When the euro shorts take off
Currency speculators boosted bets against the euro to a record high in the latest week of data (to end December 27) and built up the biggest long dollar position since mid-2010, according to the Commodity Futures Trading Commission. Here — courtesy of Reuters’ graphics whiz Scott Barber, is what happens to the euro when shorts build up:
from Global Investing:
Euro exit-ology
Whether or not it's likely or even a good idea, talk of Greece leaving the euro is no longer taboo in either financial or political circles. What is more, anxiety over the future of the single currency has reached such a pitch since the infection of the giant Italian bond market that there are many investors talking openly of an unraveling of the entire bloc. But against such an amplified "tail risk", it's remarkable how stable world financial markets have been over the past few turbulent weeks -- at least outside the ailing sovereign debt markets in question.
Yet, focussing on the possible consequences for Greece of bankruptcy and euro exit has now become an inevitable part of investment reseach and analysis. In a note to clients on Tuesday entitled "Breaking Up is Hard to Do", Bank of New York Mellon strategist Simon Derrick sketched some of the issues.
One issue he pointed out, and one raised in the September Spiegel online report, was the chance of invoking Article 143 of the Treaty on the Functioning of the European Union, which permits certain countries to "take protective measures" and which could be used to allow restrictions on the movement of capital in order to prevent a flight of capital abroad.
Derrick then went through six potentially dramatic features surrounding a sudden euro exit by Greece and likely collapse -- temporary or otherwise -- of any new "drachma". 1) Extended market closure surrounding the announcement 2) Capital controls and possible travel bans to prevent a run on banks 3) Instant bankruptcy and default for many Greek companies and households with euro-denominated debts and need for a massive support operation for the private sector 4) a need for temporary banknotes and possible "overstamping" of existing notes 5) need for a balanced budget in the absence of EU support or capital market borrowing 6) reintroduction of price controls to cap soaring inflation.
And it's perhaps because this relatively conservative list of consequences is so scary that the wider financial world remains so relatively calm. Despite the elevated risks of euro breakup, very few people really think it will happen as long as it remains a "choice" for the governments in question.
Derrick himself reckons you can't ignore the tail risk, but neither can this be a central scenario.
Is any of this likely to happen? No. As we have noted before, although it is a possibility that Greece could leave the Eurozone, it most certainly isn’t a probability. Indeed, our own guess is that the current crisis will limp to a resolution over the next month with Greece doing just enough to ensure that it gets the next tranche of aid. Next year will then see a move by the northern states to start talking about treaty change (as we have highlighted before). However, as we have learnt all too well over the past four years, considering seemingly remote possibilities is always wise.
from Amplifications:
Why the euro needs to fall
By Kenneth Rogoff The opinions expressed are his own.
Although I appreciate that exchange rates are never easy to explain or understand, I find today’s relatively robust value for the euro somewhat mysterious. Do the gnomes of currency markets seriously believe that the eurozone governments’ latest “comprehensive package” to save the euro will hold up for more than a few months?
The new plan relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding. Even the best part of the plan, the proposed (but not really agreed) 50% haircut for private-sector holders of Greek sovereign debt, is not sufficient to stabilize that country’s profound debt and growth problems.
So how is it that the euro is trading at a 40% premium to the US dollar, even as investors continue to view southern European government debt with great skepticism? I can think of one very good reason why the euro needs to fall, and six not-so-convincing reasons why it should remain stable or appreciate. Let’s begin with why the euro needs to fall.
Absent a clear path to a much tighter fiscal and political union, which can lead only through constitutional change, the current halfway house of the euro system appears increasingly untenable. It seems clear that the European Central Bank will be forced to buy far greater quantities of eurozone sovereign (junk) bonds. That may work in the short term, but if sovereign default risks materialize – as my research with Carmen Reinhart suggests is likely – the ECB will in turn have to be recapitalized. And, if the stronger northern eurozone countries are unwilling to digest this transfer – and political resistance runs high – the ECB may be forced to recapitalize itself through money creation. Either way, the threat of a profound financial crisis is high.
Given this, what arguments support the current value of the euro, or its further rise?
First, investors might be telling themselves that in the worst-case scenario, the northern European countries will effectively push out the weaker countries, creating a super-euro. But, while this scenario has a certain ring of truth, surely any breakup would be highly traumatic, with the euro diving before its rump form recovered.
@REDruin: I always thought (based on my light-weight reading of history) that massive U.S. expenditure on the Vietnam war and the Apollo space program, eventually caught up with the USA, so that the Americans were no longer able to pretend that they could back their dollars with gold. I thought there was a genuine crisis of confidence. Given that America received much of Britain’s gold by profiteering on Britain’s position early in the 2nd World War, at a time when Britain was selling under duress, and when Jews particularly were migrating with everything they had (paying for a new life in the West with their gold, under duress again of course)… I always thought that gold convertibility was a key part of the obligations the United States willingly took on, in return for Western European acquiescence in the rise of the dollar as the undisputed global reserve currency. So it’s odd to read the suggestion that European countries that actually took advantage of the terms of the original contract, were “looting” American gold! It’s interesting however to learn of another perspective.
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From one perspective, American default on the gold standard is a simple case of breach-of-contract, plus Americans living beyond their means and trying to take advantage of their side of the original contract while agitating against other currencies & markets in order to make the dollar look comparatively good (despite its loss of yellowish lustre).
From another perspective, American default on the gold standard was ultimately inevitable, since a small amount of inflation is an essential part of a healthy modern industrial economy operating within a competitive world & wider market.
I suspect the truth is somewhere in-between…
from Jeremy Gaunt:
When things stagnate
Goldman Sachs researchers have been hitting the history books again, trying to divine what happens to currencies when economies stagnate. Answer: Not as much as you might think
Looking at exchange rates for years before and during "stagnation", Goldman found that year-to-year FX volatility in such periods is lower than in normal periods. But a lot of it depends on the type of stagnation.
First, an average stagnation -- a period of sub-par economic growth lasting for at least six years:
On average, the run-up to stagnations (and the early years into an episode) tends to be characterised by moderate FX appreciation. Later on, FX remains flat for a while and gradually assumes a depreciation trend during the last years of stagnation. The average initial appreciation hovers below 5%, while the ultimate depreciation tends to be smaller than 10%.
Next, a "Great Stagnation" -- a period lasting for 10 years or more:
The initial appreciation can reach more than 20% (computed from the years prior to the stagnation) and the posterior depreciation can surpass 10 % .
What does this mean? Well is it not particularly good news for the United States.
from Jeremy Gaunt:
#ThingsStrongerThanTheKenyaShilling
Twitter does have some very strange Trends. These are the things that appear on the right-hand side of the page that show what people are talking about. They more they talk, the more likely it is that something will get listed. More often than not they are about celebrities such as Justin Bieber.
But today's Worldwide Trends was particularly unusual.
#ThingsStrongerThanTheKenyaShilling was right up there near the top.
As the graph here shows, the shilling has taken a heavy beating since the Lehman Brother collapse. This is one reason for the Twitter outburst. "Kenyans are getting fed up," said @oreo_junkie, whose Twitter feed states it is from Nairobi.
And judging by some of the other "answers" to the trendline, it is not a matter for levity in Kenya. "Government's resolve to fight Corruption" was one; "Stupidity of Kenyans to reelect the same MPs" was another.
But other Tweeters are taking advantage of the trend to broaden the answers out. Chances that "Jerry Springer weds Oprah Winfrey" is apparently stronger than the shilling, as is "Arsenal's chances of winning the League, Champions League and the FA Cup".
APEC’s robots stealing the show
A guide at the “Japanese Experience” exhibition talks to Miim, the Karaoke pal robot, on the sidelines of the APEC meetings in Yokohama, Japan on Nov. 10. REUTERS/Yuriko Nakao
Miim is one of the more popular delegates at the APEC meetings in Yokohama Japan. She sings. She dances. She tosses her shoulder length hair. She may not be able to spout an alphabet soup of APEC acronyms like the other Asia-Pacific delegates. But she’s still pretty lively. For a robot.
This week’s meetings of the Asia-Pacific Economic Cooperation forum have been earnest and most comprehensive . Foreign and trade ministers issued a 20-page statement about all the things they talked about — a giant free trade zone, protectionism, the Doha round, easing restrictions on businesses, simplifying customs procedures, promoting green industries, cooperating on health and security, you name it. They also have been, and pardon my French here, excruciatingly dull. So far, the meetings and their stupefying statements have been a testimonial to Japan’s skill at stating the ambiguous. Call it the opaque meetings. Journalists from around the Pacific rim have been desperately trying to find news as the 21 APEC leaders gather for their annual pow-wow this weekend.
The annual “silly shirts” photo shoot, in which leaders don native attire for the class picture of their summit is usually good news fodder, but is going to be a big let-down this year. The leaders are merely being asked to show up wearing “smart casual” for the photo shoot on Saturday night, before they head inside for a Kabuki show.
Which brings us back to Miim, the karaoke robot. She, er it, is one of 130 exhibits on display at “Japan Experience”, a government-sponsored exhibition in the Pacific Yokohama convention center where the APEC meetings are taking place. The exhibit also features “personal mobility vehicles”, a cyborg suit named HAL that enables the wearer to lift really heavy stuff and perform heroically in disaster relief, a talking delivery robot, cute robotic seal pets for use in pediatric therapy, and much other cool stuff .
“Welcome to APEC Japan 2010,” the anatomically correct Miim says. ”This exhibition shows Japan’s strengths and attractions. Please see, feel and touch advanced technology and initiatives of Japan.”
Giant FX market now $4 trillion gorilla
Global foreign exchange has always been one of the biggest markets in the world but its exponential growth keeps accelerating. The triennial survey by the Bank for International Settlements shows global foreign exchange market turnover leapt 20 percent to $4 trillion, compared with $3.3 trillion three years ago.
The increase in turnover was driven by growth in spot transactions, which represent 37 percent of FX market turnover. Turnover was driven by trading activity by “other financial institutions” — a category that includes hedge funds, pension funds and central banks, extending a trend seen in the past several years where buyside firms are increasingly trading currencies themselves, via prime brokerage, rather than turning to interbank dealers.
Also notably, emerging market currencies are gradually increasing their share in the marketplace. Turnover of the Russian rouble has increased its share in total turnover to 0.9 percent of 200 percent (FX is double counted as transaction involves two currencies), up from 0.7 percent three years ago, while the Brazilian real rose to 0.7 percent from 0.4 percent. The Indian rupee’s share rose to 0.9 percent from 0.7 percent. The dollar keeps its dominance, although off its 2001 peak, with its share standing at 84.9 percent.
I quote the BIS report page 7: “Global foreign exchange market turnover was 20% higher in April 2010 than in April 2007, with average daily turnover of $4.0 trillion compared to $3.3 trillion. The increase was driven by the 48% growth in turnover of spot transactions, which represent 37% of foreign exchange market turnover. Spot turnover rose to $1.5 trillion in April 2010 from $1.0 trillion in April 2007.”
No split up for euro zone in near-term at least
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The euro zone sovereign debt crisis has not made a near-term collapse of the bloc any more likely, a survey on hihifrds.com, a website devoted to the Thomson Reuters FX and money markets trading community, suggests.
The survey asked whether all 16 countries currently using the euro would still be doing so by the end of 2012. Fully 88 percent of respondents said they would.
Maybe the 16 euro zone members are tied to the single currency for now but others have more choice. Russian President Dmitry Medvedev and his Brazilian counterpart Luiz Inacio Lula da Silva have agreed to consider how to make more use of their own currencies in bilateral trade, rather than the euro or dollar.
“Neither the dollar nor the euro, nor any other currency, can claim to be a universal currency that protects all states,” Medvedev said.
Political economy and the euro
The reality of ‘political economy’ is something that irritates many economists – the ”purists”, if you like. The political element is impossible to model; it often flies in the face of textbook economics; and democratic decision-making and backroom horse trading can be notoriously difficult to predict and painfully slow. And political economy is all pervasive in 2010 – Barack Obama’s proposals to rein in the banks is rooted in public outrage; reading China’s monetary and currency policies is like Kremlinology; capital curbs being introduced in Brazil and elsewhere aim to prevent market overshoot; and British budgetary policies are becoming the political football ahead of this spring’s UK election. The list is long, the outcomes uncertain, the market risk high.
But nowhere is this more apparent than in well-worn arguments over the validity and future of Europe’s single currency — the new milennium’s posterchild for political economy.
For many, the euro simply should never have happened – it thumbed a nose at the belief that all things good come from free financial markets; it removed monetary safety valves for member countries out of sync with their bigger neighbours and put the cart before the horse with monetary union ahead of fiscal policy integration. But the sheer political determination to finish the European’s single market project, stop beggar-thy-neighbour currency devaluations and face down erratic currency trading meant the currency was born and has thrived for 11 years.
Now the budgetary and bond market upheaval currently afflicting euro member Greece and stalking Portugal, Ireland, Spain and Italy has reawakened the whole debate. “Will the euro survive?” seems a legitimate question once again.
Apart from financial analysts, Paul Krugman seems to have made his peace with the euro’s existence but he still reckons it was a bad idea. Eric Maskin thinks financial markets are right to question the future of the single currency. And much is being made once again of Milton Friedman – high priest of 20th century monetarism – having reportedly said in 1998 that the euro would not survive the zone’s first serious economic downturn.
But having an opinion about the euro is not the same as knowing whether it is going to survive. And this is what most annoys those who have money at stake. Plugging in a new set of variables into complex econometric equations is probably not going to get any of these experts closer what happens next. Hanging around the corridors of power in Brussels, Frankfurt, Berlin or Paris is likely to prove more fruitful.
In the 1990s, many financial strategists in London, Manhattan and elsewhere often confused what they thought should happen with what was likely to happen and got the call wrong on one of the most far-reaching monetary events of the century.
Nice piece Mike.
Looking at the debate raging in the Spanish press, the comical spat with FTAlphaville, and so on, I’m in two minds as to whether the penny is dropping in the biggest domino Spain (or is it the UK?).
In recent times, Spain has demonstrated its capacity to slash its fiscal deficit. But go further back and the country has a long history as a defaulter. Spain’s relatively nasty and federated internal politics is also a barrier to reform.
What is clearer is that the crisis has revealed the fundamental imbalances within the Spanish economy that will ensure Spain is a euro zone loser for some time to come. Seeing Spanish (and other) government ministers kow-towing to the City with begging bowls will also give a whole new meaning to mainland Europe’s obsession with perfidious Anglo-Saxon economics.
from Global Investing:
Pity Poor Pound
Britain's pound has long been the whipping boy of notoriously fickle currency markets, but there are worrying signs that it's not just hedge funds and speculators who have lost faith in sterling. Reuters FX columnist Neal Kimberley neatly illustrated yesterday just how poor sentiment toward sterling in the dealing rooms has become and the graphic below (on the sharp buildup of speculative 'short' positsions seen in U.S. Commodity Futures Trading Commission data) shows how deeply that negative view has become entrenched.
While the pound's inexorable grind down to parity with the euro captures the popular headlines, the Bank of England's index of sterling against a trade-weighted basket of world currencies shows that weakness is pervasive. The index has lost more than a quarter of its value in little over two years -- by far the worst of the G4 (dollar, euro, sterling and yen) currencies over the financial crisis. The dollar's equivalent index has shed only about a third of the pound's losses since mid-2007, while the euro's has jumped about 10% and the yen's approximately 20% over that period.
There's no shortage of negatives -- Britain's deep recession, recent housing bust, near zero interest rates and money printing, soaring government budget deficit (forecast at more than 12% pf GDP next year, it's the highest of the G20) and looming general election in early 2010. In the relative world of currency traders, not all of these are necessarily bad for the pound -- the country is emerging tentatively from recession, the dominant financial services sector is recovering rapidly and short-term interest rates (3-month Libor at least) do offer better returns than the dollar, yen, Swiss franc or Canadian dollar.
But recent data from the IMF on global hard currency reserves shows there may be a more disturbing exit of central bank reserve managers from the pound (no stranger to process of losing reserve currency status, as its pole position was ceded to the dollar after WWI). Sterling's share of the almost $7 trln of world central bank reserves -- which are rising sharply again after a brief hiatus due to the credit crunch -- is being steadily eroded.
Although nominal reserve holdings of sterling (the rise of which prior to the crisis was seen as a powerful supporter of both the currency and gilt market) did rise by more than $10 bln in the second quarter, they remain about $24 billion below the peaks of Q2 2008. What's more, Citi economist Michael Saunders estimates that once you adjust for revaluation effects of currency rate swings, central bank holdings of sterling actually fell in Q2 this year. He reckons that, accounting for these adjustments, Q2 was the second consecutive quarter of net sterling sales by central banks and that the 4 billion pound drop in nominal sterling holdings was the biggest on record. Saunders concludes:
The huge inflows of global FX reserves into sterling and gilts have played a big role in financing the fiscal deficit in recent years. At present, the fiscal deficit is being wholly funded by the BoE, but sterling remains vulnerable and gilts seem highly vulnerable as and when QE ends.
(Graphs by Scott Barber and IMF/Citi)
The question is how many more weeks to go before a serious correction in equities?