the financial crisis came and Latvia found itself badly caught out. Credit was needed but the attempt to issue 100 million LAT-denominated bonds resulted in no takers. In normal times and countires you devalue the currency. But that will cause trouble in Europe. For starters: Swedish banks lent heavily to Latvia and once the devaluation cascade starts, these banks will be forced to take big losses. Than there is the fact that nobody knows what will happen to neighbor countries and farther south once the currency peg will be broken up.
The Swedish Central Bank borrowed this morning 3 bln EUR from the ECB. The Riksbanken has already a swap agreement in place with the ECB of 10 bln EUR. Now why do they do this?

Now, let’s have a closer look to European banks. Total lending to emerging markets is now some 4.7 trln USD. 74% of that came from European banks. The Netherlands and Austria are the countries lending more than 50% of their GDP to these emerging countries.

We read this morning

IMF director Dominique Strauss-Khan said that Mexico, Colombia and Poland face challenging financing deficits that if not corrected soon, could put them at risk of defaulting. The external financing needs of Mexico and Colombia have been met for 2009. In this regard, the comments of Strauss- Khan seem strange and could add noise to the markets. . . .
The comments of IMF’s Strauss- Khan are particularly inopportune but should not be taken seriously. The IMF hasn’t published a formal press release confirming the fund’s view. Mexico is still investment grade and it is very unlikely that any of the three major rating agencies decide to lower it to junk.
Mauro Leos from Moodys said a couple of weeks ago that “it was far fetched to believe that Mexico would lose its invest grade category any time soon”. The view of the rating agencies has been that Mexico needs to pass structural reforms to avoid a downgrade. Shelly Shetty from Fitch commented recently that Mexico would need a plan “B” in case Congress fails to approve a fiscal reform after the July elections in order avoid a downgrade. This amounts to sort of running in order to stand still.
But the prospects for comprehensive fiscal reform are very slim. In fact, the two major political parties: the centre left PAN and centre-left PRI have both said that they are not at all interested in passing a fiscal reform package. While no party is expected to publicly say that it favors increasing taxes particularly before the congressional elections of July, the political climate does not support the passing of any reform.
Mexico will be downgraded by one notch on the back of deteriorating fiscal revenues as the economy contracts to between -5.5% and -7.5% this year. Still the comments of Strauss- Khan add noise to the market. . . .

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Eastern Europe is not out of the woods, yet...

Yesterday our friends at Danske Bank issued a warning:

The event risk has risen sharply in the Baltic markets and we advise outmost caution. Yesterday, the Swedish central bank Riksbanken said it will increase its currency reserve by SEK 100 bn through a loan from the Swedish debt agency. Investors seem to believe that this is a buffer to deal with potential problems arising from the Baltic crisis.

Strange, we thought things were getting better in the Baltic.
Share prices of Swedish banks dived, however, yesterday and some are speaking of a devaluation of the Swedish Krone.
Whatever is gonna happen, the debt situation for the Baltic countries remains horrible.

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Forget about gold...

Is China buying copper like crazy?
From the UK Telegraph last week:

China's State Reserves Bureau (SRB) has instead been buying copper and other industrial metals over recent months on a scale that appears to go beyond the usual rebuilding of stocks for commercial reasons.
Nobu Su, head of Taiwan's TMT group, which ships commodities to China, said Beijing is trying to extricate itself from dollar dependency as fast as it can.
“China has woken up. The West is a black hole with all this money being printed. The Chinese are buying raw materials because it is a much better way to use their $1.9 trillion of reserves. They get ten times the impact, and can cover their infrastructure for 50 years."

Everybody thought China would switch to gold. Instead they seem to buy industrial metals. Another thing is happening.
This message comes from Bloomberg:

China’s leaders... are making it easier for trading partners and consumers to do business in yuan.
The People’s Bank of China has agreed to provide 650 billion yuan ($95 billion) to Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea through so-called currency swaps. More such arrangements are being planned so importers can avoid paying for Chinese goods with dollars, the central bank said. In Hong Kong, which has pegged the currency to its U.S. counterpart since 1983, stores from Park’n Shop supermarkets to jewelers accept yuan.

Why is that?
We all know that the Chinese want to get rid with at least a part of their dollars and they are looking for ways to diversify their currency reserves. In exchanging swap lines they try to liquefy the yuan. Until now it’s almost impossible to buy and to sell yuan in the same way you buy or sell euros.

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Observations

The Bank of England announces swap arrangement to provide liquidity to US Federal Reserve. That was announced yesterday. Strange move, as everybody thought that the almighty FED was saving the world. Apparently they need every penny they can find.
The official explanation: the FED lends these currencies to US-based banks to meet foreign currency needs.
Is this news causing the dollar short squeeze, this morning in Europe?
Another funny thing: the trailing multiple on reported S&P500 earnings is now 100x times. I remember that even on the top of the tech-boom the NASDAQ multiple was only the half. The implosion of profits is causing much more havoc than everybody want to know.
But the bulls are out. The AAII survey shows that the share of bullish investors expanded from 18.9% to 42.7%. We were here before. Right: in January. When the other bull market faded away.
De US Securities Exchange Commission is considering four proposals to restrict short selling. The restoration of the uptick rule is one of them. Others are the ‘bid test’ and a ‘circuit breaker’.
And then there is Larry Summers. The man attires a lot of attention these days, especially his paychecks.
We always liked the guys at www.contraryinvestor.com. They show you charts which tell you more than 1000 words.
Look to this:

Jesse writes:
The Obama Administration is scrambling to obtain relief from Europe and Asia, getting them to inflate their own currencies through 'stimulus,' in order to continue to hide the unalterable truth - the US must partially default on its debt as expressed in the dollar.

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But the times, they are a-changing

China is harping on a new theme: the status of the dollar as a reserve currency. China is calling for a new currency to replace the dollar as the world’s standard. Last Monday it was the central bank governor, Zhou Xiaochun, who made some proposal on a time everybody is preparing for the Group 20 gathering next week in London.
We read in the Financial Times:

China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.
The goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies,” Zhou Xiaochuan, governor of the People’s Bank of China, said in an essay posted in Chinese and English on the central bank’s website

Without any doubt we can connect this with something else.
From Reuters:

"A U.N. panel will next week recommend that the world ditch the dollar as its reserve currency in favor of a shared basket of currencies, a member of the panel said on Wednesday, adding to pressure on the dollar. Currency specialist Avinash Persaud, a member of the panel of experts, told a Reuters Funds Summit in Luxembourg that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket. Persaud, chairman of consultants Intelligence Capital and a former currency chief at JPMorgan, said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform."

Don’t get fooled: China is slowly but surely shifting away from the dollar. In 2003 China had 83% of his foreign exchange reserves invested in US assets. This is reduced to 63%. While its net purchase of short-term Treasuries has jumped, the net purchase of all US assets has come down rather dramatically.

Something is changing. And it changes fast.

The Chinese Xinhua/china ETF is a little oversold on a daily basis.

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The buck stops here

March 13 (Bloomberg) -- China wants the U.S. government to “ensure the safety” of its investments in the world’s largest economy, Premier Wen Jiabao said.

“We have lent a huge amount of money to the United States,” Wen said today at a press conference in Beijing that marked the closure of the annual National People’s Congress meeting. “Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried.”

Well Wen, we’re worried too.

And not a little bit.

So you’re not alone.
Did you see the dollar, Wen?
The daily chart of the dollar index going back shows a notable development.
Not only failed this index to sustain a move above the old top of November 8, but also the 21-day average was broken.
Are we in for a correction?

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The amazing dollar

There is a kind of a conundrum, a paradox in the markets where people are looking for an answer but not finding one.
The dollar.
Why is the dollar strengthening where the mighty currency normally should dive.
Nobody can solve this one, it seems.
A safe haven?
Less vulnerable than his peers?
Well, a currency market – as most other markets – moves with offer and demand.
Not with someone’s best guesses.
This observation comes from Mike O'Rourke of BTIG

The first and most obvious consideration is that the Treasury needs to sell $2 Trillion of Government Securities this year. With low current yields, the currency strength is a key attraction to buyers. Permitting the Dollar to strengthen aids Europe in taking on its economic challenges, which are deemed by many to be more severe than those here in the U.S.


This is one explanation.
A good thing that Mike mentions Europe.
Europe needs dollars. Tons of dollars. To finance their dollar books.
Another thing is that maybe it is not the dollar strengthening but other currencies weakening.

Data released by the Washington-based Commodity Futures Trading Commission on Friday showed that the "net short position" of trades against the euro by hedge funds and speculators almost doubled in the week to March 3 to 19,431 contracts from 10,081 contracts a week earlier.

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Europe falls

A not so secret 17 page paper was discussed by the finance ministers of the EU on Tuesday.
A bail-out of toxic assets held by European Banks could lead to plunge the European Union into a crisis.
There is talk that European banks may be sitting on £16.3 trillion of toxic assets and could suffer massive losses.
There is a business decision to be made as well as a policy decision.
National leaders and EU officials share fears that a second bank bail-out in Europe will raise government borrowing at a time when investors - particularly those who lend money to European governments - have growing doubts over the ability of countries such as Spain, Greece, Portugal, Ireland, Italy and Britain to pay it back.
In line with the risk, and the weak performance of some EU economies compared to others, investors are demanding increasingly higher interest to lend to countries such as Italy instead of Germany. Ministers and officials fear that the process could lead to vicious spiral that threatens to tear both the euro and the EU apart.
Look to Belgium.
After the Fortis debacle yesterday, the spread with Bunds on Belgian govvies widened to almost 100 bp.

The result: a weakening euro.
Watch this space: a full fledge currency crisis will be the result if governments don’t act quickly in unisono.

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Yen

The economic destruction in Japan is quite amazing in terms of size and velocity.

Industrial production fell almost 10 per cent in December compared with November. That’s a big number but it gets worse. The government re-did its forecasts for January to a 9 per cent drop, and February down another 5 per cent. In all, that knocks almost a third off output since September, putting it back, as Macquarie notes, at 1983 levels.

For car makers it is even worse: production may halve from last year.
Some elements play an important role in these figures. Most prominent influence – for us – is the rising yen. As Japan subcontracts a lot of their production abroad, a strong yen is a negative factor.
How come that yen is so strong?
Simply put: the massive unwinding of the carry trade last year caused the yen to strengthen.
And all desperate measures the BoJ has taken (as there are buy backs of corporate bonds or bonds issued by real-estate investment firms) have not helped until now. Next step is the purchase of shares owned by financial institutions so they can boost liquidity to the tune of 11 bln USD.

It’s clear that the local authorities will do everything they can, to bring down their currency. The Japanese are notorious to handle their currency that way and with rates at 0% there is no resistance to balance their exchange rate towards 100. Welcome to the race to the bottom.

The renko chart of the USD/JPY is pointing in that direction.

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They have Obama, we had Bertie - our Bertie

Oh my.
My pub is less crowded these days. Fishermen and out-of-job bankers alike.
The latter however have a worrisome burden: they bought all those beautiful houses in the surroundings of Dublin. The classic housing trap sprang up and now everybody is in trouble as payments have to be made while the price of the underlying asset is deteriorating.
We see the colleagues of the New European Union members leaving the Emerald Isle in droves.
This is war, said Dave (McWilliams, a former official at the Irish central bank). Of course, but the enemy is not visible. Except in the middle- and back offices of banks. So where to fight?

Now, Dave is a good lad. Especially when he raises his voice after a nice dinner. He gets even better with a pint in his hands.
Speculation is rampant that Ireland will default on his debt obligations – just like Iceland – and then everybody starts to talk about Austria, Spain, Greece and Italy.

Most important observation: the dollar is getting stronger but also gold has a nice run, today.

Adieu, mon Celtic Tiger.

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Sinking

The next shoe is dropping. This time currencies are involved. So much money is needed to save local financial systems, that printing presses are working non-stop. A paper currency society has no limits in issuing money. There are no constraints. The only question is how much damage will occur when the inevitable inflation arrives. But first comes a currency crisis.
Ask Iceland.
And now Great Britain.
The British economy is bigger than tiny Iceland, of course.
But the road taken is the same. Sterling dropped today to a record low of 127.44 versus the yen and to 1.4130 versus the dollar. And the slide is far from over.
More is coming: a downgrade of the UK-debt in the near future can not be excluded.

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Waiting

In Frankfurt the talking heads of the ECB are debating a euro rate cut. What will it be? 75bp?
Lately we saw that currencies are reacting more actively on these decisions as they did in the past. That’s called competitive devaluations in the race to the bottom. So it will be interesting to observe the reaction of the euro. Versus the dollar, sure. But even better: versus the GBP.
How is Europe going to cope with the fast growing divergence between the large countries and the PIGS (Portugal, Italy, Greece and Spain)? And Ireland, too. Questions. No answers.

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What to short? Treasuries or dollars?

Has the US Treasury bubble already popped?

If so, than it went quick and swift. We observed a huge rally in December of the US Treasury complex. All maturities rallied till mid-december, than traded in a quiet range til year’s end but went in a freefall as soon as the New Year set in.
How come? The most logical explanation seems to be a mix of end-of-year accounting factors and a supply-limited window for foreign investors. And now?
Maybe these bonds tumble further, but the situation is not clear enough to build on. Especially because everyone ‘knows’ that treasuries are overvalued. So a lot of plays on the short side (price wise) were set-up.

I don’t like crowded trades. Barron’s added to this feeling by putting up on his cover ‘Get Out Now’.

If everybody is yelling to get out, than we know that the probability the opposite will happen, wins in force.
That’s one thing.

Another important factor is the FED. It’s clear that the FED doesn’t want higher interest rates. And that it will use all means to prevent rates to go up. Hey, the US faces deflation and all economic data are pointing that way. So the FED will intervene. And that brings us to something else: the dollar.
If the FED buys Treasuries in order to keep rates low they will do so at the expense of the greenback. You have to print dollars if you want to buy UST’s in the market. A weak dollar is supportive for exports. And foreign investor inflows are disappearing. Another support for the dollar is fading.
One can develop different scenarios – the economy bounces, the economy gets worse or the economy gets much worse – but never emerges the dollar as a clear favorite.

Maybe it’s not UST that one has to short, but the dollar instead.

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