A big miss by me this past week. I thought for sure we would see the BoJ at around 81.80. But they were a no show and we closed NY much lower at 81.40. In hindsight I missed a big factor in the equation.
The talk of currency wars has elevated in every capital. The IMF is urging restraint. With that as a backdrop, if the BoJ were to have supported the flagging dollar, it would have meant more global bad press for Japan. So they sucked it up and did nothing.
Japan is getting hit from both sides. The weak dollar scares them to death but China’s dollar peg will kill them. It amazes me to see how the economic fate of nations is being played out in the currency market. It is even more amazing that all of the key players are attempting to rig the game.
There are so many cross currents that I am not sure what comes next. Taken by itself the absence of the BoJ this week says USDJPY has to go lower. If I had to guess what’s in store I would say volatility is going up. The mark to market loss from the 9/15 $25b of intervention is now over $800mm. Of course that is chump change. The number to look at is the whole dollar book of 800b. They are down $66b on that just since August. They gave up 8.4%, or about four years worth of interest in less than three months. I wonder if anyone even notices?
The rest of the action was not of significance to me. It does not surprise me that the Euro traded over 1.40 and Sterling north of 1.60 for a good part of the week. After all, that’s what Uncle Ben wants. It also does not surprise me that they closed below those levels in NY. They both look a bit peaked.
The winner of the week was Aussie. The market conclusion, “The dollar stinks, the Euro is a trap over 1.40 and then Yen is setting up as a colossal short in a few big figures, so I want to own the AUD.” Completely logical in an illogical world.
The EURCHF is hiding in the woods. At 1.3400 it looks like a better short than a long. The problem is the number of the big positions and how they move. When the Euro is strong against the dollar the EURCHF will also have a steady bid. The Swiss don’t really care where the dollar rate is. But looking at the NY close of USDCHF .9590 you have to wonder how many folks from the US are going to St. Moritz this winter.
The China story will drive FX markets for a bit longer. There are only three possible outcomes:
#1- China continues what it has been doing. Fractionally increasing the CNY against the dollar and telling the world to, “drop dead”.
#2 – China signals that it is willing to accelerate the process of CNY revaluation. The new “assumed rate of appreciation” is satisfactory to the US, Japan and the EU.
#3 – China does a one shot revaluation of the CNY by 7%. After doing so it tells the rest of the world, “OK, we did our part, now drop dead“.
#1 means that the “currency war” talk stays in the headline. By itself I see that as a weak dollar environment. Pure economics says that an overvalued CNY puts pressure on the US current A/C. So that is a logical reason to be $ bearish. I don’t think economics has much to do with it in the short run. Market sentiment is more important. To me the China story is just uncertainty that weighs on the dollar. The US is beating on its largest foreign creditor with a very big stick. And they don’t like it. It’s not hard to think of scenarios where this could end badly.
#2 is a possible outcome. It is a middle of the road approach. It would ease the tensions for a while. But they will resurface.
#3 would seem a long shot. It is the opposite of what China Inc. has been saying. Yet it has some appeal. It would shut down the opposition from Japan, US and EU for at least 18 months. The IMF would hail China. For its part China will have locked in a very favourable exchange rate for the next few years. In addition, everyone in China becomes a little “richer” overnight, and that would not be so bad either.
I would see #2 as being dollar neutral to slightly positive. I see #3 as being dollar bullish. I don’t think #3 is the long shot that it is perceived to be. It might be the preferred option given that one result would be China’s ability to say once and for all, “Now drop dead”.
An interesting story during the week that maybe China might be buying up some gold with their bountiful reserves. The story made sense and was good for $20+ on the gold price. China is getting next to no interest on its reserves and the policy makers behind all those reserves are doing their level best to reduce the purchasing power of what China is holding. One can’t blame China for wanting to own something that was not so hostile.
The numbers don’t add up for me however. China is sitting on $2.65T (worth) of financial assets. They can’t buy gold for any reasonable percentage of that big number. The biggest holder of gold is still the USA with 8,000+ tones. That comes to $400b. That is still only 1/8th of the Chinese cash hoard. I make this comparison to show that China can’t diversify any meaningful amount of its reserves into gold. They would overwhelm supply with even a modest effort to diversify. The price action in gold would undermine the dollar and that would not be in China’s interest. But, on the other hand, if your really wanted to say, “Drop dead” this would be a good way to say it.